Hybrid financing: A strategy for all seasons

What’s part debt, part equity and green all over? Hybrid financing, aka, flexible capital.

The hybrid strategy is thriving against a backdrop of higher rates, earnings pressure and a lack of appetite for bank credit. So said Apollo co-president Scott Kleinman on the firm’s first-quarter earnings call in early May.

As if to put a fine point on that, the following week the global alternative asset manager named partner Jason Scheir as co-head of Apollo’s Hybrid Value business, to serve alongside co-head Rob Ruberton. Scheir succeeded Matt Michelini, who has been named head of Asia-Pacific at the firm and its investment committee chair.

Apollo said that Scheir, as head of Hybrid Value US and as a partner with the firm for 15 years, “has excelled as a deal originator, underwriter, Hybrid Value Investment Committee member and team culture leader”.  Among the many deals Scheir has led are Atlas Air, Expedia and Westinghouse.

Scheir had worked with Ruberton, who has been with the firm for 19 years, on distressed credit during the global financial crisis. He then migrated to opportunistic credit and became part of the team that founded the hybrid business in 2017.

Private Debt Investor caught up with Ruberton and Scheir early this month, to discuss the outlook for the strategy – one of those about which Apollo is most bullish.

Ruberton said that hybrid value is in some ways “a natural evolution” of opportunistic credit, which gained popularity in 2015 and 2016 as yields continued to drop and managers were looking at ways to add return for investors in illiquid portfolios.

The current lack of appetite for, and availability of, bank-led syndicated credit is “very favourable” for the hybrid strategy, Scheir said. “A lot of corporates are facing upcoming debt maturities,” he said, adding that sponsors who are seeking to exit and return capital to investors are having a tough time doing so. “All of these factors are leading to an increased demand for a private market solution in structured equity and credit.”

Apollo has two flagship funds as well as several SMAs in its Hybrid Value strategy, which totals $14 billion of AUM, with the most recent fund holding a final close in March 2022 at $4.6 billion – a 40 percent increase from Fund I and above the $4 billion target, per PDI research.

Within the strategy, Apollo has been doing deals of several hundred million into the billions of dollars, including a $1.8 billion deal for food and drug retailer Albertsons, in which HVF led a $1.8 billion structured equity investment of convertible preferred stock in the company. That investment strategically was a strong validation of the business ahead of its public listing.

Through creative structuring and flexible solutions, including non-control and preferred equity, hybrid strategies appeal to companies that “want something with a bit more of a partnership flavour but aren’t willing to go as far as to lose control of their business”, Scheir said. The “hands-on” nature of the strategy renders it more akin to PE investment than credit, said Ruberton.

“When we set up the business, one of our mantras was that we would try to deliver something close to PE returns to our investors but with more downside protection,” said Ruberton.

Apollo’s first hybrid value fund has had an IRR of 19 percent since inception, according to the company’s investor presentation in May. The strategy “is meant to be holistic – a one-stop shop whether you’re playing offense or defence”, said Scheir.

“There’s a lot of demand for this type of capital from borrowers and interest from LPs,” Ruberton said, adding, “We have a lot of years until we hit the peak of growth.”