When Expedia boss Peter Kern dialled into an earnings call last May, hotels were closed, flights were grounded and the new chief executive of the world’s biggest travel agency had just asked Wall Street for $4bn in emergency financing. “I’m really excited about the opportunities ahead of us,” Kern said, before adding: “I’m not crazy.”
Bereft of revenue, Expedia urgently needed cash to cope with the economic impact of coronavirus. Yet most sources of liquidity were dry. Banks were in no position to lend quickly. Bond investors were in retreat. Even Warren Buffett, who had thrown multibillion-dollar lifelines to companies as mighty as Goldman Sachs and General Electric during the financial crisis a decade earlier, was licking his wounds from an enormous investment in US airlines whose collapsing shares he was now selling.
If Buffett’s Berkshire Hathaway in 2008 provided refuge to companies whose crisis-inflicted injuries did not quite condemn them to bailout or failure, then in 2020 that role most often fell to Apollo Global Management, the $455bn investment group.
Founded in 1990 as a buyout firm, Apollo announced two weeks ago that it is to merge with its insurance affiliate, Athene Holding, a move that may finally heal the running sore surrounding the relationship between the two companies. After a Financial Times investigation in 2018 two investors in Athene sued Apollo, claiming that the investment group had taken unfair advantage of its influence over the insurer, and the controversy has been a severe drag on the insurance group’s shares ever since.
The enlarged Apollo will be a financial powerhouse that bears comparison with Buffett’s twin insurance-investing empire. It follows an $88bn dealmaking spree in 2020 that had earned Apollo the reputation as Wall Street’s responder of last resort, helping keep the Hertz car rental chain running, United Airlines flying and Expedia’s recovery plan on track.
“No one has done what we are doing,” says Marc Rowan, who will soon take over as chief executive of the enlarged Apollo. “Yes, there are elements of Berkshire Hathaway . . . but we are doing something in our own way with our own strategy and with our own rationale.”
Athene’s explosive growth in recent years already makes it the principal source of funding for a sprawling investment empire. The insurance business, which Rowan created barely a decade ago, injects cash into Apollo’s vast lending business, which functions less like a Wall Street investment partnership than a diversified national bank.
Now Athene will become by far the biggest part of Apollo itself, underscoring how the firm Rowan co-founded with Leon Black and Joshua Harris has transformed itself from a scrappy buyout shop into a linchpin of the US financial system — one that is supplanting banks as a provider of financing for businesses and households across the US.
Yet the deal, which values the combined group at just under $30bn, is a risky move. Overnight Apollo will switch from a nimble asset manager to a lumbering insurance company, with more than $200bn in assets, on which it bears the losses if bets sour.
While that pleased some investors in Athene, who had been unhappy about the relationship between the two companies, others were left puzzled about why Apollo’s billionaire founders had decided to put so much more of their own wealth on the line.
“The merger is proof that for Apollo this [Athene] was never just a fee business,” Rowan told the Financial Times. “We were focused on the assets.”
Insuring the future
Rowan’s early exposure to investment and insurance was at Drexel Burnham Lambert in the 1980s. His title was associate, one of the lowest ranks in banking, but his colleagues gave him the unofficial status of “managing associate”, one former banker recalls, after noticing that he often provided answers when managing directors with decades of experience could not.
During stints at Drexel’s office in Beverly Hills, Rowan worked on high-octane financing deals, while across town in the Brentwood neighbourhood of Los Angeles, a less glamorous empire was taking shape. There an entrepreneur named Eli Broad was taking his quieter financial revolution to the suburbs. In time, it would become Rowan’s model.
Broad had gone into business as a builder in the 1950s, throwing up no-frills houses for young families seeking their first suburban foothold. Three decades on, he saw that baby boomers were entering a new life stage. Broad’s company spun off its housebuilding unit, renamed itself SunAmerica and focused on selling retirement annuities.
The corporate raiders backed by Drexel were all-or-nothing operators, trying to rake in staggering sums from big, high-stakes bets. By contrast, SunAmerica earned pennies on the dollar from what people in finance call “spread” — the result, in effect, of borrowing money at a lower interest rate than they can earn. Insurers typically plough the premiums they receive from customers into the credit markets, in effect lending out the money to companies and other borrowers. Over time, as the debts are repaid, the insurer sends policyholders their promised annuity payments. Typically, the margins are narrow and because payments to policyholders are fixed in advance, any shortfall can be catastrophic for the insurer.
But for a resourceful insurer — and one with a high enough earnings multiple — earning excess spread on a large book of policies can be lucrative.
SunAmerica was extremely resourceful, ploughing some of its cash into junk bonds, car loans and other unconventional assets. One executive boasted that the company was earning nearly 3 percentage points more in interest than it was paying out to policyholders.
In 1990, Drexel collapsed, and junk bond prices plummeted. That spelt disaster for Executive Life, a Drexel client and SunAmerica rival that had been among the biggest buyers of junk bonds. As insurance regulators organised a fire sale of Executive Life’s portfolio, savvy investors saw an opportunity to make enormous profits by buying bonds that were still being paid off.
SunAmerica put in a bid, only to lose out to a Wall Street upstart named Apollo. It was a deal that would make the fortunes of Rowan and his co-founders, who raked in decent profits from borrowers that kept up on their payments, while taking over companies that went into default. The deal helped convince investors to back Apollo’s core investment funds, while the hardball tactics the company employed in its dealings with delinquent debtors made it one of the most feared distressed debt investors in America.
For Broad, the decade ended so well that the missed opportunity hardly mattered. Insurance group AIG bought his company for $18bn in stock in 1998, an astounding valuation that was equivalent to five times book value.
The birth of Athene
When Rowan spotted his next big opportunity in insurance, he would surpass even Broad’s ingenuity. In 2009, an Iowa-based insurer called American Equity Investment Life (AEL) was looking to hive off some of its annuity policies. Apollo bought them cheaply, and ploughed the corresponding assets into commercial mortgages that had collapsed in price during the financial crisis, but were nonetheless being paid off. Rowan had expanded the spread from both sides.
Like a wildcat driller who had struck oil, he raced to build structure around his new business model. Athene was its central support. Incorporated in Bermuda, advised by Apollo and initially owned by the firm’s clients, the insurance company made a permanent business out of what Rowan had originally conceived as a one-off trade in AEL.
Apollo and Athene hired a small army of industry veterans to scour insurance company balance sheets for more retirement annuities to buy on the cheap. Everywhere they looked, insurers were trying to rid themselves of annuity business that was dragging down their financial results. A decade on, Aviva, Voya and Prudential have all sold blocks of policies to Rowan’s team. “Athene has replaced Berkshire Hathaway as the buyer of last resort of insurance assets,” says one of its former executives.
By 2011 and with the economy in recovery, there were no longer any bargains in mortgage-backed securities. And with its biggest client being an insurance company, Apollo — which had specialised in leveraged buyouts, that carried huge risks but could generate billions of dollars in profit for the firm — needed to become a spread-generating machine.
Only a sliver of Athene’s balance sheet is unusual. About 95 per cent of the insurer’s assets are invested in corporate debt, mortgage-backed securities and cash. The insurance company carries little debt, and a lot of excess capital. But Rowan hopes he can deliver extra profits from “alternative” investments, which represent 4.5 per cent of Athene’s total assets, and are invested in Apollo’s “origination platforms”, essentially a collection of mini-banks.
In Maryland, there is MidCap, which specialises in secured lending to medium-sized businesses, many of them in the healthcare sector. In Ireland, there is Merx Aviation, which provides finance leases for aircraft. In New York, a team of Apollo executives works on its Buffett-style corporate rescues, which use Athene capital alongside money from other clients. Last year, the insurer paid at least $875m to buy part of Hertz, the bankrupt car rental company.
Such deals are complex, but potentially highly profitable. One travel industry deal last year involved parachuting in a team of Apollo executives to figure out whether the contemplated rescue financing would enable the stricken company to survive without revenue for two to three years. “The answer was ‘yes’,” according to an Apollo executive who was closely involved. “But you couldn’t tell that from the outside, if you didn’t work with management and consultants.”
Those capabilities exist mostly inside banks, which have long provided such rescue financing, and investment firms such as Apollo, which until recently did not. “I am excited about that,” Rowan said recently, “because there is excess spread.”
Yet the stock market has never displayed much excitement over Athene. Some of Apollo’s most loyal clients earned as much as four times their investment before the insurance group’s 2016 initial public offering, and Apollo itself did even better, having put up virtually no cash of its own for its double-digit stake in Athene which had increased to around 35 per cent by the time the merger was announced. But four years later, the share price is barely any higher.
While few expect an insurer to match the heady valuation that SunAmerica attained two decades ago, Athene’s share price performance has been noticeably dismal even as earnings per share have doubled since the IPO.
The problem stems in part from some investors’ perceptions of Apollo. Athene’s board is stuffed with Apollo loyalists, according to a shareholder lawsuit filed in 2019. The relationship has delivered hundreds of millions of dollars in asset management fees to Apollo, an amount the lawsuit called “exorbitant”, citing an FT investigation that reported Apollo’s own executives believed an independent asset manager would charge less. Apollo said the lawsuits were without merit and although the litigation subsequently stalled, it magnified unease over Apollo’s outsized influence over the insurer.
The price of that unease may run into billions of dollars. One industry executive estimates that, given its double-digit return on equity and matching earnings growth, Athene should trade at two times book value. Lately, it has traded below one. Apollo has suffered a double blow. Its senior executives own a large chunk of Athene’s underperforming shares, as does Apollo itself. But, because of an accounting quirk, the investment group’s accounts do not reflect its one-third share of Athene’s profits.
With Athene now accounting for roughly one-third of Apollo’s asset base, a divorce was inconceivable. In 2019, Apollo ploughed an additional $1.6bn into the insurer while cutting its voting stake from 45 per cent — an effort, one insider says, to appease Athene shareholders who were spooked by the idea that Apollo might be using its influence to further its own interests rather than theirs. Ultimately, the stock price barely budged.
Rowan long ago concluded that the two companies should merge, according to people familiar with his thinking. And when he was chosen to replace Leon Black as chief executive in January, he acted swiftly.
Not everyone is convinced by the logic, and Apollo’s own shares have fallen slightly since the deal was announced. “I get why it is good for Athene but [am] not totally clear on why it is good for Apollo,” says a former executive in the firm’s credit business. As a private equity firm, Apollo earned enormous fees while tying up little capital of its own. Now the firm will be a capital-intensive insurance company, overseen by regulators watching for risks that could impair its hundreds of billions of dollars in assets.
“Owning more insurance on [the] balance sheet does bring a lower multiple,” wrote Glenn Schorr, an equity research analyst, in a note after the deal. “Apollo [is] being Apollo and embracing complexity to create value — it’s how they roll.”
As it strives to move past the controversy surrounding its founder Leon Black — and his links to the late paedophile Jeffrey Epstein — Apollo no longer conceives of itself as a buyout firm but as a vital part of America’s financial system.
Yet there is a tension in Rowan’s pitch. He is taking credit for creating a new kind of financial institution, while trying to persuade wary investors that it is one they can understand and eventually embrace. “I assure you that this merger is not an investment in the insurance business,” he said when announcing the merger. “Nor is it an attempt to build a conglomerate. We are building an asset manager.”