Newsletters

AP Alternative Assets also added 71bps to NAV as the share price of its sole
underlying holding Athene Insurance rose 11% on speculation that Athene
would bid for Fidelity & Guaranty Life (FGL). FGL had agreed a sale to
Anbang Insurance well over a year ago, but the Chinese buyer has struggled
to obtain the necessary regulatory approvals. While FGL announced an
extension to the deal termination date at the start of the month, the terms of
the extension now allow FGL to solicit competing offers. As a mono-line
fixed (mainly equity-indexed) annuity business with c$20bn of assets, FGL is
a natural fit for Athene. With $1.5bn of excess capital and no financial
leverage, Athene certainly has the balance sheet strength to support such
an acquisition. Athene’s ROE has been depressed by the capital it raised
back in 2015 to fund acquisition(s) – assuming amongst other things that
Athene pays the same price offered by Anbang (c$1.6bn, roughly equivalent
to FGL’s GAAP book value), we estimate a deal would boost Athene’s ROE
by over 200bps and would raise operating EPS by almost 20%. We
continue to believe Athene’s current price/book multiple fails to fully reflect
the significant optionality inherent in its excess capital position, whether or
not this is used specifically for a deal with FGL. Although we have reduced
our holding in AP from the disproportionately large weight to which it had
grown, it is still our fourth largest position reflecting the attractive returns we
anticipate from the unwinding of the 8% discount as the Athene shares it
holds are freed from lock-up and distributed to AP shareholders, and from a
likely upwards re-rating of Athene itself.

We first invested in AP Alternative Assets in mid-2012, attracted by the 40%
discount and management’s unambiguous message that they saw no better
investment than buying back their own shares at such a cheap rating.
Launched in 2006 at a time when US private equity and hedge fund
managers were coming to Europe in search of permanent capital, AP
Alternative Assets was established to co-invest alongside Apollo’s private
equity funds and in its credit and hedge funds, and had just under a third of
its NAV invested in a privately-held life insurance company called Athene.

The financial crisis saw sharp mark-downs in its heavily-levered private
equity investments exacerbated by further leverage at the AP Alternative
level. Apollo’s response was aggressively pro-active, buying up debt issued
by their portfolio companies at deep discounts to par, and the portfolio had
been much stabilised by the time we invested. Late-2012 saw a
restructuring under which AP Alternative injected its investments into Athene
in exchange for additional shares in Athene to effectively become a singleasset
holding company.

We viewed Athene, a pure-play provider of fixed (mainly equity-indexed)
annuities, as an attractive high-growth business with clear and embedded
cost of capital and competitive advantages over peers. We have held and
added materially to our position in AP Alternative since then despite its
shares trading at times at premiums approaching 30% to official reported
NAVs – our analysis suggested the value of Athene was appreciably
undervalued by the official marks at which it was held. Athene’s successful
IPO in the first half of December saw us reduce our position, and we have
since sold some more of our holding. Over the life of our investment to 2016
year-end, the investment in AP Alternative has recorded a return on
investment of 106% and an IRR of 46% (134% and 56% respectively in
GBP).

Our top position, AP Alternative Assets (AAA), was by far our largest
contributor as its sole holding – fixed annuity specialist Athene Insurance –
officially launched its IPO and AAA shares rose 16% (in USD) in response to
add 89bps to our NAV. AAA is distributing 12.5% of its stake in Athene to
AAA shareholders which can then be sold at the IPO. The remaining stake
will be distributed in three separate tranches 7.5 months, 12 months, and 15
months after the IPO. Athene’s indicative IPO pricing range values the
company at $7-$7.8 billion and equates to a value per AAA share of $40-$44
after adjusting for carried interest compared to AAA’s share price of $37 at
month-end. We foresee further upside to Athene shares from this indicative
level given the relatively modest price/book multiple (1.2x-1.3x) it represents
for a company with long-term low cost liabilities locked in place that have
helped generate high historic ROEs, and with a management team that has
demonstrated a consistent ability to add value through M&A. Athene also
benefits from the investment management skills of Apollo and an
advantageous tax structure, has a robust balance sheet with over $1bn of
excess capital and no financial leverage, and has grown book value per
share at a compound rate of 28% annually over the last 5 years. The election
of Donald Trump has proved very timely for Athene, with its listed life
insurance peer group up 16% since the US election on the back of a sharply
higher 10y Treasury yield and speculation that regulation affecting fixed
indexed annuity players such as Athene may be rolled back.

AP Alternative Assets wrote up the
carrying value of its sole remaining asset, Athene Insurance, although we
still believe it is materially undervalued in AP’s NAV, let alone its share
price which trades on a 20% discount to published NAV.

As mentioned in the June newsletter we have been adding to names
where we have seen discount widening. In this regard we added
significantly to AP Alternative Assets (AAA) on weakness. This
Euronext-listed closed-end fund, which has for a number of years now
effectively been a mono-holding company for unlisted Athene
Insurance, is now our 5th largest position. We have consistently valued
Athene at a significant premium to its carrying value in AAA’s NAV, and
envisage material upside upon its New York IPO which should occur
later this year. The majority of our additional purchases of AAA in July were at levels that implied a price/book for Athene of less than 0.9x
while our analysis suggests a ratio of 1.5x can easily be justified.
Shortly after month-end, AAA increased its carrying value for Athene by
almost 20% due in part to guidance received during its IPO process.
We continue to see significant potential for outsized returns even from
this written up value, and more so from AAA’s share price which is at a
20%+ discount to this figure.

AP Alternative Assets was the next largest contributor as its shares
recovered from the effects of a sizable sell order. We had taken
advantage of the pressure on the share price in February to add to our
holding at levels more than 20% below where the share price ended
March. The likely IPO of Athene Insurance later this year should serve
as a catalyst for a further re-rating. Other strong contributors included
Wendel (strong performance from underlying listed holdings, Bureau
Veritas and St Gobain, and 210bps narrowing of discount), Kinnevik
(330bps of discount contraction due to strong results and share
buybacks, of which we expect more given the robust balance sheet),
and Hudson’s Bay (sale of equity in its US REIT which further validates
the value of its real estate).

We still expect AP Alternative (AAA)’s sole remaining asset, annuity
provider Athene Insurance, to IPO later this year. The US Life Insurance
sector has been weak in 2016 on the back of the narrowing 2-10y
Treasury spread and concerns on energy exposure.
AAA’s share price has been knocked back in sympathy, and we added to
our holding at a price that implies a P/B of just 0.8x for Athene despite
its consistently high ROE, its low high-yield energy exposure (27bps of
invested assets), and its $1bn of dry powder available to take advantage
of any M&A opportunities that arise from distress in the sector.

AP Alternative Assets’ shares rose strongly over the month. The 11.5%
jump over the month was boosted further in Sterling terms by a strong
US dollar. Despite the stellar gains already recorded on the position to
date (up almost +200% in less than 3 years), we still see significant
future upside from the company’s sole asset, Athene Insurance. We
expect an IPO of Athene, slated for later this year, to be achieved at a
value substantially in excess of the valuation used by AP Alternative in
its reported NAV.

We first invested in Apollo-managed AP Alternative Assets (AAA) in
August 2012. Since then its shares are up by 170%. We still see
potential for further significant upside. A corporate restructuring in
late 2012 has left AAA with a single holding in Athene Insurance, a
privately held provider of annuities. In April, Athene raised $1bn from
institutional investors in a private placement at a premium to AAA’s
carrying value. The capital raise, double the original target, could lead
to a ratings upgrade which would lower Athene’s cost of funds and
boost its net investment spread. AAA’s shares have moved from trading
at a 42% discount when we acquired our position to a premium of 28%
to reported NAV, which itself is up +40% over our holding period. We
believe the carrying value of 1.1x book for Athene to be too low given
the multiples assigned to listed peers and Athene’s superior ROE. We
expect this value to be unlocked upon an IPO slated to occur no later
than Nov 2015 but which we would be unsurprised to see happen
towards the end of this year.