Apollo Investment: New Make And Model (NASDAQ:AINV)

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After parading the model, Widra, for several years, Apollo Investment Corporation (AINV) announced a new make and model, the “MidCap Financial Investment Corporation” (MFIC-OLD) featuring the Tanner Powell. The transformative changes opened doors, windows and collapsed walls for investment growth. Management, with the Widra, put together a portfolio of high quality, low risk 1st line liens. The design of the Tanner Powell now targets growth, continued growth.

The Quarter

Apollo reported the last quarter on the 2nd of August having moved the date forward a few days. The leverage ended the quarter at 1.58, but with the $30 million of infused capital by others and net sells, the net leverage dropped to a more conservative 1.45 post quarterly report. Capital infused included post quarter pay downs ($15 million from Merck) and $30 million from MidCap Financial. Management noted that “[a]t the end of June, [Apollo’s] investment in Merck’s had a fair value of $284 million, representing 11% of the total portfolio.” They also noted again that the investments are well positioned to benefit from rising interest rates estimating that 100 basis points and a 200 basis point increase in reference rate to result in annual incremental earnings of approximately $0.02 [to] $0.25 respectfully.” Net Asset Value I dropped slightly to $15.52 while Net Asset Value II (FQI) equaled $0.37. The company temporarily dropped the special dividend until early next year (the earliest in our view) while raising the basic dividend to $0.32. This represented a dividend cut, by the way, of $0.05.

The New Make: MidCap Financial Investment Corporation

MidCap Financial Investment Corporation will rely on MidCap Financial, a privately held by institutional investors and managed by Apollo Global, for its 1st lien loans.

  • MidCap Financial, a large mid-cap originator based in Bethesda, Maryland.
  • Employees 250 in 12 offices.
  • Ticker for the new BDC: MFIC.
  • MidCap Financial added $30 million primary equity investment in MFIC.
  • Pure play in the middle market.
  • New fee structure:
    • Incentive Fee dropped from 20% to 17.5% permanently.
    • Base Management Fee dropped from 3.4% on net assets to 1.75%, lowest in the market place, 50% cut (“thereby expanding the universe of MidCap originated loans that . . . meet[s] the BDCs well required asset yield.”)
  • Base Dividend begins at $0.32 (Management believed this level is appropriate at this time. Future supplemental distributions will be declared as appropriate.)

The Model: The Tanner Powell

  • Tanner Powell Promoted to Chief Executive Officer

  • Ted McNulty Promoted to President

  • Kristin Hester Promoted to Chief Legal Officer

Tanner and answered multiple questions during the call about a variety of subjects. In our view, this stood out. The first concurring Return on Equity (ROE), “The ROE, I would say, if you just took an apples-to-apples approach and said the fees and everything else stays neutral, you’d have an increase in ROE of like 2%. So as you assume some reduction in yield and some reduction in leverage from where we were now, you’re talking about an increase of the ROE from the low 8s to the low 9s, 10% increase in ROE, sort of like as a base case.”

Howard Widra, the former CEO, added comments on leverage, “I would say, either you can look at it as moving our range down some or expecting to operate like in the 1.35 to 1.5 range as opposed to what we articulated before [at] 1.4 to 1.6.”

Referring to the dividend cut from $0.36 to $0.32, Widra reminded the analyst, “where our spillover is in which we have a substantial amount right now and where the earnings were… So the answer really is, yes, we expect there to be meaningful supplemental dividends paid because there’s – we’re covering – we’re not going to pay the excise taxes. We’re going to distribute to stay in compliance. So you’re right, there’s quite a bit of room, but we just – effectively, what we did is we raised the base dividend and we got rid sort of our standing promise that we will distribute at least $0.05 of supplemental each quarter. But if you look at our earnings power, where we have substantially more than that once that these chances kick in.” Until the lower fees on investment are effective, January 1, 2023, and the reductions targeted at Apollo’s ownership in Merx Aviation are completed, management isn’t comfortable in committing to a dividend increase. But, they also made clear that the expansions resulting from lower fees aren’t ominous either.

The following table using the last 8 quarters of dividends versus NAVII calculates a possible special dividend size coming lately this year or early next year.

Excess Earnings Sept. 20 Dec. 20 March 21 June 21 Sept. 21 Dec. 21 March 22 June 22
NAVII $0.43 $0.43 $0.39 $0.39 $0.33 $0.35 $0.42 $0.37
Dividend $0.36 $0.36 $0.36 $0.36 $0.36 $0.36 $0.36 $0.32
Difference +$0.07 +$0.07 +$0.03 +$0.03 -$0.03 -$0.01 +$0.06 +$0.05

The total difference is $0.27 over the past few years, plenty left to distribute. In our view, management will distribute a special dividend of $0.05-$0.10 in the next few quarters.

Price Action: Bullish

We included a day bar chart self-generated using TradeSecurity software of Apollo.

AINV Daily.png

TradeStation Securities

The price reaction in-spite of the dividend reduction was bullish. The action is also getting tired and for good reason. The new dividend at least for the next quarter is $0.32 down from $0.36 or on a yearly basis equals $1.28. Apollo is now trading for the first time in years below a 10% yield.

Risk & Investment

We own thousands of shares and have no plans to add until the chart becomes underbought. For new investors, it becomes a personal choice. And with respect to risk, many abound. The economy could shut down from another world health issue, for example. But the lower fee schedules and the increase in ROE that follows make it difficult to bypass future opportunities. The new make and model are transformative to this BDC. Transformative. The idea of a pristine 1st lien approach with a leverage at 1.4 is compelling. The new make and model add value and though growth is limited at some higher level, it appears to us that the car show just began. The market, thus far, agrees.

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