Best Idea Update : Apollo Investment
February 2, 2022
Back on November 8, 2021, we named Apollo Investment (AINV) as a Best Idea, with a potential 87% return over 5 years and a $17.83 Target Price. At the time, AINV was trading for $13.12 a share. We admitted this was a "contrarian" call as most observers expected a cut in the BDC's $0.36 quarterly distribution ($0.31 regular and $0.05 supplemental) that has been paid since IIIQ 2020. Our prediction was that there was a good chance AINV would find a way to maintain an unchanged quarterly $0.36 payout/$1.44 a year.
Also, AINV trades at a low price multiple to its dividend - never reaching over 10.6x in the past 52 weeks. We - on the other hand - believe the multiple will eventually rise to match more of its peers at 12.0x.
The key moment we were looking forward to last November was AINV's IVQ 2021 earnings release, which is the last period in which management had committed to maintain the $0.36 per share distribution level. For 2022 - on its conference call - announced a new dividend approach. However, this left investors still up in the air as to the likely payout going forward. Here's how management explained its new dividend policy:
One of our objectives is to provide greater visibility for our shareholders with respect to the distribution. So for the next 2 quarters, we intend to declare a base dividend of $0.31 per share plus a supplemental dividend in an amount such that the base and supplemental combined will equal the prior quarter's net investment income per share. This means that next quarter, we expect to declare a base dividend of $0.31 plus a supplemental dividend of $0.04 or $0.35 in total, which is equivalent to the NII per share for the December quarter.
In a way the future dividend is now clear - but only for a quarter at a time, which is a low bar for the supposed "greater visibility" involved. In fact, distributions under this policy will vary from quarter to quarter and suggest that AINV does not have any great confidence in the level of its ultimate 2022 earnings. In the very same breath as announcing the new dividend policy, AINV added the following:
We expect to have greater clarity in the coming quarters regarding the timing of the embedded upside in our portfolio and the impact of interest rates on our earnings.
There were some favorable developments in the IVQ 2021 that continue to provide hope that AINV can dispose of more of its underperforming "non-core" investments in the quarters ahead, while improving its earnings outlook.
During the December quarter, we received repayments of approximately $10 million from 3 of our noncore positions, 2 of which were nonearning, which included $4 million from 1 position without any reduction in NAV and $2 million from 1 investment which was $2 million above fair value...Post quarter end, Dynamic Product Tankers, one of our shipping investments, closed on the sale of 3 ships, which will be generating an additional $18 million in cash proceeds at our December 31st NAV in the March quarter.
The Dynamic Product Tankers news is the most interesting as AINV has $72mn in debt and equity at cost invested in the business. What we can't tell is whether the eventual disposition of all 4 tankers in the fleet will result in higher or lower income than being generated currently, but will at least closed that long unresolved chapter.
With the Dynamic Product Tankers sale and the other dispositions, "noncore assets represent only 6% of AINV's total investment portfolio" and second lien assets only 5%. AINV is making undeniable progress in re-positioning itself into a diversified, middle market, first lien debt-focused BDC - a format that most of the successful large-cap players have adopted. Also undeniable is that the progress made has been insufferably slow and continues - to hang like a pall over the BDC and its stock price.
Nonetheless, we continue to be bullish that the BDC will maintain a $0.36 dividend running rate and are not bothered by a ($0.01) deviation in the IQ 2022. EPS should be nudged up by the existing and likely non-core asset sales; the slight room for growth in AUM (although we recognize that AINV is more leveraged than virtually any other BDC of its size). Less likely - but plausible - might be an increased income contribution from the Merx Aviation investment - far and away the largest single portfolio company. Of course, if short-term interest rates do move sharply up, by 2023 AINV should also benefit from higher interest income and the fact that 30% of its debt investments are at a fixed cost.
We were disappointed that the Apollo Global (APO) manager did not do the "right thing" and waive a portion of its fees (which amounted to $14.6mn in the IVQ - equal to 65% of what shareholders earned in Net Investment Income). After many quarters of not receiving an incentive fee due to the total return calculation in AINV's compensation agreement - the manager seems anxious to squeeze out every penny for itself. This is despite the fact that AINV shareholders have seen their NAV Per Share drop (18%) since IVQ 2017 and their quarterly payout by (22%).
Better than a waiver would be a permanent reduction in the management fee to 1.0% of assets as Goldman Sachs and Investcorp have done for their BDCs. We calculate that such a cut would have added $0.02 a share to the quarter's earnings and allowed AINV to exceed the $0.36 dividend bogey in the IVQ 2021 results. There's no indication, though, that the BDC's Board or its many analysts and investors are beating the drum for a compensation overhaul - yet another reminder of the sorry state of BDC corporate governance.
In any case, this debate about a few cents here or there in EPS might be beside the point. More important is that AINV shed its reputation for investing in higher risk areas (shipping, oil and gas, alternative energy, second lien loans, etc) and for serial dividend reductions and get compared favorably by the market with other BDCs seen as a "safe", such as Golub Capital (GBDC). (That BDC has traded as high as 13.6x its current dividend level in the last year). Thankfully this quarter's credit quality seems good, with no new loans on non-accrual and non-performing assets (after many losses along the way) accounting for only 0.5% of the value of the entire $2.6bn portfolio.