Apollo Investment Corporation (NASDAQ:AINV) is one of the larger players in the BDC space, with a market cap of about $2 billion and a 10-year history. The company's portfolio is externally managed by an affiliate of Apollo Global Management, which is to say it's part of the Apollo Global private equity family. That firm, co-founded by Leon Black and two partners, has been around for 20 years and is one of the big players in the leveraged buyout world.
Apollo went public in 2004 and today sports a fairly diversified portfolio of middle-market debt products and equities, targeting companies with $50 million to $2 billion in revenue. The company also invests in structured products and foreign securities.
Over the course of its 20 year history, Apollo has invested some $13.1 billion in 291 companies. Quite a long track record for a BDC, although it's one that isn't without its blemishes.
The Innkeepers fiasco
The financial crisis was not kind to Apollo , a story best illustrated by its poorly timed purchase in Innkeepers USA Trust, a publicly traded REIT that the company purchased and took private through an affiliate.
Apollo bought Innkeepers in 2007 for a total value of $1.5 billion including debt. You might recall that real estate was rather hot at the time, and the commercial space was no exception.
The purchase was part of a larger trend of public REITs being taken private in the clamor for position in commercial real estate, as the Wall Street Journal put it when describing the deal.
There were already signs of trouble in 2009, and Innkeepers filed for bankruptcy the following year. Falling valuations, reduced revenue, and a considerable debt burden related to the Apollo purchase were behind the bankruptcy, and unfortunately for Apollo, Innkeepers represented a major portion of the company's portfolio.
After a long back-and-forth which included both a deal and a lawsuit, most of Innkeepers assets were sold to Cerberus Capital Management, a private equity fund, and Chatham Lodging Trust, a REIT, toward the end of 2011. The two companies bought the bulk of Innkeepers' portfolio of hotels for $1.02 billion.
Diversifying and reducing risk
The affair obviously had a major impact on the firm's earnings.
By that time, shares of Apollo had lost about a third of their value, and the company decided to adjust its strategy, probably to keep things going. A move into larger cap credits didn't work, so Apollo decided to diversify, even establishing an energy team in Houston.
In the aftermath and some adjustment pains, Apollo has developed a focus in three key areas, namely aviation, oil and gas, and structured products.
In the past year the company has sold $1 billion of assets to improve the risk profile of the portfolio, and to reduce leverage and improve interest rate coverage.
The Innkeepers story and its aftermath offers an interesting perspective on the myriad risks involved with BDCs.
The first is of course that BDCs are rather credit dependent: When the going is good, financing and deals can come easily, but as soon as credit dries up and investors get nervous, things can go south very quickly. Apollo was no exception: It fairly hobbled through the financial crisis because its portfolio and management weren't prepared to withstand a change in fortune.
It also brings to mind some of the risks of diversification, which Apollo has also turned to in the years since. It's clear now that, like many, the company didn't quite grasp the real estate market at the time, and you can't help but wonder if it's really pursuing a sustainable competitive advantage in the various areas it's targeting now. How do we know that Apollo is really that good at energy, for example, or at originating loans?
Finally, I'm all for forward-looking risk reduction in a portfolio, but I'm curious to find out more about Apollo's structured products. How risk-averse can a company be while playing in this space, and how deeply does AINV pursue this strategy? These are questions worth asking.