IPOs create fee windfall for Apollo Global Management

Transcription

1 IPOs create fee windfall for Apollo Global Management Manager stands to collect as much as $126 million in for 43 years of advisory services it will not provide Key Points In the past several months, Apollo Global Management has taken a number of portfolio companies through initial public offerings (IPOs) or sales. In early May, Apollo CEO Leon Black told the Milken Institute conference We are selling everything thatʼs not nailed down. In its multiple recent or recently filed IPOs, Apollo stands to generate a windfall from termination fees on advisory services agreements it signed with portfolio companies. Following buyouts, Apollo typically charges portfolio companies an advisory or monitoring fee for providing advisory services through agreements that last 10 to 12 years. By comparison, the median portfolio company hold period for buyouts exited in 2012 was 5.37 years. When it goes through an IPO or other change in control, Apollo portfolio companies are typically required to pay the remaining years of advisory services to terminate the agreement. For six recent IPOs (Rexnord, Realogy, Evertec, Taminco, Claireʼs Stores, and Constellium), Apollo stands to make as much as $126 million in fees for terminating advisory services agreements extending cumulatively 43 years beyond the IPOs i.e. for 43 years of advisory services Apollo will not provide. Payouts to exit advisory services agreements can eat into IPO proceeds, accounting for as much as 16% of proceeds from one recent Apollo portfolio company IPO. Extracting IPO proceeds through such termination fees disproportionately benefits Apollo versus limited partners, with Apollo retaining 32%-35% of the fees from recent IPOs rather than dividing them based on pro-rata investment in the fund. On a company-wide basis, transaction and monitoring fees spiked at Apollo 2012 and the first quarter versus prior years, driven in part by advisory agreement termination fees. In question is whether Apollo will continue to retain a portion of transaction and monitoring fees from the $10-$12 billion Apollo Investment Fund VIII the manager is currently marketing. Key questions What benefit does Apolloʼs practice of collecting fees for early termination of advisory services agreements provide to portfolio companies? To Apollo limited partners? Why has Apollo structured advisory services agreements to last years when it typically holds portfolio companies for a much shorter period? Will Apollo eliminate the misalignment of interests created by these fees by offsetting management fees with 100% of transaction and monitoring/ advisory fees?

2 Selling everything that's not nailed down Over the past several months, Apollo Global Management has been aggressively pursuing initial public offerings (IPOs) for a number of its portfolio companies. Having brought companies such as Rexnord 1, Realogy 2, Evertec 3, and Taminco 4 to market in the past several months, two new portfolio companies retailer Claireʼs Stores 5 and metals manufacturer Constellium 6 (formerly Alcan) filed registration statements in early. At an April conference, Apollo Chairman and CEO Leon Black talked about Apolloʼs IPO spree. "It's almost biblical: There's a time to reap, and there's a time to sow. We are harvesting now," 7 Black said, adding We're selling everything that's not nailed down. 8 A little-noticed aspect of recent IPOs by Apollo portfolio companies are the fees the manager stands to collect for terminating advisory service agreements with the companies that extend years beyond the IPO i.e. fees for years of advisory services Apollo will not provide. There's a time to reap, and there's a time to sow. We are harvesting now Leon Black, Apollo Chairman and CEO April In total, Apollo has collected or stands to collect around $126 million from the above portfolio companies that have gone through or filed for an IPO in exchange for terminating advisory service agreements extending cumulatively a total of 43 years beyond the IPOs. Company Acquisition year/ Fund 9 IPO Advisory fee yrs total Advisory fee years left at IPO Annual advisory fee Payout at IPO for terminating advisory fee Constellium Claire's Stores Taminco Evertec Realogy Rexnord 2010/ Fund VII 2007/ Fund VI 2012/ Fund VII 2010/ Fund VII 2007/ Fund VI 2006/ Fund VI May Filed May April April October 2012 April Greater of $2 million or 1% of adjusted EBITDA $20 million $3 million 14 million for Tri- Artisan) $8.3 million (+ $1.2 (estimate) $3.9 million 17 $35 million Greater of $2 million or 2% of EBITDA 20 Greater of $15 million or 2% of adjusted EBITDA 23 $8.5 million to Apollo (+$8.2 million to Popular) $39 million $3 million 26 $15 million 27 Total 43 $126 million

3 Typically, fees for terminating Apolloʼs advisory services agreements are calculated based on remaining fee payments due discounted to present value. The discount rates utilized vary dramatically, from 10% at retailer Claireʼs Stores 28 to just 1.95% for specialty chemicals producer Taminco. 29 Management services agreements outlast typical private equity hold periods The durations of the management services agreements Apollo put in place for portfolio companies years are significantly longer than the period that Apollo and peers typically hold portfolio companies 30, making significant payouts for portfolio companies to exit the agreements almost a forgone conclusion at the outset. Indeed, the six companies had an average of 7.16 years remaining on their advisory fee agreements when they reached IPO (or filing of prospectus for companies that have not yet reach IPO). A analysis by Pitchbook Data found that across the industry, the median holding time for portfolio companies exited in 2012 was 5.37 years. 31 In addition, Apollo does not appear to have shortened the duration of management services agreements with limited partners in recent years even as transaction and monitoring fees have come under pressure from limited partners. 32 For example, when Apollo took over Taminco Corp in early 2012, it put in place a management services agreement due to last twelve years. 33 Just over a year later, in April, Apollo held an IPO for Taminco, collecting $35 million in exchange for eleven years of advisory services it will not provide. 34 Fees eat into IPO proceeds The fees portfolio companies are required to pay can take a significant bite out of IPO proceeds that could otherwise be used to pay down debt or invest in expansion. At Taminco, for example, the $35 million Apollo collected for terminating its advisory services agreement accounts for nearly 16% of the $222 million the company raised in its IPO. 35 Taminco initially priced its April IPO at $18-$20 per share but then dropped the price to $15 per share. 36 Despite the drop in offering price, the $35 million termination fee stayed the same. 37 Claireʼs Stores (Claireʼs Inc.) filed a registration statement on May 3, seeking to raise as much as $100 million through an IPO. 38 In 2007, Apollo put in Upon completion of this offering, we will pay the Sponsors a fee, determined based on the date of completion, but estimated to be approximately $ million (plus any reimbursed expenses) in connection with this termination of the management services agreement. Claireʼs Inc Registration Statement May 3,

4 place a management services agreement at Claireʼs Stores that requires the retailer to pay $3 million annually ($2.62 million to Apollo and $385,000 to Tri-Artisan Capital Partners, a co-investor) until May This is in addition to a $20 million transaction fee that Apollo collected on the 2007 Claireʼs acquisition. The agreement allows that in the event of a qualified public offering, Claireʼs can terminate the agreement by paying the remaining fees due, discounted to present value. 39 While the initial May 3 registration statement for Claireʼs left blank the amount it would pay Apollo and Tri-Artisan to terminate the advisory services agreement, it would be around $9.5 million (9.5% of offering) based on the formula laid out in the 2007 management services agreement. 40 Photo: Sameer Vasta (CC CY-SA 2.0) Handing over nearly 10% of the cash raised through the IPO would cut into Claireʼsʼ ability to pay down debt. The Wall Street Journal recently reported that Claireʼs carries more than $2.3 billion in borrowings, and its profit dwindled to $6.2 million in the most recent fiscal year on sales of $1.56 billion, as interest payments on its debt soared to $206 million. The company has $522 million in debt that comes due in Benefit of agreements disproportionately accrues to Apollo The benefit to Apollo Global Management of collecting a portion of IPO proceeds through termination of advisory fee agreements is that 32% to 35% of the fees collected go directly to Apollo as the general partner. The remainder of the payouts is split on a pro-rata basis with Fund VI and Fund VII limited partners (including Apollo based on its own commitment to the funds) through a management fee offset. 42 For the six IPOs listed above, Apollo stands to collect around one third ($42 million out of $126 million) of the advisory agreement termination fees directly. 43 The remaining fees are used to offset LPsʼ management fees i.e. they are shared with Fund VI and Fund VII LPs. Fees spiked at Apollo in 2012, first quarter During the first quarter, Apollo collected nearly twice as much in advisory and transaction fees $47.4 million than it had a year prior, in 1Q Apolloʼs transaction and monitoring fees collected spiked in 2012 ($149.5 million), reaching near double the managerʼs 2010 and 2011 fees. 45 Fees Apollo collected on years of advisory services not provided would have been a significant contributor

5 to the spike in transaction and monitoring and advisory fees that Apollo experienced in 2012 and the first quarter of. 46 ILPA Principles The Institutional Limited Partners Association (ILPA) principles, which Apollo Global Management has endorsed 47, state that: Alignment of interest between LPs and GPs is best achieved when GPsʼ wealth creation is primarily derived from carried interest and returns generated from a substantial equity commitment to the fund, and when GPs receive a percentage of profits after LP return requirements are met. GP wealth creation from excessive management, transaction or other fees and income sources, reduces alignment of interest. 48 The $126 million Apollo stands to collect from the early termination of advisory agreements at portfolio company IPOs would seem to run afoul of this principle, negatively impacting interest alignment with limited partners, insofar as (1) it is not dependent on the performance of the investment and (2) it does not serve to compensate any actual services or expenses. Will Apollo move to 100% fee offset with Fund VIII? Apollo is in the process of marketing a new buyout fund, Apollo Investment Fund VIII, seeking to raise $10-$12 billion. In question is whether Apollo will continue to take a portion of transaction and monitoring fees (it took 35% in Fund VI and 32% for Fund VII) or move to a 100% management fee offset i.e. where it gives 100% of fees back to limited partners. A article by Bloomberg noted that Apollo Investment Fund VIII would offer limited partners an 80% fee offset 49 i.e. Apollo would keep 20% off transaction and monitoring fees and use the remaining 80% to offset limited partnersʼ management fees. On May 1, the Oregon Investment Council committed to Apollo Investment Fund VIII, but made its commitment contingent on Apollo agreeing to give 100% of transaction and monitoring fees to limited partners. 50 A consultant for the Oregon fund told trustees that Apollo was in the process of having internal conversations about a 100% management fee offset. 51 A June 2012 report by Preqin Ltd. noted that for new buyout funds, a 100% management fee offset had become the median offering. 52 Key questions What benefit does Apolloʼs practice of collecting fees for early termination of advisory services agreements provide to portfolio companies? To Apollo limited partners? Why has Apollo structured advisory services agreements to last years when it typically holds portfolio companies for a much shorter period? Will Apollo eliminate the misalignment of interests created by these fees by offsetting management fees with 100% of transaction and monitoring/ advisory fees?

6 References: 1 Rexnord Corp form 424B4, Mar. 30, Realogy Holdings Corp form 424B4, Oct. 11, Evertec, Inc. form 424B4, Apr. 15,. 4 Taminco Corp form 424B4, Apr. 19,. 5 Claireʼs Inc. form S-1, May 3,. 6 Constellium Holdco B.V. form F-1, May 13,. 7 Apolloʼs Leon Black: Financing market as good as we have ever seen, The Wall Street Journal, Apr. 30,. 8 Leon Black: The market is pricey, ʻSo weʼre selling everything thatʼs not nailed down, Business Insider, Apr. 30,. 9 Apollo Global Management form 10-K, Mar. 1,, p Constellium Holdco B.V. from DRS, Dec. 4, Constellium Holdco B.V. form F-1, May 13,, p Constellium Holdco B.V. form F-1, May 13,, p Claireʼs Management Services Agreement, Dec. 17, Claireʼs Inc. form S-1, May 3,, p Based on four years of fees ($2,615,449 to Apollo and $384,551 to Tri-Artisan), discounted at a 10% discount rate. Claireʼs Management Services Agreement, Dec. 17, Taminco Corp form 424B4, Apr. 19,, p Taminco Corp form 424B4, Apr. 19,, p Taminco Corp form 10-Q, May 14,, p Evertec, Inc. form 424B4, Apr. 15,, p Evertec, Inc. form 424B4, Apr. 15,, p Evertec, Inc. form 10-Q, May 15,. 22 Realogy Holdings Corp form 10-K, Feb. 25,, p Realogy Holdings Corp form 10-K, Feb. 25,, p Realogy Holdings Corp form 10-K, Feb. 25,, p Rexnord Corp form 424B4, Mar. 30, 2012, p Rexnord Corp form 424B4, Mar. 30, 2012, p Rexnord Corp form 10-K, May 10, 2012, p Claireʼs Stores Inc-Apollo Management Services Agreement, May 29, Taminco Corp form 424B4, Apr. 19,. 30 E.g. in January, Apollo principal Geoff Strong gave a presentation that listed a 5 year hold period as a typical LBO assumption. Also, see Annual Private Equity Breakdown, Pitchbook Data,, p Annual Private Equity Breakdown, Pitchbook Data,, p See, for example, Private equity faces the future: Candid views from the market, BNY Mellon, May Taminco Corp form 424B4, Apr. 19,, p Taminco Corp form 10-Q, May 14,, p Taminco Corp form 424B4, Apr. 19,, p Reuters reported the company raised $237 million in the offering, which corresponds which, less $13 million in underwriting discounts and commissions, would be $222 million. Taminco shares fall in NYSE debut, Reuters, Apr. 18,. 36 Taminco shares fall in NYSE debut, Reuters, Apr. 18,. 37 Taminco form S-1/A, Apr. 15, 38 Claireʼs Inc. form S-1, May 3,. 39 Claireʼs Management Services Agreement, Dec. 17, Based on four years of fees ($2,615,449 to Apollo and $384,551 to Tri-Artisan), discounted at a 10% discount rate. Claireʼs Management Services Agreement, Dec. 17, Debt laden Claireʼs IPO is for test market, Wall Street Journal, May 8,. 42 Based on 65% management fee offset for Fund VI, 68% fee offset for Fund VII, New Jersey Office of the Attorney General, Division of Gaming Enforcement letter, May 28, 2008, p. 34.; Apollo latest fund offers clients bigger share of fees, Bloomberg, Nov. 28, Based on 35% of Rexnord ($15 million), Realogy ($39 million), and Claireʼs Stores ($8.3 million); 32% of Evertec ($8.5 million), Taminco ($35 million), and Constellium ($20 million). 44 Apollo Global Management form 10Q, May 7,, p Apollo Global Management form 10K, Mar. 1,. P Apollo Global Management form 10K, Mar. 1, ; Apollo Global Management form 10Q, May 7,. 47 ILPA Private Equity Principles Endorsements, Apr. 26,. 48 ILPA Private Equity Principles Version 2.0, Jan. 2011, p Apollo said to be near $5 billion closing for buyout fund, Bloomberg, May 1,. 50 Oregon Investment Council puts $1 billion of PERS funds into private equity, Oregonian, May 1,. 51 Oregon Investment Council meeting, May 1,. 52 Median buyout fund transaction fee rebates reach 100%, Preqin, Jun. 29, 2012.