Everyone wants access to a new private asset class. This is how Apollo helped create it.
When Dominic Bagnoli, chairman and former CEO of US Acute Care Solutions, started speaking to a handful of private equity firms, healthcare systems, and strategic buyers last September, he had two options. One was to sell the entire company or merge it with a strategic buyer. The other was to find a way to acquire the private equity firm Welsh, Carson, Anderson & Stowe, which acquired a 30 percent stake in the acute care provider in 2015.
Bagnoli, an ambulance who founded the medical organization in 1992, was not used to relinquishing control. In fact, almost thirty years before starting the company, he had a belief that patients were far better off turning to a surgeon who owned – and in control of – their practice rather than trusting one who worked for someone else.
A few weeks after meeting a group of potential buyers, Barclays investment banker Richard Landgarten convinced Bagnoli to meet and hear from Apollo. Bagnoli thought he’d get a better deal from a strategic buyer, but Landgarten said Jason Scheir, an associate and head of US hybrid stocks at the private markets firm, had heard of the US Acute Care process and had something different in mind than that Control of equity.
Scheir told Bagnoli that his company would not have to give up control. And Apollo would continue to provide strategic growth advice and capital to make acquisitions and fund other long-term initiatives.
“It’s hard to thread that needle to get the capital so you can deliver the care and service that the health system expects and the communities deserve, with the scale and efficiency required,” said Bagnoli. “And keep control, right? Lots of companies have tried this, and it’s usually easier to throw up your hands and say we can’t be in control anymore. But we were always ready to bet on ourselves, so why change that now? ”
Before closing the deal in February and after months of Zoom calling, Bagnoli flew to New York and met Scheir and the team face-to-face for the first time. Under the agreement, Apollo would invest up to $ 470 million in preferred stock, and US Acute Care Solutions issued $ 375 million in bonds to refinance debt and purchase Welsh Carson. Shareholders received some liquidity and the company received capital for its growth plans. It has already made an acquisition.
The Apollo deal shows how private lending is changing amid increased competition – and Apollo isn’t the only company seeing the opportunity. Other private equity firms, including Blackstone, have begun offering a new form of capital to companies, somewhere between credit and private equity. In credit market jargon, this means that the deals have around 50 to 80 percent loan-to-value. It’s a fundamental shift in the industry that allows access to capital and flexibility in doing business that doesn’t require management teams and boards of directors to give up control of their businesses.
Apollo’s hybrid value business, founded in 2018, grew out of two big changes the company faced.
On the private equity side, CEOs wanted access to capital to deleverage or expand factories without having to sell control of their businesses.
For example, a chemical, financial, or media company would come to an Apollo partner they’d worked with for maybe a decade building the business and say that control isn’t on the table, but they wanted to structure a company Act. Most of these special situations have been turned away.
“At the time, our platform was essentially credit – void – private equity,” said Matt Michelini, the firm’s co-head of hybrid equity, speaking to Institutional investor in Apollo’s New York office. “The problem is that the PE people only had one tool in their toolbox, which is ‘Do you want to get private?'”
Meanwhile, Rob Ruberton, who co-chairs Michelini, said Apollo’s lending business faced tightening spreads and lower yields as direct lending matured as an asset class. The target returns for something like mezzanine rose from 12 to 14 percent in the single digits during the financial crisis.
“So in our lending business we started thinking about what if I didn’t offer the borrower a bond but rather equity; something structured more like a converter or preferred where there is still a decent coupon but with some stock kickers, ”Ruberton said.
Ruberton and his team initially invested some of these new stocks in Apollo’s higher-yielding loan funds, but ultimately the company had to develop a specific strategy.
A foundation chief investment officer who spoke to the co-leaders said that one of the charms of flexible investing like Apollo from an allocator’s perspective is that managers can get the kinds of deals that go into what’s going on in the industry fit larger business world. In March and April 2020, when the pandemic broke out, investors could have bought some assets at emergency selling prices, but the opportunity was short-lived when markets returned.
“Take distressed funds now: managers can’t sit on all the money they’ve raised for too long, so they have to close deals to see if there aren’t any good ones,” said the CIO. “This is not a new problem, but there has to be a solution.”
With resilient capital markets and high government and consumer spending, the strategy is right now for CEOs looking for partners to help them grow. “Today almost all companies play offensively,” said Michelini. “The capital markets feel great; There are many issues, many mergers and acquisitions. But they don’t want to issue stocks – it’s too dilutive. You like to create structured equity and bring in a partner to steer growth. “
The hybrid value unit’s transaction with Albertsons Companies prior to its IPO in late June 2020 was a growth game as grocers benefited from the people locked in their homes. Albertsons also had to replace longtime private equity owner Cerberus Capital Management, who had to return money to shareholders. Knowing that if the locks were lifted, CEO Vivek Sankaran knew that profitability would eventually decline, he wanted Apollo’s help with other growth ideas.
“You have been a great observer and investor on the board as you also understand how to add value by, for example, connecting us with the right people or giving us a macro perspective. At the same time, however, they know where their line ends as an investor and where our line begins as a management team, “said Sankaran II.
As Ruberton explains, Hybrid Value offers companies and investors an alternative to private equity.
“We can give you access to the same resources that you get from a PE fund, but we don’t need control of your boardroom,” he said. For example, CEOs can get support in expanding their sales force, implementing enterprise resource planning, and supporting HR and other corporate resources. Meanwhile, investors get some protection against losses that they would not get in a PE fund. The Apollo team, for example, cordoned off Albertson’s valuable property in case the company got into trouble.
“From the management team’s point of view, it’s not really that different from PE,” said Sankaran. “I see it as I have Apollo as a board member and a major investor in the company. Yes, I will pay a slightly higher dividend on preferred stock for now, but that’s probably temporary as preferred stock will likely convert to common stock over time. “
So far, the hybrid strategy has worked. According to the latest Apollo results, the hybrid stock had a gross internal return of 29 percent and a net IRR of 23 percent. It also works for Apollo, whose net worth recently hit $ 13.1 billion, which was also announced in terms of profits.
But even if the strategy does not “go that far outside the box”, as the head of alternatives at a medium-sized guesthouse said, it does not yet have a natural home for some referring physicians.
“My answer is that is why you should do it,” said Michelini. “Because this point of view is shared by many LPs around the world, it means that there is not much capital after this asset class.”