Apollo Makes A Bad Call

I have never used this space to write about the protracted battle between Huntsman Corp. and Hexion Specialty Chemicals. And it would seem that the opportunity has passed me by, given that both sides recently agreed to a termination of their $6.5 billion merger agreement, and to a $1 billion settlement of Huntsman’s litigation against Hexion owner Apollo Management.

But I beg of your indulgence, because I’ve been left with a nagging question since the settlement was announced on Sunday night: Namely, who exactly is paying the various pieces of that $1 billion? To be sure, it isn’t all coming out of Leon Black’s pocket. Perhaps more importantly, some of the pockets involved seem to be getting picked.

What follows is based on interviews with limited partners in some, or all, of Apollo’s past four funds. In addition, peHUB has obtained confidential correspondence that Apollo sent its investors on December 15. Apollo itself declined to comment.

To begin, it’s important to understand the origins of Hexion and it was planning to pay for its acquisition of Huntsman.

Hexion was officially formed in 2005 as a roll-up of three different chemical companies: Borden Chemical, Resolution Performance Products and Resolution Specialty Materials. Apollo held Hexion as a portfolio company of both its fourth and fifth funds, because the Resolution investments were originally made out of Fund IV, while Borden was made out of Fund V. Apollo had also ensured that the investments were profitable for limited partners of both funds, via dividends.

By the time Hexion agreed to acquire Huntsman, however, Apollo was in the midst of investing its sixth fund and was talking about raising a seventh. Its solution was to fund the equity portion with the newer money. Funds IV would get cashed out (I’m not certain about Fund V), which was welcome news given that the vehicle was raised back in 1998.

Fast forward to last Sunday, when the deal officially died. In its official statement, Huntsman said that the agreement included an aggregate of $1 billion in considerations. This included:

  • Huntsman would receive a $325 million breakup fee, to be paid by banks Credit Suisse and Deutche Bank.
  • Huntsman would receive $425 million in cash payments from “certain Apollo affiliates.”
  • Apollo affiliates would buy $250 million for 10-year convertible notes, which could be converted into Huntsman common stock or repaid in cash at maturity.

My assumption was that Apollo would pay most of the settlement out of its newer funds (and perhaps via its publicly-traded AAA affiliate), since they were the ones that stood to profit had the merger gone through and proven financially successful. Moreover, they were the ones financing it in the first place. At worst, it would share the pain pro rata with Funds IV and V.

What Apollo actually did, however, is troubling. Here is what it told LPs, as part of its Dec. 15 letter:

“Under the settlement, Apollo Funds IV and V will pay Huntsman $225 million. An affiliate of the General Partner will pay $200 million to settle all claims, and we are hopeful that a portion of these payments will be covered by existing insurance policies. Apollo entities will also be sharing certain proceeds when and if received by Huntsman as a result of the Texas litigation against the banks were it to settle. This is a potential offset to the settlement payments.

In addition, Apollo Fund VI and its co-investment affiliate AAA have agreed to purchase $250 million of senior convertible notes of Huntsman, with a 7% interest rate and a conversion price of $7.86. Based on updated macro-economic assumptions, this investment is underwritten to a mid 20’s internal rate of return.”

To be specific, Fund IV is being asked to pay $70 million, while Fund V is being asked to pay $155 million. In other words, the only Apollo funds paying actual penalties – monies that cannot be recovered by future performance of Huntsman common stock – are the only two funds that could never have profited from the Huntsman-Hexion merger, had it gone through. Fund VI and AAA, on the other hand, don’t pay a dime in unrecoverable monies.

But wait, it gets worse. Not yet reported is that Apollo also decided that Funds V, VI and AAA would invest an additional $200 million into Hexion “for general business purposes… This investment will be senior to the common equity.” In other words, not only does Fund IV pay out instead of cashing out, but now it’s getting crammed down on its remaining Hexion stake. 

Imagine being an LP in Fund IV but not in Fund VI (and there are some). If it were me, I’d be on the phone with my lawyer before sending out a check by next Tuesday’s due date.

Apollo obviously won’t explain itself to me, but one theory is that Fund IV is no longer allowed to make new investments, due to its advanced age. In fact, the Fund IV capital call letter refers to the payment as an “operating expense.” Again: If you’re an LP in all three funds, this doesn’t matter a bit. But if you’re only in Fund IV, only in Fund V or only in both of them, you’re getting taken advantage of.

Whole thing reminds me of a political campaign I was once a part of. Everyone worked the field on election day, and we were told during orientation to knock on our voters’ doors at least five times throughout the day. Someone pointed out that such persistence might actually annoy our voters, particularly if they’d already gone to the polls. Our field director replied: “If they’ve already voted for us, then we can’t lose their vote. It no longer matters if we annoy them.”

Apollo apparently believes that its Fund IV and Fund V LPs have already voted. It no longer matters if they get annoyed.