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Apollo's numbers reveal private equity's fall

Buyout firm wants to raise $520 million from you, but is the price right?

By Roddy Boyd, writer
Last Updated: August 13, 2008: 3:20 PM EDT

Leon Black's Apollo hopes to sell $520 milllion in stock to the public.

NEW YORK (Fortune) -- It made all the sense in the world last year when Apollo Global Management LLC started making sounds about going public. At the time, private equity firms were riding high and everyone seemed to want a piece.

But a look at the firm's latest numbers shows why the private-equity gameplan of using cheap debt to take companies private, cut costs and re-sell them is running into complications in a credit crunch that has investors shying away from risk.

The numbers, contained in an SEC filing in advance of the planned public stock offering, also explain why institutional investors that have been putting their money into Apollo now are eager to pull some out.

Consider that Apollo, co-founded and run by Leon Black, the legendary former Drexel Burnham mergers chief, lost over $96 million in the first quarter, as its investments dropped more than $142 million in value. In comparison, the same period in 2007 saw Apollo book a $144 million net profit. (The filing did not contain second-qaurter figures.)

Like all private equity managers, Apollo earns its money from performance and management fees from the portfolio of companies and securities it controls via various funds that are sold to large investors.

Starting earlier this year, according to the filing, "adverse market conditions" made it difficult to deploy new capital effectively, hurting Apollo's ability to generate management fees. It also naturally led to a drop in the value of its investments, which in turn affects its ability to generate performance fees.

Equally troubling for Apollo, which has $40 billion in assets under management, its internal rate of return - a measure of the profits Apollo books on investments in its various funds - has been in free fall. The returns for Apollo's most recently launched buyout fund dropped to 21% from 42% in just three months, according to the latest pre-IPO filing.

To be fair, Apollo has said it expects internal returns to be volatile. That's because Apollo eschews short-term market bets in favor of long-term wagers on companies.

Down 41%

While the public thus far has been spared any pain by Apollo's failure to get its IPO out the door, its so-called initial purchasers - the institutional investors that bought 30 million private-placement shares at $24 each last July, and have since seen those shares lose 41% of their value - are eager to let you in on the Apollo experience.

One private-placement investor, Credit Suisse - which also helped underwrite the sale to the initial purchasers - ponied up $180 million via the purchase of 7.5 million shares. That bet is now $75 million under water, based on trades made on a Goldman Sachs-controlled private equity share market, GSTrue. A CS spokesman declined comment.

But Credit Suisse's investment is small beer next to the total of $6.4 billion that the Abu Dhabi Investment Authority and California Public Employees Retirement System have invested in various Apollo funds.

In the July 2007 round of capital raising, the two mega-funds invested a total of $1.2 billion, according to the filing, in various Apollo securities. It's likely that some, but not all, of that investment was in the privately-placed common stock (then valued at $24).

Apollo now seeks to raise about $520 million via the public sale of 37.3 million shares at $14 each. All the shares are being sold by the institutional investors that hold the GSTrue-traded shares.

Of note is the share amount: Apollo's last filing, on Dec. 31, envisioned the sale of 29.8 million shares at $14 apiece. So the latest plans show Apollo investors are aiming to raise 25% more money - although no reason was given the increase.

An Apollo spokesman did not return an e-mail requesting comment.

Similar to the pre-IPO documents of other private equity shops like Blackstone Group (BX) and Fortress (FIG), the "Risks" section of the filing is quite telling about what rights Apollo's shareowners have if they are unhappy with their investment. In a phrase: next to none.

That's because of the complicated legal structure of the fund management group and the fact that Apollo's managers control most of the economic and voting rights of the company. As a result, investors will have very little ability to demand dividend payments, shift strategy or even vote out unproductive managers.

As for how an IPO investor might fare, Blackstone's price chart tells a cautionary tale: Though Blackstone shares are up from their March panic lows just above $13, they recently fetched $18 - less than half their post-offering peak and down 40% from their IPO pricing level.  To top of page

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