Apollo’s IPO discount looks too steep

March 22, 2011

By Lisa Lee and Lauren Silva Laughlin
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Apollo is heading into public life at a steep discount to larger rivals. Too steep. This week’s pricing of the IPO puts a $6.4 billion value on Leon Black’s buyout shop. One reason investors may be holding back is because of how Apollo currently trades on an illiquid private market. But once the firm’s shares spend some time on the New York Stock Exchange, recent history suggests the valuation should make strides on peers.

Apollo’s performance has improved while prepping for the IPO. Economic net income, a profit measure used by private equity firms, surged to $1.4 billion in 2010. Three months earlier, on an annualized basis, the figure was half as much. In January, Breakingviews estimated Apollo’s value on an after-tax basis at about $6 billion.

Given the changes for the better, the valuation ascribed by investors looks weak. Management fees, after applying a 10 percent tax rate, come to $265 million. Apply a multiple of 16 times, the lower end of the range for traditional asset managers, makes them worth $4.2 billion. If volatile fees from investment gains are valued at a more modest multiple of eight times, then Apollo should be worth nearly $12 billion.

Sliced another way, Apollo still looks cheap. Blackstone trades at 14 times its economic net income and KKR six times. Apollo’s IPO is priced at 5.3 times. There could be better growth prospects ascribed to Apollo’s rivals but an illiquidity discount also appears to be at work. Black’s firm trades on the GStRUE marketplace, where only a few months ago it was valued at just $3 billion.

It’s hard to ask for more money when there’s already a visible appraisal. But KKR may provide a reason for optimism. When the firm co-founded by Henry Kravis moved last July from the Amsterdam exchange to the NYSE, its valuation was a quarter of Blackstone’s. The gap has narrowed and KKR now trades at a 57 percent discount using its 2010 economic net income. Looking ahead at estimated 2011 earnings, the gap closes to about 40 percent.

Investors may have other reasons for enriching KKR’s value. But assuming much of it is just a comfort level that needs to be reached with a complexly structured, notoriously private business that elicits much skepticism, Apollo investors have good things in store.

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