Apollo
Investment Corporation (AINV),reported earnings per share of $0.36, excluding certain items, on Monday, June
1. Consensus estimates were $0.35.
Apollo is
a business development company under the Investment Company Act of 1940. The
company’s investment portfolio is principally in middle-market private
companies with senior secured and mezzanine loans.
As a
lender in a deep recession economy, let’s start with the premise that Apollo is
risky. The credit quality of the portfolio is approximately 24 percent second lien, with the rest of the investments either subordinated debt
or equity. Since most of its equity assets are level III, it's difficult to get
a handle on just how much any particular company in the portfolio is worth. All of that equity and subordinate debt means
in a bankruptcy of companies in their portfolio, Apollo would not be first in
line to be paid.
Business Development Companies (BDCs) like Apollo are not allowed to leverage
up more than 1:1. Due to some
deleveraging, a smaller balance sheet, and a very small decline in net asset
value (NAV) this quarter (.05%), Apollo’s leverage ratio has fallen from 83
percent to 76 percent during the quarter. This might be viewed as a good thing,
as it makes them less likely to violate any debt covenants. However, the
quarter before their NAV was down about 24 percent. This means that the rate of change in the
decline in their assets has really leveled off in parallel with the general
economy.
Long term, the real issue for Apollo is the $2 billion line of credit they
have, and whether it gets renewed in 2011 at terms anywhere near what was available
in 2006. That is a significant risk. Growth is highly unlikely so they will not
increase leverage and violate covenants.
On the other hand, if the portfolio values can stabilize or increase with a
marginal improvement in the overall economy in 2010, Apollo could engage in accretive
secondaries and raising of
equity. In this scenario, Apollo’s stock
price would likely rise.
At this point, BDC's with high leverage are risky. But Apollo is one of the
best on the block in this space. Apollo’s non-accruals have gone up a bit from
1.2 percent to 6.6 percent. But this level of non-accruals appears to be very
low compared to other BDCs, though it is difficult to determine with certainty
from published financial reports.
There could be some value in Apollo that may be unrealized at the current share
price. Assets in the portfolio are
listed at about 75 percent of cost in the aggregate. At the end of the day, investors would be
paid a seemingly manageable 17 percent annual dividend to wait for a potential
recovery of Apollo’s assets.
Based
on what we know, the balance of rewards and risks for Apollo Investment
Corporation appears to favor a higher share price over the next 12 months.
Disclosure: The author does not own shares
in this company but has traded it in the past.
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