Joshua Harris, the marathon-running co-founder of Apollo Global Management LLC, was in a hole.
The 2008 collapse of housewares retailer Linens ’n Things Inc. had wiped out most of Apollo’s $430 million investment. A global financial crisis threatened its leveraged buyouts of casino operator Harrah’s Entertainment Inc. and real estate broker Realogy Holdings Corp. A $360 million bet on the debt of a Rotterdam-based chemicals maker was losing money every day as the company spiraled toward default.
That’s when Harris, 48, and his partners, including Leon Black, a fellow billionaire and veteran of junk-bond firm Drexel Burnham Lambert Inc., decided to dig deeper. They accumulated even more debt of LyondellBasell Industries NV, the world’s largest manufacturer of polypropylene, before it filed for bankruptcy in January 2009.
“We seek to buy when the world appears to be very, very cheap,” says Harris, an Apollo senior managing director, sitting in a 43rd-floor Manhattan office overlooking Central Park that’s adorned with Lucite tombstones, photos of himself at road races and an insignia of the Philadelphia 76ers basketball team, which he and a group of investors bought in 2011. (In August, an investment group led by Harris bought the New Jersey Devils hockey team for more than $320 million—a price that reportedly included the payment of $200 million in debts that were accumulated by the NHL franchise.)
The Lyondell bet paid off. The $2 billion Apollo sank into the company, whose products are used to make tires and bathroom fixtures, has turned into a $9.6 billion paper profit, the biggest gain ever on a private-equity investment, according to data compiled by Bloomberg.
That eclipses the $7 billion that Henry Kravis’s KKR & Co. reaped from the 1986 buyout of supermarket chain Safeway Inc. and a similar profit that a group led by financier J. Christopher Flowers reaped from the 2000 takeover of the predecessor to Tokyo-based Shinsei Bank Ltd.
The gain has propelled a turnaround in Apollo’s fortunes, boosted by a rally in asset values that has lifted returns across most classes of alternative investments. Private equity has rebounded from the lows of the financial crisis, generating a 15.2% average annual return during the three years ended December 31, according to data compiled by Boston-based Cambridge Associates LLC.
Apollo, the third-largest U.S.-based private-equity firm, with $114 billion under management, has outshone its peers. The $10.1 billion Apollo Investment Fund VI LP, which had tumbled as much as 40% from its 2006 inception, according to a person with knowledge of the matter, had a 10% average annual net internal rate of return, or IRR, through March 31, regulatory filings show.
A $14.7-billion pool from 2008 known as Fund VII, which invested in LyondellBasell, posted a 28% annual average IRR through that date. At year-end, it ranked highest among 2008 megafunds, those with more than $4.3 billion in committed capital, according to London-based research firm Preqin Ltd. Since Apollo’s founding in 1990, its private-equity funds have generated an average annual net IRR of 26%, according to filings. That’s better than the 19% since inception posted by KKR, the 18% by David Rubenstein’s Carlyle Group LP and the 15% by Stephen Schwarzman’s Blackstone Group LP.
Focusing On Price
Apollo stoked its results by snapping up loans and bonds—an unusual move in an industry famous for issuing debt, not buying it. After the 2008 financial crisis hit, Apollo gathered billions of dollars of debt, including some in its own battered companies. Often the firm purchased debt from panicky lenders and bondholders before companies converted it to equity through bankruptcy or a negotiated restructuring. Before that, Apollo calculated what the value might be after a financial overhaul.
The strategy was central to Lyondell. Apollo also used it to transform a looming wipeout of an almost $1 billion bet on Realogy, acquired in 2007, into an 85% gain.
“They are great distressed-debt investors,” says Mark Epley, co-head of the private-equity-banking group at Nomura Holdings Inc., which has helped Apollo finance buyouts. “It’s in their DNA. They take a fundamental view on the downside, and if debt prices go down, they don’t get scared; they buy more. Most private-equity guys aren’t distressed investors at the end of the day. They don’t think in those terms.”
Many of its non-distressed deals involve carve-outs, or buyouts of brands, product lines and divisions parent companies no longer want to own. These include Apollo’s $7.15 billion purchase in 2012 of El Paso Corp.’s oil and gas exploration and production operations and its $2.4 billion purchase this year of McGraw-Hill Cos.’ textbook and education unit.
In any Apollo deal, the paramount rule is to pay a low cash-flow multiple, Harris says. That’s less of a concern for buyout firms seeking gains mainly by cutting costs, adding cash flow and wielding leverage to boost returns.
“The single biggest determinant of investment return is the purchase price,” Harris says. “When you get in at the right price, you have the wind at your back. Distressed deals are one way to do that.” With carve-outs, he says, “we trade complexity and aggravation for rate of return.”
LyondellBasell, which wasn’t a carve-out, brought plenty of aggravation. The company was created by Len Blavatnik, a Ukrainian-born American citizen who built a fortune in oil, media and real estate valued at $15.8 billion, according to the Bloomberg Billionaires Index. He merged Dutch chemicals maker Basell NV, which he bought in 2005, and Houston-based Lyondell Chemical Co., an oil refiner and producer of ethylene and propylene oxide.
The deal forged a company with $34 billion in sales; 15,000 employees; more than two dozen plants in the U.S., Europe, Argentina and Australia; and $22 billion of debt.
Credit markets had started to unravel by the time the merger was completed in December 2007, and Citigroup Inc., the deal’s main lender, couldn’t sell LyondellBasell’s senior debt to investors. Stuck with $43 billion of loans it had made to finance corporate buyouts, Citigroup agreed in April 2008 to sell about $12 billion of them to TPG Capital, Apollo and Blackstone for at least 10% off face value.
The buyers could cherry-pick loans, and Apollo was drawn to a $1.8 billion chunk of LyondellBasell debt, for which it paid 80 cents on the dollar, or more than $1.4 billion. It put up $360 million, with Citigroup financing the rest, according to a person with knowledge of the matter. Harris, who had shepherded other successful chemicals deals, expected Apollo would recoup the full principal value plus interest, the person says.
It didn’t look that way at first. The economy slumped after the September 2008 bankruptcy of Lehman Brothers Holdings Inc., clobbering LyondellBasell as global demand fell for its products.
By January 2009, LyondellBasell couldn’t pay its bills and filed for bankruptcy. Apollo kicked in $600 million of a $3.2 billion debtor-in-possession loan, a type of financing to keep the business running. Well into that year, Apollo kept buying more debt. All told, it amassed more than $3 billion in face value of LyondellBasell’s senior loans at an average cost of 50 cents to 60 cents on the dollar, the person says.
Executives at two private-equity firms say they watched in amazement as Apollo loaded up on LyondellBasell debt, even as it was reeling from losses on Realogy, Caesars and other buyouts. The two people, who asked not to be named because they didn’t want to openly criticize a competitor, say Apollo was betting the house.
Harris says talk of excessive risk-taking is ill-informed.
“When people hear the phrase distressed debt, they think risk,” he says. “But we generally are buying secured, senior bank debt at the top of the capital structure.”
Harris was eventually vindicated. Ebitda rose to $4.1 billion in 2010 and reached $5.7 billion last year. In LyondellBasell’s April 2010 reorganization, Apollo traded in its debt for equity and bought additional shares to bring its stake to 29%.
Since LyondellBasell exited bankruptcy, its stock has climbed 196%. Apollo, which began to sell its stake in September, has reaped $5.5 billion from share sales and received $1.53 billion in dividends. Including the value of its unsold shares, the firm’s $2 billion investment has increased almost sixfold in value. That gain excludes Apollo’s $600 million debtor-in-possession loan, which it recouped with interest.
‘Fabulous’ Time To Sell
Amid a recent surge in debt and equity markets, Apollo announced 11 investments in 2012 with a combined enterprise value of at least $13.8 billion, according to data compiled by Bloomberg. Mostly, though, it has benefited by selling as the stock market hit new highs. Last year, Apollo sold Hughes Telematics Inc., a maker of wireless systems for cars, and movie theater operator AMC Entertainment Inc.
“We think it’s a fabulous environment to be selling,” Black said in April at the Milken Institute Global Conference in Beverly Hills, Calif. “We’re selling everything that’s not nailed down, and if it is nailed down, we’re refinancing it.”
Apollo returned $16.1 billion to investors in its private-equity funds in 2011 and 2012 and handed back $3.4 billion more in the first quarter of this year, according to filings.
The current ebullience has Harris dreaming of future opportunities.
“There’s froth in the market, and I don’t think it will end well, though not as badly as in 2008,” he says of efforts by central banks around the world to keep interest rates low. “When rates rise, you’re going to see valuations re-price, and things will get more treacherous.”
Apollo will be in its element.