I typed this up yesterday for somebody I was messaging with via Twitter regarding Apollo’s annuity earnings (or Spread Related Earnings, as APO calls it). Not spell checked or edited – just a quick note, but wanted to record it here for my own reference in the future. The question discussed was what is an appropriate multiple for the spread related earnings business:
The annuities business model, separate from how multi-line insurers work, is really a pile of other people’s money, with a guaranteed return that is similar to AA bonds (over-simplifying). Insurers invest that money for the most part in investment grade, so BBB and higher, debt. Something like 95%. 5% can be invested in equity.
So it’s not too dissimilar from banks, or the old GE capital – it’s just that the funding source is locked in with roughly a 7-9 year duration, all things equal. Other funding bases can be deposits, short term credit, etc. So I think the annuities business gets a plus in that it’s more permanent capital than others’ funding bases and are far better duration matched than other levered finance business models. The minus is APO’s funding source is more complex. Surrender rates, options hedging, minimum guaranteed returns, etc. But APO / KKR would argue that these are highly manageable.
On the asset side, not too dissimilar from banks, they are trying to make investment grade loans, either public or private. They are definitely exposed to the credit cycle, but the question is how much. Do they do better, the same, or worse than comparable levered finance vehicles. The sponsors will tell you they are taking excess spread with the same or less risk. Covid wasn’t a good test, things came back before they really blew. ‘18 wasn’t a good test, and Athene / General Atlantic were born out of the credit crisis.
Furthermore, is the business just effectively a loan book or has actual franchise value? How much are they actually originating themselves or is this just a chop shop for old blocks? I think recurring earnings should make a difference on the perceived quality of earnings.
I think similar levered finance vehicles are a good starting point. Comparable sized banks maybe trade for high single digit to low teens P/E. Other fixed annuity providers trade around book value, which is roughly high single digit P/E with low teens ROE.
Stepping aside, the question APO asks is what do you value a business that is growing at 15%+ with relatively “predictable” revenue streams, with 15%+ ROE, that is the largest in the industry by far, etc. Rowan thought that 6x earnings is too cheap and therefore bought Athene. I think he wouldn’t sell this business for 15x. I think that he believes that it should trade at 20x+ but I personally don’t think it ever will, because ultimately you need to trust what’s inside the black box. In the 2000s people didn’t care what was inside the black box and you got to 20-30x earnings. Think that’s a bad way to calibrate and once there is another credit cycle, if it is proven to be a low loss loan book, it gets closer to 15x than the single digits it trades at today.
One has to remember that the entire industry of insurance has been a tough one over time. JXN trades for a low single digit P/E with variable annuities. Brutal. Overall, as an investment, I think the SRE earnings streams in the fixed annuities space likely should trade higher than what APO and others acquired them for, but that’s because I also believe that they are good investors. If that’s not right in the next credit downturn, then they aren’t worth more than book, etc. So for me, I’m happy to own it at the current implied multiple and if the sponsor proves it out, it’s upside, but I’m not really paying for it, nor do I expect returns from a re-rate.
Disclosure: I own shares in APO, this isn’t investment advice. Do your own work.