Editor’s Letter: Leon Black dissects the market

Leon Black, chairman and chief executive officer of Apollo Global Management, joined us in March for Buyouts Insider’s PartnerConnect East conference in Boston. He talked about the growth of the firm and gave his view on the markets and how Apollo is navigating high prices and uncertainty.

About the current market, Black said: “It was easy getting here (to Boston). Getting back to New York might be more challenging, but not as challenging as traversing the environment today.”

Black said the market is past due for a correction, but the economy looks strong, especially after tax reform.

“Most signs are of continued stability from the point of view of the overall economy,” he said. “I think that yes, rates will continue to go up, but as long as inflation doesn’t go haywire, and there doesn’t seem to be any signs that it is, I think rates will go up gradually.

“My own feeling is that we’ll continue to live in a relatively high-priced, low-interest-rate environment for the foreseeable future,” Black said.

Apollo continues to focus on paying lower purchase-price multiples than other firms in this market, Black said. Apollo’s Fund VIII, which closed on more than $18 billion at the end of 2013, invested at a 5.7x multiple over the past three or four years in an around 10.5x multiple environment, he said.

To do that, the firm focuses on three strategies: distressed-for-control, complex situations like corporate carveouts, and idiosyncratic buyouts where the firm develops an edge. An example of the latter was the 2016 buyout of ADT. The key to that deal, Black said, was that Apollo already owned two smaller security companies.

Sticking to its identity as a value-oriented investor, Apollo has generated a 39 percent gross and 26 percent net return overall, Black said.

Stock price: Black said the market “grossly undervalues” Apollo’s stock price.

Publicly traded private equity firms have two sources of income: management fees and carried interest. “The market arbitrages those two in a really crazy manner,” he said.

Management fees are more predictable, and it’s important for a firm like Apollo to continue growing that income stream, he said.

Target prices for publicly traded private equity firms are calculated by stripping out the value of investments and cash on hand, and applying a comparable multiple to what’s left, meaning the management fees (ignoring performance fees), according to an article in Fortune.

The multiple the market puts on management fees is 15x to 20x, Black said. Performance fees — which Black said Apollo has consistently generated over its 28-year life with its 39 percent gross/26 percent net return track record — get an around 3x multiple, he said.

“One is more stable than the other in terms of predicting it, but that’s a pretty crazy spread,” he said. “It should be 16x vs 8x or 10x but not 16 vs 3. But it is what it is; you can’t fight the market. You can educate them, keep performing over time.”

One problem in valuing private equity public stock is that firms go through seeding and harvesting periods with their investments. “During harvest time they’ll give you a higher multiple,” he said.

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky