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The following is an excerpt from a S-1/A SEC Filing, filed by APOLLO GLOBAL MANAGEMENT LLC on 3/21/2011.
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APOLLO GLOBAL MANAGEMENT LLC - S-1/A - 20110321 - MARKET_RISK

Quantitative and Qualitative Disclosures About Market Risk

Our predominant exposure to market risk is related to our role as investment manager for our funds and the sensitivity to movements in the fair value of their investments and resulting impact on carried interest income and management fee revenues. Our direct investments in the funds also expose us to market risk whereby movements in the fair values of the underlying investments will increase or decrease both net gains (losses) from investment activities and income (loss) from equity method investments. For a discussion of the impact of market risk factors on our financial instruments refer to “—Critical Accounting Policies—Consolidation—Valuation of Investments.”

The fair value of our financial assets and liabilities of our funds may fluctuate in response to changes in the value of investments, foreign exchange, commodities and interest rates. The net effect of these fair value changes impacts the gains and losses from investments in our consolidated statements of operations. However, the majority of these fair value changes are absorbed by the Non-Controlling Interests.

The company is subject to a concentration risk related to the investors in its funds. Although there are more than 1,000 limited partner investors in Apollo’s active private equity, capital markets and real estate funds, no individual investor accounts for more than 10% of the total committed capital to Apollo’s active funds.

Risks are analyzed across funds from the “bottom up” and from the “top down” with a particular focus on asymmetric risk. We gather and analyze data, monitor investments and markets in detail, and constantly strive to better quantify, qualify and circumscribe relevant risks.

Each segment runs its own investment and risk management process subject to our overall risk tolerance and philosophy:

 

   

The investment process of our private equity funds involves a detailed analysis of potential acquisitions, and asset management teams assigned to monitor the strategic development, financing and capital deployment decisions of each portfolio investment.

 

   

Our capital markets funds continuously monitor a variety of markets for attractive trading opportunities, applying a number of traditional and customized risk management metrics to analyze risk related to specific assets or portfolios, as well as, fund-wide risks.

Impact on Management Fees— Our management fees are based on one of the following:

 

   

capital commitments to an Apollo fund;

 

   

capital invested in an Apollo fund; or

 

   

the gross, net or adjusted asset value of an Apollo fund, as defined.

Management fees could be impacted by changes in market risk factors and management could consider an investment permanently impaired as a result of (i) such market risk factors cause changes in invested capital or in market values to below cost, in the case of our private equity funds and certain capital markets funds, or (ii) such market risk factors cause changes in gross or net asset value, for the capital markets funds. The proportion of our management fees that are based on NAV is dependent on the number and types of our funds in existence and the current stage of each fund’s life cycle.

Impact on Advisory and Transaction Fees— We earn transaction fees relating to the negotiation of private equity and capital markets transactions and may obtain reimbursement for certain out-of-pocket expenses incurred. Subsequently, on a quarterly or annual basis, ongoing advisory fees, and additional transaction fees in connection with additional purchases or follow-on transactions, may be earned. Management Fee Offsets and any broken deal costs are reflected as a reduction to advisory and transaction fees from affiliates. Advisory and transaction fees will be impacted by changes in market risk factors to the extent that they limit our opportunities

 

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to engage in private equity and capital markets transactions or impair our ability to consummate such transactions. The impact of changes in market risk factors on advisory and transaction fees is not readily predicted or estimated.

Impact on Carried Interest Income— We earn carried interest income from our funds as a result of such funds achieving specified performance criteria. Our carried interest income will be impacted by changes in market risk factors. However, several major factors will influence the degree of impact:

 

   

the performance criteria for each individual fund in relation to how that fund’s results of operations are impacted by changes in market risk factors;

 

   

whether such performance criteria are annual or over the life of the fund;

 

   

to the extent applicable, the previous performance of each fund in relation to its performance criteria; and

 

   

whether each funds’ carried interest income is subject to contingent repayment.

As a result, the impact of changes in market risk factors on carried interest income will vary widely from fund to fund. The impact is heavily dependent on the prior and future performance of each fund, and therefore is not readily predicted or estimated.

Market Risk— We are directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues and expenses will be adversely affected by changes in market conditions. Market risk is inherent in each of our investments and activities, including equity investments, loans, short-term borrowings, long-term debt, hedging instruments, credit default swaps, and derivatives. Just a few of the market conditions that may shift from time to time, thereby exposing us to market risk, include fluctuations in interest and currency exchange rates, equity prices, changes in the implied volatility of interest rates and price deterioration. For example, subsequent to the second quarter of 2007, the debt capital markets around the world began to experience significant dislocation, severely limiting the availability of new credit to facilitate new traditional buyouts. Volatility in the debt and equity markets can impact our pace of capital deployment, the timing of receipt of transaction fee revenues, and the timing of realizations. These market conditions could have an impact on the value of investments and our rates of return. Accordingly, depending on the instruments or activities impacted, market risks can have wide ranging, complex adverse affects on our results from operations and our overall financial condition. We monitor our market risk using certain strategies and methodologies which management evaluates periodically for appropriateness. We intend to continue to monitor this risk going forward and continue to monitor our exposure to all market factors.

Interest Rate Risk— Interest rate risk represents exposure we have to instruments whose values vary with the change in interest rates. These instruments include, but are not limited to, loans, borrowings and derivative instruments. We may seek to mitigate risks associated with the exposures by taking offsetting positions in derivative contracts. Hedging instruments allow us to seek to mitigate risks by reducing the effect of movements in the level of interest rates, changes in the shape of the yield curve, as well as, changes in interest rate volatility. Hedging instruments used to mitigate these risks may include related derivatives such as options, futures and swaps.

Credit Risk— Certain of our funds are subject to certain inherent risks through their investments.

Certain of our entities invest substantially all of their excess cash in open-end money market funds and money market demand accounts, which are included in cash and cash equivalents. The money market funds invest primarily in government securities and other short-term, highly liquid instruments with a low risk of loss. We continually monitor the funds’ performance in order to manage any risk associated with these investments.

Certain of our entities hold derivatives instruments that contain an element of risk in the event that the counterparties may be unable to meet the terms of such agreements. We minimize our risk exposure by limiting

 

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the counterparties with which we enter into contracts to banks and investment banks who meet established credit and capital guidelines. We do not expect any counterparty to default on its obligations and therefore do not expect to incur any loss due to counterparty default.

Foreign Exchange Risk— Foreign exchange risk represents exposures we have to changes in the values of current holdings and future cash flows denominated in other currencies and investments in non-U.S. companies. The types of investments exposed to this risk include investments in foreign subsidiaries, foreign currency-denominated loans, foreign currency-denominated transactions, and various foreign exchange derivative instruments whose values fluctuate with changes in currency exchange rates or foreign interest rates. Instruments used to mitigate this risk are foreign exchange options, currency swaps, futures and forwards. These instruments may be used to help insulate us against losses that may arise due to volatile movements in foreign exchange rates and/or interest rates.

Non-U.S. Operations— We conduct business throughout the world and are continuing to expand into foreign markets. We currently have offices in London, Frankfurt, Luxembourg, Mumbai, Hong Kong and Singapore, and have been strategically growing our international presence. Our investments and revenues are primarily derived from our U.S. operations. With respect to our non-U.S. operations, we are subject to risk of loss from currency fluctuations, social instability, changes in governmental policies or policies of central banks, expropriation, nationalization, unfavorable political and diplomatic developments and changes in legislation relating to non-U.S. ownership. We also invest in the securities of corporations which are located in non-U.S. jurisdictions. As we continue to expand globally, we will continue to focus on monitoring and managing these risk factors as they relate to specific non-U.S. investments.

Sensitivity

Our assets and unrealized gains, and our related equity and net income are sensitive to changes in the valuations of our funds’ underlying investments and could vary materially as a result of changes in our valuation assumptions and estimates. See “—Critical Accounting Policies—Valuation of Investments” for details related to the valuation methods that are used and the key assumptions and estimates employed by such methods. We also quantify the Level III investments that are included on our consolidated statements of financial condition by valuation methodology in “—Fair Value Measurements.” We employ a variety of valuation methods of which no single methodology is used to value our consolidated investments more than any other methodology. Furthermore, the investments that we manage but are not on our consolidated statements of financial condition, and therefore impact carried interest, also employ a variety of valuation methods of which no single methodology is used more than any other. A 10% change in any single key assumption or estimate that is employed by any of the valuation methodologies that we use will not have a material impact on our financial results. As described in “—Quantitative and Qualitative Disclosures About Market Risk,” changes in fair value will have the following impacts before a reduction of profit sharing expense and Non-Controlling Interests in the Apollo Operating Group and on a pre-tax basis on our results of operations for the years ended December 31, 2010 and 2009:

 

   

Management fees from the funds in our capital markets segment are based on the net asset value of the relevant fund, gross assets, capital commitments or invested capital, each as defined in the respective management agreements. Changes in the fair values of the investments in capital markets funds that earn management fees based on net asset value or gross assets will have a direct impact on the amount of management fees that are earned. Management fees from our capital markets funds that were dependent upon estimated fair value during the years ended December 31, 2010 and 2009 would increase or decrease by approximately $9.3 million and $8.0 million, respectively, after assuming that the fair values of the investments held by such funds were 10% higher or lower during the same respective periods.

 

   

Management fees for our private equity funds range from 0.65% to 1.5% and are charged on either (a) a fixed percentage of committed capital over a stated investment period or (b) a fixed percentage of invested capital of unrealized portfolio investments. Changes in values of investments could indirectly affect future management fees from private equity funds by, among other things, reducing the funds’

 

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access to capital or liquidity and their ability to currently pay the management fees or if such change resulted in a write-down of investments below their associated invested capital.

 

   

Management fees earned from AAA and its affiliates range between 1.0% and 1.25% of AAA adjusted assets, defined as invested capital plus proceeds of any borrowings of AAA Investments, plus its cumulative distributable earnings at the end of each quarterly period (taking into account actual distributions but excluding the management fees relating to the period or any non-cash equity compensation expense), net of any amount AAA pays for the repurchase of limited partner interests, as well as capital invested in Apollo funds and temporary investments and any distributable earnings attributable thereto. Management fees earned from AAA Investments during the years ended December 31, 2010 and 2009 would increase or decrease by approximately $1.4 million and $1.0 million, respectively, if the fair values of the investments held by AAA Investments were 10% higher or lower during the same respective periods.

 

   

Carried interest income from most of our capital markets funds, which are quantified above under “—Results of Operations” and “—Segment Analysis,” are impacted directly by changes in the fair value of their investments. Carried interest income from most of our capital markets funds generally is earned based on achieving specified performance criteria. We anticipate that a 10% decline in the fair values of investments held by all of the capital markets funds at December 31, 2010 and 2009 would decrease consolidated carried interest income for the years ended December 31, 2010 and 2009 by approximately $131.9 million and $55.2 million, respectively. Additionally, the changes to carried interest income from most of our capital markets business assume there is no loss in the fund for the relevant period. If the fund had a loss for the period, no carried interest income would be earned by us. By contrast, a 10% increase in fair value would increase consolidated carried interest income for the years ended December 31, 2010 and 2009 by approximately $163.4 million and $74.3 million, respectively.

 

   

Carried interest income from private equity funds generally is earned based on achieving specified performance criteria and is impacted by changes in the fair value of their fund investments. We anticipate that a 10% decline in the fair values of investments held by all of the private equity funds at December 31, 2010 and 2009 would decrease consolidated carried interest income for the years ended December 31, 2010 and 2009 by $934.7 million and $130.8 million, respectively. The effects on private equity fees and income assume that a decrease in value does not cause a permanent write-down of investments below their associated invested capital. By contrast, a 10% increase in fair value would increase consolidated carried interest income for the year ended December 31, 2010 and 2009 by $484.4 million and $130.8 million, respectively.

 

   

For select Apollo funds, our share of investment income as a limited partner in such funds is derived from unrealized gains or losses on investments in funds included in the consolidated financial statements. For funds in which we have an interest, but are not included in our consolidated financial statements, our share of investment income is limited to our accrued compensation units and direct investments in the funds, which ranges from 0.006% to 12.2%. A 10% decline in the fair value of investments at December 31, 2010 and 2009 would result in an approximately $28.3 million and $18.9 million, respectively, decrease in investment income at the consolidated level.

Recent Accounting Pronouncements

A list of recent accounting pronouncements that are relevant to Apollo and its industry are included in note 2 to our consolidated financial statements included elsewhere in this prospectus.

Off-Balance Sheet Arrangements

In the normal course of business, we engage in off-balance sheet arrangements, including transactions in derivatives, guarantees, commitments, indemnifications and potential contingent repayment obligations. See note 16 to our consolidated financial statements included elsewhere in this prospectus, for a discussion of guarantees and contingent obligations.

 

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Contractual Obligations, Commitments and Contingencies

As of December 31, 2010, the company’s material contractual obligations consist of lease obligations, contractual commitments as part of the ongoing operations of the funds and debt obligations. In addition, on a historical basis, the company had the contractual obligations of the consolidated funds while the capital commitments to these funds were substantially eliminated in consolidation. Fixed and determinable payments due in connection with these obligations are as follows:

 

     2011      2012      2013      2014      2015      Thereafter      Total  
     (in thousands)  

Operating lease obligations

   $ 36,002       $ 23,646       $ 22,878       $ 22,528       $ 14,100       $ 40,155       $ 159,309   

Other long-term obligations (1)

     17,067         7,242         4,766         3,548         3,548         3,548         39,719   

AMH credit facility (2)

     33,987         33,339         32,926         87,864         80,567         651,798         920,481   

CIT secured loan agreement (3)

     2,426         2,362         20,858         —           —           —           25,646   
                                                              

Total Obligations as of December 31, 2010

   $ 89,482       $ 66,589       $ 81,428       $ 113,940       $ 98,215       $ 695,501       $ 1,145,155   
                                                              

 

(1) Includes (i) payments on management service agreements related to certain assets and (ii) payments with respect to certain consulting agreements entered into by Apollo Investment Consulting, LLC. Note that a significant portion of these costs are reimbursable by funds of portfolio companies.
(2) $723.3 million, net ($995.0 million portion less amount repurchased) of the AMH credit facility matures in January 2017 and $5.0 million matures in April 2014. Amounts represent estimated interest payments until the loan matures using an estimated weighted average annual interest rate of 4.39%, which includes the effects of the interest rate swap through its expiration in May 2012 and certain required repurchases of at least $50.0 million by December 31, 2014 and at least $100.0 million (inclusive of the previously purchased $50.0 million) by December 31, 2015 as described in note 12 to our consolidated financial statements included elsewhere in this prospectus.
(3) The company intends to sell its interest in certain assets related to the CIT secured loan agreement. Upon the sale, the company will satisfy the loan associated with the related asset which the company approximates to be $12.2 million.

 

Note: Due to the fact that the timing of certain amounts to be paid cannot be determined or for other reasons discussed below, the following contractual commitments have not been presented in the table above.

 

(i) Amounts do not include the senior secured revolving credit facility entered into by AAA’s investment vehicle, of which $537.5 million was utilized as of December 31, 2010. The credit facility matures on June 1, 2012. AAA is consolidated by the company in accordance with U.S. GAAP. The company does not guarantee and has no legal obligation to repay amounts outstanding under the credit facility. Accordingly, the $537.5 million outstanding balance was excluded from the table above.

 

(ii) As noted previously, we have entered into a tax receivable agreement with our managing partners and contributing partners which requires us to pay to our managing partners and contributing partners 85% of any tax savings received by APO Corp. from our step-up in tax basis. The tax savings achieved may not ensure that we have sufficient cash available to pay this liability and we might be required to incur additional debt to satisfy this liability.

 

(iii) Debt amounts related to the consolidated VIEs are not presented in the table above as the company is not a guarantor of these non-recourse liabilities.

 

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Contingent Obligations —Carried interest income in our private equity funds and certain capital markets and real estate funds is subject to reversal in the event of future losses to the extent of the cumulative carried interest recognized in income to date. If all of the existing investments and receivables from these investments were liquidated at zero values, the amounts of cumulative revenues that have been recognized by Apollo through December 31, 2010 that would be reversed approximates $2.5 billion. Management views the possibility of liquidating all existing investments at zero values as remote. Carried interest income is affected by changes in the fair values of the underlying investments in the funds that we manage. Valuations, on an unrealized basis, can be significantly affected by a variety of external factors including, but not limited to, bond yields and industry trading multiples. Movements in these items can affect valuations quarter to quarter even if the underlying business fundamentals remain stable. The table below indicates only the potential future reversal of carried interest income.

 

     December 31, 2010  
     (in thousands)  

Fund VI

   $ 661,400   

Fund VII

     628,800   

Fund IV

     523,800   

Fund V

     307,813   

COF I

     149,039   

COF II

     76,799   

SOMA

     34,363   

AIE II

     26,168   

ACLF

     24,964   

AAA

     12,587   

SVF

     6,755   

VIF

     5,710   
        

Total

   $ 2,458,198   
        

 

Note: EPF has not incurred or paid carried interest income as of December 31, 2010.

Additionally, at the end of the life of the funds there could be a payment due to a fund by the company if the company has received more carried interest than was ultimately earned. The general partner obligation amount, if any, will depend on final realized values of investments at the end of the life of the fund.

Certain funds may not generate carried interest income as a result of unrealized and realized losses that are recognized in the current and prior reporting period. In certain cases, carried interest income will not be generated until additional unrealized and realized gains occur. Any appreciation would first cover the deductions for invested capital, unreturned organizational expenses, operating expenses, management fees and priority returns based on the terms of the respective fund agreements.

 

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I NDUSTRY

Asset Management

Overview

Asset management involves the management of investments on behalf of investors in exchange for a fee, and often cases include incentive income based upon the financial performance of investments. Asset managers employ a variety of investment strategies, which fall into two broad categories: traditional asset management and alternative asset management. The key differences between traditional asset managers and alternative asset managers primarily relate to investment strategies, return objectives, compensation structure and investor access to funds.

Traditional asset managers, such as mutual fund managers, engage in managing and trading investment portfolios of equity, fixed income, derivative securities and commodities. The investment objectives of these portfolios may include total return, capital appreciation, current income and/or replicating the performance of a particular index. Managers of such portfolios are compensated on a predetermined fee based on a percentage of the assets under management, generally substantially independent of performance. Performance measurement of traditional funds is typically against given benchmark market indices and peer groups over various time periods. Investors in traditional funds generally have unrestricted access to their funds either through market transactions in the case of closed-end mutual funds and exchange traded funds, or through withdrawals in the case of open-end mutual funds and separately managed accounts.

Alternative asset managers such as managers of hedge funds, private equity funds, venture capital funds, real estate funds, mezzanine funds and distressed investment funds, utilize a variety of investment strategies to achieve returns within certain stipulated risk parameters and investment criteria. These returns are evaluated on an absolute basis, rather than benchmarked in relation to an index. The compensation structure for alternative asset managers may include management fees on committed or contributed capital, transaction and advisory fees as capital is invested (typically for private equity funds) and carried interest or incentive fees tied to achieving certain absolute return hurdles. Unlike traditional asset managers, alternative asset managers may limit investors’ access to funds once committed or invested until the investments have been realized.

The asset management industry has experienced significant growth in worldwide assets under management in the past decade, fueled by growth in pension assets and savings globally. According to the Boston Consulting Group, as cited in their July 2009 report, “Conquering the Crisis—Global Asset Management 2009” (Copyright, The Boston Consulting Group, Inc. 2009), the total value of assets under management globally reached an estimated $48.6 trillion in 2008, an 18% decline from 2007. This sharp decline followed average growth of 12% per year from 2002 through 2007. According to the Winter 2009-10 Global Private Equity Barometer published by Coller Capital, which polled 108 private equity investors from around the world, by the end of 2010, 31% of North American investors are likely to have total commitments in excess of their target private equity allocations, with only one quarter of North American investors and one third of European investors expecting their actual percentage of total assets invested in private equity to be lower than their target by the end of 2010. Furthermore, the global search for yield continues to drive alternative asset growth as portfolio allocations to alternatives have nearly tripled to 19% during the past decade based on data accumulated by Towers Watson and published in their global pension asset study in February 2011.

According to Pensions & Investments Online, the top five public pension funds in the United States had on average approximately 85% of their portfolios allocated to equities, fixed income, real estate and cash, compared to approximately 15% allocated to private equity, credit opportunities and emerging markets. As of December 31, 2010, the 10-year returns for equities, fixed income and real estate were 1.4%, 5.8% and 7.4%, respectively. The equity returns are based on the S&P 500 index, the fixed income returns are based on the Barclays Aggregate Bond Index and the real estate returns are based on the NCREIF National Index. By contrast, the 10-year net return for private equity was 8.1% based on the Cambridge Associates LLC U.S. Private Equity Index ® as of September 30, 2010, and the 10-year return for credit opportunities and emerging markets were 8.6% and 15.9%, respectively, as of December 31, 2010 based on the Merrill Lynch High Yield Master II index and the MSCI Emerging Markets Free Index, respectively. Based on the Cambridge Associates LLC U.S. Private Equity Index ® 10-year net return for private equity as of September 30, 2010, Apollo estimates that the top quartile of the private equity industry generated a 16.1% net annual return during the last 10 years.

 

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Private Equity

Private equity funds raise pools of capital from institutional investors, such as insurance companies and pension and endowment funds, as well as high net worth individuals. These funds typically seek to acquire controlling or influential ownership interests in businesses. Private equity funds typically invest in the common equity or preferred stock of private and sometimes those of public companies.

Private equity funds are typically structured as unregistered limited partnership funds with terms of typically eight to ten years, and can contain provisions to extend the life of the fund under certain circumstances. Investors in private equity funds provide a commitment to the fund that is called by the fund as investments are made and equity capital is required. Private equity fund managers typically are compensated as follows: (i) management fees based on the amount of invested or committed capital, (ii) transaction and advisory fees as capital is invested and portfolio companies are managed and (iii) a carried interest in the profits of the fund, which is often subject to a preferred return for investors, or “hurdle.”

The objective of a private equity fund is to earn attractive returns on its investment commensurate with the risk being taken. The returns come either in the form of capital gains upon realization of the fund’s underlying investments, or in the form of income, such as interest, dividends or fees. Private equity funds aim to realize their capital gain on an underlying business by either selling the business or selling its shares in the public markets. Since time is required to implement the value growth strategy for the business, private equity investments tend to be held for three or more years, although typical hold periods vary according to market conditions.

Private equity funds may seek to enhance returns through the use of financial leverage, which led to the term “leveraged buyout,” or “LBO.” In the course of acquiring a business, a private equity fund will utilize capital that it has raised from its investors to pay for a portion of the transaction value and will typically borrow the remaining proceeds. In leveraged buyouts, the borrowings typically constitute the majority of funds used to pay the transaction value, generally ranging from 60% to 80% of the purchase price.

Prior to the current global economic downturn, global private equity activity had increased significantly in recent years. According to Thomson Financial as of December 31, 2010, European LBO volume set a new record in 2006 at $234 billion but recorded lower volume in 2007 of $154 billion; additionally, Europe surpassed the U.S. market in buyout activity in 2008 with $52 billion in volume compared to the U.S. market’s $35 billion. Both the U.S. and Europe recorded lower LBO levels in 2009 of $18 billion and $20 billion, respectively, with the U.S. already at higher levels in 2010 with $80 billion. The same source indicates that in 2006 the Asia-Pacific region increased its LBO volume significantly to reach $20 billion, though 2007 Asia-Pacific LBO volume was down from that record high to $6 billion with 2008 volume further declining to $3 billion but had a minor recovery in 2010 of $6 billion. Conditions in the debt markets had been very favorable in 2006 through the first half of 2007; however, beginning in the second half of 2007, the markets experienced a serious contraction in the availability of debt financing for traditional LBO transactions resulting in a significant decline of such transactions in 2008 and the first half of 2009. The use of leverage increases both the potential risk and potential reward of investments, including assets purchased in LBOs. The chart below shows global LBO volume from 2000 through 2010.

Global LBO Volume ($ billions)

LOGO

Source: Thomson Financial as of February 7, 2011

 

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Over the past two decades, from 1989 to 2009, the upper quartile of private equity funds has, in the aggregate, outperformed the S&P 500 Index by about 20.2% per year net of management fees, partnership expenses and fund managers’ carried interest, according to Thomson Financial. During the last 20 years, the private equity industry has generated a 13% net annual return, as measured by Cambridge Associates LLC U.S. Private Equity Index ® , using the most recent private equity industry data available through September 30, 2010. The 13% return represents an end-to-end pooled mean net to limited partners (i.e., net of fees, expenses and carried interest) for private equity investors in the United States. Based on this information, Apollo estimates that the top quartile of the private equity industry generated a 20% net annual return during the last 20 years.

In 2005 through 2007, U.S. buyout and mezzanine inflows experienced significant growth, with more money raised in each of these three years than the cumulative funds raised in the previous three years, according to Thomson Financial (Buyouts Magazine, January 7, 2008). More recently, however, private equity and mezzanine fundraising has experienced a significant slowdown as institutional investors have become over-allocated to alternative investments as a result of declines in the overall values of their public portfolios, which has exceeded the decline in value of their private investments as well as a reduction in the value of cash realizations from their investments in private equity, mezzanine and real estate funds.

As displayed in the chart below, the pace of private equity fundraising had accelerated dramatically in the past few years prior to the current global economic downturn. The duration and impact of the current economic environment on private equity and mezzanine fundraising in the future is unknown.

U.S. LBO and Mezzanine Fundraising ($ billions)

LOGO

Source: Thomson Financial (Various issues of Buyouts Magazine)

Record fundraising, together with historically high levels of liquidity in the debt capital markets, was a key driver of large private equity transactions. The scope of transaction size and complexity has also grown, often requiring several private equity firms to form a consortium to acquire a specific target. The above source reports that in 2007 alone, there were six completed LBOs with transaction values exceeding $20 billion. According to Thomson Financial as of December 31, 2010, private equity transactions increasingly comprised a larger percentage of total merger and acquisition transaction dollar volume, with financial sponsor activity reaching 19.5% of U.S. volume in 2007, particularly as large public-to-private transactions had become more prevalent. However, the same source indicates a decrease in financial sponsor activity in the wake of recent credit turmoil as LBO transactions represented only 2.5% and 10.2% of U.S. merger and acquisition transaction dollar volume in 2009 and 2010, respectively. As a result, private equity fund managers are focused on managing their existing portfolio companies and are evaluating non-control transactions such as private investments in public equity, or “PIPE.” According to PrivateRaise’s “PIPE Market Blurb,” there have been approximately 3,976 PIPEs since the beginning of 2008 with over $195 billion of capital invested.

 

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Mezzanine Funds

Mezzanine funds are investment vehicles that invest primarily in mezzanine securities, typically high-yielding long-term subordinated loans or preferred stock that may include an equity component or feature, such as warrants or co-investment rights, to enhance returns for the lender. Mezzanine lending is related to the volume of financial sponsor-driven transactions. This form of financing is most frequently utilized in the buyout of middle-market and smaller public companies.

There are several factors that are commonly believed to have contributed to the expansion of mezzanine investing over the past decade. The broad-based consolidation of the U.S. financial services industry over the past two decades has significantly reduced the number of FDIC-insured financial institutions. In recent years, this is believed to have caused many senior lenders to de-emphasize their service and product offerings to middle market businesses in favor of lending to larger corporate clients and managing larger capital markets transactions. As a result, many middle-market firms have faced increased difficulty raising debt from commercial lenders, thus creating demand for alternative sources of financing such as mezzanine debt financing. Additionally, over the past several years, the availability of large pools of capital has increased as mutual funds, private equity funds and hedge funds have all experienced significant growth. In particular, we believe that there is a considerable amount of un-invested private equity capital that will seek mezzanine capital to support investments in middle market companies being made by the private equity capital.

Given the fragmented nature of the mezzanine market, capital providers of mezzanine financing include a broad array of companies. Early mezzanine lenders include traditional investment management firms, investment arms of major companies and insurance companies. Growth in demand for such capital has encouraged various capital providers to enter this market over the last decade, including private equity firms, hedge funds, high-yield debt investors, business development companies and investment banks with dedicated mezzanine funds.

Distressed Funds

Distressed funds typically engage in the purchase or short sale of securities of companies where the price has been, or is expected to be, affected by a distressed situation. This may involve reorganizations, bankruptcies, distressed sales or other corporate restructurings. Investment opportunities arise in the market for distressed securities because holders of previously sound instruments find themselves in possession of creditor claims of uncertain value and, therefore, under pressure to dispose of them.

Investments are made for both the short-and long-term and are both active and passive with respect to participation in restructuring and company operations. In a distressed buyout, the investor works proactively through the restructuring process to equitize its debt position and gain control of the company with the objective of achieving a large return via a turnaround. A second strategy, more common among hedge funds, is to hold a position in a distressed debt security with the expectation that improved performance will lead to a run-up in the price of the debt instrument that will result in high short-term internal rate of return.

 

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The chart below from the Fourth Quarter 2010 HFR Industry Report shows that the distressed investing industry experienced increased net asset flow during the recessionary period of 2002, during which stock market valuations were relatively depressed, there was an increase in the number of corporate distressed sellers of assets who needed to raise cash and company earnings had decreased. However, in light of the current global economic downturn, which is more severe than the one experienced in 2002, the distressed investing industry experienced declines in net asset flows in both 2008 and 2009, but the trend has started to reverse in 2010.

Estimated Growth of Assets/ Net Asset Flow Distressed / Restructuring ($ billions)

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Source: HFR Industry Reports © HFR, Inc., Fourth Quarter 2010, www.hedgefundresearch.com

Hedge Funds

Hedge funds are privately held and unregistered investment vehicles managed with the primary aim of delivering positive risk-adjusted returns under various market conditions. Hedge funds differ from traditional asset managers such as mutual funds by the asset classes in which they invest and/or the investment strategies they employ. Asset classes in which hedge funds invest may include liquid and illiquid securities, asset-backed securities, pools of loans and bonds or other financial assets. Hedge funds also employ a variety of strategies that may include short selling, equity long-short convertible arbitrage, fixed income arbitrage, merger arbitrage, event-driven, global macro and other quantitative strategies. The strategies may employ use of leverage, hedges, swaps and other derivative instruments.

Hedge funds are typically structured as limited partnerships, limited liability companies or offshore corporations. Hedge fund managers earn a base management fee typically based on the net asset value of the fund and incentive fees based on a percentage of the fund’s profits. Some hedge funds set a “hurdle rate” under which the fund manager does not earn an incentive fee until the fund’s performance exceeds a benchmark rate. Another feature common to hedge funds is the “high water mark” under which a fund manager does not earn incentive fees until the net asset value exceeds the highest historical value on which incentive fees were last paid. Typical investors include high net worth individuals and institutions. These investors can invest and withdraw funds periodically in accordance with the terms of the funds, which may include lock-up periods on withdrawals. Hedge fund managers often commit a portion of their own capital in the funds they manage to align their interests with the investors.

 

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According to the Fourth Quarter 2010 HFR Industry Report, as of December 31, 2010, there were 9,237 hedge funds in existence globally. The same report shows global assets under management in the hedge fund industry have grown by approximately 22% annually since 1990 to exceed $1.9 trillion at December 31, 2010. Net asset inflows in 2007 increased to a record high of $195 billion, but reversed course in 2008 and 2009 with net asset outflows of $154 billion and $131 billion, respectively. As of December 31, 2010, the industry has shown signs of recovering with $55 billion of inflows. The chart below shows hedge fund assets under management from 1990 through 2010.

Hedge Fund Assets Under Management ($ billions)

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Source: HFR Industry Reports © HFR, Inc., Fourth Quarter 2010, www.hedgefundresearch.com

 

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B USINESS

Overview

Founded in 1990, Apollo is a leading global alternative asset manager. We are contrarian, value-oriented investors in private equity, credit-oriented capital markets and real estate, with significant distressed expertise. We have a flexible mandate in the majority of the funds we manage that enables the funds to invest opportunistically across a company’s capital structure. We raise, invest and manage funds on behalf of some of the world’s most prominent pension and endowment funds, as well as other institutional and individual investors. As of December 31, 2010, we had AUM of $67.6 billion in our private equity, capital markets and real estate businesses. Our latest private equity fund, Fund VII, held a final closing in December 2008, raising a total of $14.7 billion. Fund VII began investing in January 2008 and has deployed $7.8 billion of capital through December 31, 2010, generating gross and net IRRs of 46% and 32%, respectively, during this period. We have consistently produced attractive long-term investment returns in our private equity funds, generating a 39% gross IRR and a 26% net IRR on a compound annual basis from inception through December 31, 2010. A number of our capital markets funds have also performed well since their inception through December 31, 2010.

Over our more than 20-year history of investing, we have grown to become one of the largest alternative asset managers in the world and attribute our historical success to the following key competitive strengths:

 

   

our track record of generating attractive long-term risk-adjusted returns in our private equity investment funds;

 

   

our integrated business model which combines the strength of our businesses and the intellectual capital base of the global Apollo franchise to create a sustainable competitive advantage;

 

   

our expertise in distressed investing and ability to invest capital and grow AUM throughout economic cycles;

 

   

our deep industry knowledge and expertise with complex transactions;

 

   

our collaboration with our portfolio company management teams;

 

   

our creation of an “edge” in investing by combining our core industry expertise, comfort with complexity and use of strategic platforms to create proprietary investment opportunities;

 

   

our long-standing investor relationships that include many of the world’s most prominent alternative asset investors;

 

   

our strong management team, brand name and reputation; and

 

   

our long-term capital base.

Apollo is led by our managing partners, Leon Black, Joshua Harris and Marc Rowan, who have worked together for more than 20 years and lead a team of 485 employees, including 171 investment professionals, as of December 31, 2010. This team possesses a broad range of transaction, financial, managerial and investment skills. We have offices in New York, Los Angeles, London, Frankfurt, Luxembourg, Singapore, Hong Kong and Mumbai. We operate our private equity, capital markets and real estate businesses in an integrated manner, which we believe distinguishes us from other alternative asset managers. Our investment professionals frequently collaborate across disciplines. We believe that this collaboration, including market insight, management, banking and consultant contacts, as well as investment opportunities, enables us to more successfully invest across a company’s capital structure. For a discussion of the risks associated with this approach, see “Risk Factors—Risks Related to Our Businesses—Possession of material, non-public information could prevent Apollo funds from undertaking advantageous transactions; our internal controls could fail; we could determine to establish information barriers.” This platform and the depth and experience of our investment team have enabled us to deliver strong long-term investment performance in our private equity funds throughout a range of economic cycles. For example, Apollo’s most successful private equity funds (in terms of net IRR), Funds I, II, MIA and

 

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Fund V, were initiated during economic downturns. Funds I, II and MIA, which generated a combined gross IRR of 47% and a combined net IRR of 37% on a compound annual basis since inception through the date of the disposition of their final investment on September 30, 2004, were initiated during the economic downturn of 1990 through 1993 and Fund V, which generated a gross IRR of 62% and a net IRR of 45% on a compound annual basis since inception through December 31, 2010, was initiated during the economic downturn of 2001 through late 2003. We began investing our latest private equity fund, Fund VII, in January 2008 in the midst of the current economic downturn. Similarly, with respect to our capital markets business, our flagship Value Funds, which were launched in 2003 and 2006, have also delivered attractive returns since inception through a range of economic cycles.

Our objective is to achieve superior long-term risk-adjusted returns for our fund investors. The majority of our investment funds are designed to invest capital over periods of seven or more years from inception, thereby allowing us to generate attractive long-term returns throughout economic cycles. Our investment approach is value-oriented, focusing on nine core industries in which we have considerable knowledge, and emphasizing downside protection and the preservation of capital. We are frequently contrarian in our investment approach, which is reflected in a number of ways, including:

 

   

our willingness to invest in industries that our competitors typically avoid;

 

   

the often complex structures we employ in some of our investments, including our willingness to pursue difficult corporate carve-out transactions;

 

   

our experience investing during periods of uncertainty or distress in the economy or financial markets when many of our competitors simply reduce their investment activity;

 

   

our orientation towards sole sponsored transactions when other firms have opted to partner with others; and

 

   

our willingness to undertake transactions that have substantial business, regulatory or legal complexity.

We have applied this investment philosophy over our more than 20-year history, allowing us to identify what we believe are attractive investment opportunities, deploy capital across the balance sheet of industry leading, or “franchise,” businesses and create value throughout economic cycles.

During the most recent global economic crisis, which we believe began in the third quarter of 2007, we have been relying on our deep industry, credit and financial structuring experience, coupled with our strengths as value-oriented, distressed investors, to deploy a significant amount of new capital. As examples of this, from the beginning of the third quarter of 2007 through December 31, 2010, we have invested approximately $24 billion of capital across our private equity and capital markets funds focused on control distressed and buyout investments, leveraged loan portfolios and mezzanine, non-control distressed and non-performing loans. In addition, from the beginning of the fourth quarter of 2007 through December 31, 2010, the funds managed by Apollo have acquired approximately $13.5 billion in face value of distressed debt at discounts to par value and purchased approximately $30.7 billion in face value of leveraged senior loans at discounts to par value from financial institutions. Since we purchased these leveraged loan portfolios from highly motivated sellers, we were able to secure attractive long-term, low cost financing and select credits of companies well known to Apollo. The benchmark S&P/LSTA Leveraged Loan Index, which includes a group of securities we believe is similar to those owned by our funds, had a net return of approximately 6% during the life to date performance of our leveraged loan investments (COF I and COF II), which have exceeded this benchmark.

As in prior market downturns and periods of significant volatility, we have been purchasing distressed securities and continue to opportunistically build positions in high quality companies with stressed balance sheets in industries where we have expertise such as cable, chemicals, packaging and transportation. Our approach towards investing in distressed situations often requires us to purchase particular debt securities as prices are declining, since this allows us both to reduce our average cost and accumulate sizable positions which may

 

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enhance our ability to influence any restructuring plans and maximize the value of our distressed investments. As a result, our investment approach may produce negative short-term unrealized returns in certain of the funds we manage. However, we concentrate on generating attractive, long-term, risk-adjusted realized returns for our fund investors, and we therefore do not overly depend on short-term results and quarterly fluctuations in the unrealized fair value of the holdings in our funds.

In addition to deploying capital in new investments, we have been depending on our over 20 years of experience to enhance value in the current investment portfolio of the funds we manage. We have been relying on our restructuring and capital markets experience to work proactively with our funds’ portfolio company management teams to generate cost and working capital savings, reduce capital expenditures, and optimize capital structures through several means such as debt exchange offers and the purchase of portfolio company debt at discounts to par value. For example, as of December 31, 2010, Fund VI and its underlying portfolio companies purchased or retired approximately $18.7 billion in face value of debt and captured approximately $9.3 billion of discount to par value of debt in portfolio companies such as CEVA Logistics, Caesars Entertainment, Realogy and Momentive Performance Materials. In certain situations, such as CEVA Logistics, funds managed by Apollo are the largest owner of the total outstanding debt of the portfolio company. In addition to the attractive return profile associated with these portfolio company debt purchases, we believe that building positions as senior creditors within the existing portfolio companies is strategic to the existing equity ownership positions. Additionally, the portfolio companies of Fund VI have implemented approximately $3.0 billion of cost savings programs on an aggregate basis from the date we acquired them through December 31, 2010, which we believe will positively impact their operating profitability.

Since the beginning of 2007, we have experienced significant globalization and expansion of our investment management activities. We have grown our global network by opening offices in Frankfurt, Luxembourg, Singapore, Hong Kong and Mumbai. During this period through December 31, 2010, we have also launched a new private equity fund, a new strategic investment account investing in CMBS and a commercial real estate finance company, as well as several new capital markets funds and leveraged investment vehicles. In addition, we completed the acquisition of a real estate investment management group. These vehicles had a combined AUM of $43.9 billion as of December 31, 2010. In addition, in order to more fully leverage our long history of investing in the real estate sector, we continue to hire senior members of the real estate team. Similar to the growth and evolution of our real estate business, we expect to continue to grow our company by applying our value-oriented approach across related investment categories which we believe have synergies with our core business and provide attractive opportunities for us to continue to expand our equity base.

Our financial performance during the past five years reflects our growth achievements. Total AUM grew from approximately $25 billion as of December 31, 2006 to approximately $68 billion as of December 31, 2010, resulting in an approximate CAGR of 28%. Total revenues, reported on a combined segment basis, grew from approximately $0.7 billion during the year ended December 31, 2006 to approximately $2.1 billion during the year ended December 31, 2010, resulting in an approximate CAGR of 32%. Total management fees, reported on a combined segment basis, grew from approximately $204 million during the year ended December 31, 2006 to approximately $431 million during the year ended December 31, 2010, resulting in an approximate CAGR of 21%, and finally, economic net income grew from approximately $377 million during the year ended December 31, 2006 to approximately $1,351 million during the year ended December 31, 2010, resulting in an approximate CAGR of 38%. See “Risk Factors—Risks Related to Our Businesses—We may not be successful in raising new funds or in raising more capital for certain of our funds and may face pressure on fee arrangements of our future funds.”

 

 

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In addition, we benefit from mandates with long-term capital commitments in our private equity, capital markets and real estate businesses. Our long-lived capital base allows us to invest assets with a long-term focus, which is an important component in generating attractive returns for our investors. We believe our long-term capital also leaves us well-positioned during economic downturns, when the fundraising environment for alternative assets has historically been more challenging than during periods of economic expansion. As of December 31, 2010, approximately 91% of our AUM was in funds with a contractual life at inception of seven years or more, and 10% of our AUM was in permanent capital vehicles with unlimited duration, as highlighted in the chart below:

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We expect our growth in AUM to continue over time by seeking to create value in our funds’ existing private equity, capital markets and real estate investments, continuing to deploy our available capital in what we believe are attractive investment opportunities, and raising new funds and investment vehicles as market opportunities present themselves. See “Risk Factors—Risks Related to Our Businesses—We may not be successful in raising new funds or in raising more capital for certain of our funds and may face pressure on fee arrangements of our future funds.”

 

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Our Businesses

We have three business segments: private equity, capital markets and real estate. We also manage (i) AAA, a publicly listed permanent capital vehicle, which invests substantially all of its capital in or alongside Apollo-sponsored entities, funds and other investments, and (ii) several strategic investment accounts established to facilitate investments by third-party investors directly in Apollo-sponsored funds and other transactions. We may also seek to raise natural resources funds that target global private equity opportunities in energy, metals and mining and select other natural resources sub-sectors. The diagram below summarizes our current businesses:

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(1) All data is as of December 31, 2010. The chart does not reflect legal entities or assets managed by former affiliates.
(2) Includes three funds that are denominated in Euros and translated into U.S. dollars at an exchange rate of €1.00 to $1.34 as of December 31, 2010.

Our financial results are highly variable, since carried interest (which generally constitutes a large portion of the income from the funds we manage), and the transaction and advisory fees that we receive, can vary significantly from quarter to quarter and year to year. We manage our business and monitor our performance with a focus on long-term performance, an approach that mirrors the investment horizons of the funds we manage and is driven by the investment returns of our funds.

Private Equity

Private Equity Funds

Our private equity business had total and fee-generating AUM of $38.8 billion and $27.9 billion, respectively, as of December 31, 2010. Our private equity business grew total and fee-generating AUM by a 25.9% and 37.3% CAGR, respectively, from December 31, 2004 through December 31, 2010. Our private equity fee-generating AUM grew by an approximately 26% CAGR from December 31, 2007 through December 31, 2010. From our inception in 1990 through December 31, 2010, our private equity business invested approximately $34.6 billion of capital. As of December 31, 2010, our private equity funds had $10.3 billion of available capital commitments, providing us with a significant source of capital for future investment activities. Since inception through December 31, 2010, the returns of our private equity funds have performed in the top quartile for all U.S. buyout funds, as measured by Thomson Financial, and have outperformed the top quartile by over two times on average. Our private equity funds have generated a gross IRR of 39% and a net IRR of 26% on a compound annual basis from inception through December 31, 2010, as compared with a total annualized return of 7% for the S&P 500 Index over the same period. See “Management’s Discussion and Analysis of Financial

 

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Condition and Results of Operations—The Historical Investment Performance of Our Funds” for reasons why our historical private equity returns are not indicative of the future results you should expect from our current and future funds or from us.

As a result of our long history of private equity investing across market cycles, we believe we have developed a unique set of skills which we rely on to make new investments and to maximize the value of our existing investments. As an example, through our experience with traditional private equity buyouts, we apply a highly disciplined approach towards structuring and executing transactions, the key tenets of which include acquiring companies at below industry average purchase price multiples, and establishing flexible capital structures with long-term debt maturities and few, if any, financial maintenance covenants.

We believe we have a demonstrated ability to adapt quickly to changing market environments and capitalize on market dislocations through our traditional, distressed and corporate buyout approach. In prior periods of strained financial liquidity and economic recession, our private equity funds have made attractive investments by buying the debt of quality businesses (which we refer to as “classic” distressed debt), converting that debt to equity, seeking to create value through active engagement with management and ultimately monetizing the investment. This combination of traditional and corporate buyout investing with a “distressed option” has been deployed through prior economic cycles and has allowed our funds to achieve attractive long-term rates of return in different economic and market environments. At December 31, 2010, our private equity funds had $9.2 billion of remaining capital at work from investments that were made during the period June 30, 2007 through December 31, 2009, which includes $2.6 billion of follow-on investments made in 2010. The realized and unrealized value of these investments was $5.5 billion and $14.5 billion, respectively, at December 31, 2010. See “Risk Factors—Risks Related to Our Businesses—Difficult market conditions may adversely affect our businesses in many ways, including by reducing the value or hampering the performance of the investments made by our funds or reducing the ability of our funds to raise or deploy capital, each of which could materially reduce our revenue, net income and cash flow and adversely affect our financial prospects and condition.”

In addition, during prior economic downturns we have relied on our restructuring experience and worked closely with our funds’ portfolio companies to maximize the value of our funds’ investments. For example, during the economic downturn during 2001-2003, we successfully restructured several of the portfolio companies in Fund IV that were experiencing financial difficulties, and as a result, Fund IV was able to generate a gross IRR of 11% and a net IRR of 9% on a compound annual basis from inception through December 31, 2010. During this same time period, we relied on our credit market expertise to deploy approximately 54% of the capital from Fund V, primarily in distressed for control situations, and this fund generated a gross IRR of 62% and a net IRR of 45% on a compound annual basis as of December 31, 2010. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Historical Investment Performance of Our Funds” for a discussion of the reasons we do not believe our future IRRs will be similar to the IRRs for Fund V.

Traditional Buyouts

Traditional buyouts have historically comprised the majority of our investments. We generally target investments in companies where an entrepreneurial management team is comfortable operating in a leveraged environment. We also pursue acquisitions where we believe a non-core business owned by a large corporation will function more effectively if structured as an independent entity managed by a focused, stand-alone management team. Our leveraged buyouts have generally been in situations that involved consolidation through merger or follow-on acquisitions; carveouts from larger organizations looking to shed non-core assets; situations requiring structured ownership to meet a seller’s financial goals; or situations in which the business plan involved substantial departures from past practice to maximize the value of its assets. Some of our traditional buyout investments include Compass Minerals International in 2001, Nalco Investment Holdings and United Agri Products in 2003, Intelsat in 2004, Berry Plastics in 2006, Smart & Final in 2007 and Caesars Entertainment in 2008.

 

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Distressed Buyouts and Debt Investments

Over our more than 20-year history, approximately 44% of our private equity investments have involved distressed buyouts and debt investments. We target assets with high quality operating businesses but low-quality balance sheets, consistent with our traditional buyout strategies. The distressed securities we purchase include bank debt, public high-yield debt and privately held instruments, often with significant downside protection in the form of a senior position in the capital structure, and in certain situations we also provide DIP financing to companies in bankruptcy. Our investment professionals generate these distressed buyout and debt investment opportunities based on their many years of experience in the debt markets, and as such they are generally proprietary in nature.

We believe distressed buyouts and debt investments represent a highly attractive risk/reward profile. Our investments in debt securities have generally resulted in two outcomes. The first has been when we succeed in taking control of a company through its distressed debt. By working proactively through the restructuring process, we are able to equitize our debt position, resulting in a well-financed buyout. Once we control the company, the investment team works closely with management toward an eventual exit, typically over a three- to five-year period as with a traditional buyout. The second outcome for debt investments has been when we do not gain control of the company. This is typically driven by an increase in the price of the debt beyond what is considered an attractive acquisition valuation. The run-up in bond prices is usually a result of market interest or a strategic investor’s interest in the company at a higher valuation than we are willing to pay. In these cases, we typically sell our securities for cash and seek to realize a high short-term internal rate of return. Some of our distressed buyout investments during economic downturns include Vail Resorts in 1991, Telemundo in 1992, SpectraSite in 2003, Cablecom in 2003, Charter Communications in 2009, Gala Coral in 2010 and LyondellBasell in 2010.

Corporate Partner Buyouts

Corporate partner buyouts offer another way to capitalize upon investment opportunities during environments in which purchase prices for control of companies are at high multiplies of earnings, making them less attractive for traditional buyout investors. Corporate partner buyouts focus on companies in need of a financial partner in order to consummate acquisitions, expand product lines, buy back stock or pay down debt. In these investments, we do not seek control but instead make significant investments that typically allow us to demand control rights similar to those that we would require in a traditional buyout, such as control over the direction of the business and our ultimate exit. Although corporate partner buyouts historically have not represented a large portion of our overall investment activity, we do engage in them selectively when we believe circumstances make them an attractive strategy.

Corporate partner buyouts typically have lower purchase multiples and a significant amount of downside protection, when compared with traditional buyouts. Downside protection can come in the form of seniority in the capital structure, a guaranteed minimum return from a creditworthy partner, or extensive governance provisions. Importantly, Apollo has often been able to use its position as a preferred security holder in several buyouts to weather difficult times in a portfolio company’s lifecycle and to create significant value in investments that otherwise would have been impaired. Some of our corporate partner buyouts include Sirius Satellite Radio in 1998, Educate in 2000, AMC Entertainment in 2001 and Oceania Cruises (now Prestige Cruise Holdings) in 2007.

Other

In addition to our traditional, distressed and corporate partner buyout activities, we also maintain the flexibility to deploy capital of our private equity funds in other types of investments such as the creation of new companies, which allows us to leverage our deep industry and distressed expertise and collaborate with experienced management teams to seek to capitalize on market opportunities that we have identified, particularly in asset-intensive industries that are in distress. In these types of situations, we have the ability to establish new entities that can acquire distressed assets at what we believe are attractive valuations without the burden of managing an existing portfolio of legacy assets. Similar to our corporate partner buyout activities, other

 

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investments, such as the creation of new companies, historically have not represented a large portion of our overall investment activities, although we do make these types of investments selectively. Examples of our other investments include Vantium in 2007 and Veritable Maritime in 2010.

Our Recent Buyouts

The following table presents the buyouts made by Fund VI and Fund VII from 2006 to 2010.

 

Company

  Year of Initial
Investment
    Fund(s)    

Buyout Type

 

Industry

  Region     Invested
Capital (1)
    Sole
Financial
Sponsor
 
                              (in millions)        

Alcan

    2010        Fund VII      Corporate Partner   Materials     Western Europe      $ 177        Yes   

Athlon

    2010        Fund VII      Other   Oil & Gas     North America        27        Yes   

Twin River

    2010        Fund VII      Distressed   Gaming & Leisure     North America        3        No   

CKE Restaurants Inc.

    2010        Fund VII     

Traditional

 

Food Retail

    North America        436        Yes   

Evertec

    2010        Fund VII      Traditional   Banking     Puerto Rico        184        No   

LyondellBasell

    2010        Fund VI & VII    

Distressed

 

Chemicals

    Global        1,509        No   

Aleris International

    2010        Fund VI & VII     

Distressed

 

Building Products

    Global        163        No   

Gala Coral Group

    2010        Fund VI & VII     

Distressed

 

Gaming & Leisure

    Western Europe        117        No   

Monier

    2010        Fund VII     

Distressed

 

Building Products

    Western Europe        67        No   

Veritable Maritime

    2010        Fund VII      Other   Shipping     North America        189        Yes   

Charter Communications

    2009        Fund VI & VII    

Distressed

 

Media, Entertainment & Cable

    North America        975        No   

Parallel Petroleum

    2009        Fund VII     

Traditional

 

Oil & Gas

    North America        273        Yes   

Dish TV

    2009        Fund VII      Other   Media, Entertainment & Cable     India        101        No   

Skylink

    2008        Fund VII     

Traditional

 

Logistics

    North America        58        Yes   

Caesars Entertainment

    2008        Fund VI     

Traditional

 

Gaming & Leisure

    North America        1,454        No   

Norwegian Cruise Line

    2008        Fund VI     

Corporate Partner

 

Cruise

    North America        830        Yes   

Vantium

    2007        Fund VII      Other   Business Services     North America        683        Yes   

Smart & Final

    2007        Fund VI     

Traditional

 

Food Retail

    North America        262        Yes   

Noranda Aluminum

    2007        Fund VI     

Traditional

 

Materials

    North America        215        Yes   

Countrywide

    2007        Fund VI     

Traditional

 

Real Estate Services

    Western Europe        417        Yes   

Claire’s

    2007        Fund VI     

Traditional

 

Specialty Retail

    Global        498        Yes   

Prestige Cruise Holdings (2)

    2007        Fund VI & VII     

Corporate Partner

 

Cruise

    North America        985        Yes   

Realogy

    2007        Fund VI     

Traditional

 

Real Estate Services

    North America        1,050        Yes   

Jacuzzi Brands

    2007        Fund VI     

Traditional

 

Building Products

    Global        112        Yes   

Verso Paper

    2006        Fund VI     

Traditional

 

Paper Products

    North America        261        Yes   

Berry Plastics (3)

    2006        Fund VI     

Traditional

 

Packaging

    North America        347        Yes   

Momentive Performance Materials (6)

    2006        Fund VI     

Traditional

 

Chemicals

    North America        609        Yes   

CEVA Logistics (4)

    2006        Fund VI     

Traditional

 

Logistics

    Western Europe        423        Yes   

Rexnord (5)

    2006        Fund VI     

Traditional

 

Diversified Industrial

    North America        714        Yes   
                   

Total

           

 

 

 

$13,139

 

  

 
                   

 

(1) Invested capital amounts are amounts invested by Fund VI and Fund VII as part of the buyout in equity and securities that can be converted into equity. Fund VI and Fund VII investments include AAA and Palmetto co-investments, where applicable.

 

(2) In connection with its acquisition of Regent Seven Seas Cruises, Oceania Cruise Holdings, Inc. changed its name to Prestige Cruise Holdings.

 

(3) Prior to the merger with Covalence.

 

(4) Includes add-on investment in EGL, Inc.

 

(5) Includes add-on investment in Zurn.

 

(6) In the fourth quarter of 2010, Momentive Performance Materials Holdings Inc. and Momentive Specialty Chemicals Holdings LLC (formerly known as Hexion LLC) finalized an agreement to merge, effective October 1, 2010.

Building Value in Portfolio Companies

We are a “hands-on” investor and remain actively involved with the operations of our buyout investments for the duration of the investment. As a result of our organization around core industries, and our extensive network of executives and other industry participants, we are able to actively participate in building value for our portfolio of investments. Following an investment, the deal team that executed the transaction focuses its role on functioning as a catalyst for business-transforming events and participates in all significant decisions to develop and support management in the execution of each portfolio company’s business strategy. In connection with this strategy, we have established relationships with operating executives that assist in the diligence review of new opportunities and provide strategic and operational oversight for portfolio investments. In addition, we have established a group purchasing program to leverage the combined corporate spending among Apollo and portfolio companies of the funds it manages in order to seek to reduce costs, optimize payment terms and improve service levels for all program participants.

 

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Exiting Investments

We realize the value of the investments that we have made on behalf of our funds typically through either an initial public offering, or IPO, of common stock on a nationally recognized exchange or through the private sale of the companies in which we have invested. The advantage of having long-lived funds and complete investment discretion is that we are able to time our exit when we believe we may most easily maximize value. We rigorously review the ongoing business plan for each portfolio company and determine if we believe we can continue to compound increases in equity value at acceptable rates of return. Generally, if we believe we can, we continue to hold and manage the investment and if we do not, we seek to exit. We also monitor the debt capital markets closely, which often times provides windows of opportunity to reduce risk in an investment by recouping a large portion of our investment through a leveraged recapitalization. We sponsored the IPOs of 12 of our portfolio companies from January 1, 2002 through the date of this prospectus, as summarized in the table below. We believe that a track record of successful IPOs facilitates access to the public markets in exiting fund investments.

Private Equity Sponsored IPOs

The following table summarizes the breakdown of our private equity sponsored IPOs from January 1, 2002 through the date of this prospectus.

 

Company

   Fund    Date of
Initial
Investment
   IPO
Date

Noranda Aluminum

   Fund VI    May-07    May-10

Metals USA

   Fund V    Nov-05    Apr-10

Verso Paper

   Fund VI    Aug-06    May-08

Goodman Global Holdings

   Fund V    Dec-04    Apr-06

Hughes Communications

   Fund IV    Jan-06    Feb-06

United Agri Products

   Fund V    Nov-03    Nov-04

Educate

   Fund IV    Jul-00    Sep-04

Compass Minerals International

   Fund V    Nov-01    Dec-03

Nalco Investment Holdings

   Fund V    Nov-03    Nov-04

QDI (Quality Distribution)

   Fund III    Jun-98    Nov-03

National Financial Partners

   Fund IV    Jan-99    Sep-03

Pacer International

   Fund IV    May-99    Jun-02

Our Recent Private Equity Funds

The following charts summarize the breakdown of our funds’ private equity investments by type and industry from our inception through December 31, 2010.

 

Private Equity Investments by Type   Private Equity Investments by Industry
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  * Includes investments in special purpose entities that invest in debt-related securities of companies included in multiple industries.

 

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Among our more recent funds, Fund V, with $3.7 billion of committed capital, started investing during the economic downturn of 2001 through late 2003. This fund has generated a gross IRR of 62% and a net IRR of 45% from our first investment in April 2001 to December 31, 2010. It has already returned nearly $11.0 billion to investors through December 31, 2010. At December 31, 2010, Fund V had an estimated unrealized value of $1.8 billion. This performance was generated during an initial period of economic distress followed by substantial economic and capital markets expansion, which we believe illustrates our ability to use our flexible investment approach to generate returns across a range of economic environments. Fund V is in the top quartile of similar vintage funds according to Thomson Financial.

With $10.1 billion of committed capital as of December 31, 2010, Fund VI has invested or committed to invest approximately $11.4 billion through December 31, 2010. Currently, the Fund VI portfolio includes 18 companies, all but five of which are transactions where we were the sole financial sponsor, eight of which were proprietary in nature (meaning deals that arise other than from winning a competitive auction process), five of which were complex corporate carveouts and all of which were in industries well known to us. The Fund VI portfolio also includes debt investment vehicles formed by our affiliates to invest in debt securities to take advantage of volatility in the credit markets.

Fund VI has generated a gross IRR of 13% and a net IRR of 10% from the first investment in July 2006 to December 31, 2010 and has already returned approximately $3.7 billion to investors. We believe these IRRs reflect the early stage nature of Fund VI, the impact of applying mark-to-market valuations to the portfolio of investments, and the impact of the current global economic downturn on the performance of our funds’ investments. While we cannot predict the length and severity of the current global economic downturn and the impact it will ultimately have on our funds’ portfolio investments, as in past recessionary periods we are relying on our restructuring and distressed investing experience to work proactively with our funds’ portfolio company management teams to generate cost and working capital savings, reduce capital expenditures, divest non-core business lines and optimize capital structures through several means such as debt exchange offers and the purchase of portfolio debt at discounts to par. As of December 31, 2010, Fund VI and its underlying portfolio companies purchased or retired approximately $18.7 billion of debt and captured approximately $9.3 billion of discount to par value of debt in portfolio companies such as CEVA Logistics, Caesars Entertainment, Realogy and Momentive Performance Materials. In certain situations, such as CEVA Logistics, funds managed by Apollo are the largest owner of the total outstanding debt of the portfolio company. In addition to the attractive return profile associated with these portfolio company debt purchases, we believe that building positions as senior creditors within the existing portfolio companies is strategic to the existing equity ownership positions from the date of acquisition through December 31, 2010. Portfolio companies of Fund VI have also implemented approximately $3.0 billion of cost savings programs on an aggregate basis, which we believe will positively impact their operating profitability.

Our most recent private equity fund, Fund VII, closed with $14.7 billion in commitments in December 2008. Fund VII began investing in January 2008 and has deployed $7.8 billion of capital through December 31, 2010, generating gross and net IRRs of 46% and 32%, respectively, during this period. Approximately 43% of the deployed invested capital has been invested in debt investments.

Capital Markets

Since Apollo’s founding in 1990, we believe our capital markets expertise has served as an integral component of our company’s growth and success. Our credit-oriented capital markets operations commenced in 1990 with the management of a $3.5 billion high-yield bond and leveraged loan portfolio. Since that time, our capital markets activities have grown significantly, and leverage Apollo’s integrated platform and utilize the same disciplined, value-oriented investment philosophy that we employ with respect to our private equity funds. Our capital markets operations are led by James Zelter, who has served as the managing director of the capital markets business since April 2006. Our capital markets business had total and fee-generating AUM of $22.3 billion and $16.5 billion, respectively, as of December 31, 2010 and grew its total and fee-generating AUM by a 55.8% and 48.5% CAGR, respectively, from December 31, 2004 through December 31, 2010.

 

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Our credit-oriented capital markets funds have been established to capitalize upon our investment experience and deep industry expertise. We seek to participate in capital markets businesses where we believe our industry expertise and experience can be used to generate attractive investment returns. As depicted in the chart below, our capital markets activities span a broad range of the credit spectrum, including non-performing loans, distressed debt, mezzanine debt, senior bank loans and “value-oriented” fixed income.

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The value-oriented fixed income segment of the capital markets spectrum is the most recent investment area for Apollo, and it is characterized by its ability to generate attractive risk-adjusted returns relative to traditional fixed income investments. An example of our value-oriented fixed income investments is Athene Asset Management. We established Athene Asset Management, which is substantially owned by a subsidiary of Apollo, to provide asset management services to Athene Life Re and other third parties. Athene Life Re is an Apollo sponsored vehicle formed to focus on opportunities in the life reinsurance sector. Athene Life Re sources, analyzes and negotiates the acquisition of fixed annuity policies from primary insurance companies. As of December 31, 2010, Athene Asset Management had approximately $2.0 billion of AUM, $0.3 billion of which was included in our real estate segment.

As of December 31, 2010, our capital markets funds included six distressed and event-driven hedge funds with total AUM of $2.8 billion, three mezzanine funds with total AUM of $4.5 billion, seven senior credit funds with total AUM of $11.2 billion, and a European non-performing loan fund with total AUM of $1.9 billion. Our capital markets segment includes strategic investment accounts and also Athene Asset Management.

Distressed and Event-Driven Hedge Funds

We currently manage six distressed and event-driven hedge funds that invest primarily in North America, Europe and Asia. These funds had a total of $2.8 billion in AUM as of December 31, 2010. Investors can invest in several of our distressed and event-driven hedge funds as frequently as monthly. Our distressed and event-driven hedge funds utilize similar value-oriented investment philosophies as our private equity business and are focused on capitalizing on our substantial industry and credit knowledge. In addition to owning the companies that manage our distressed and event-driven hedge funds, the Apollo Operating Group holds the general partner interests in the general partners of each of these funds.

Value Funds. We are the investment managers for our flagship distressed Value Funds, which utilize similar investment strategies. The Value Funds seek to identify and capitalize on absolute-value driven investment opportunities. VIF began investing capital in October 2003 and is currently closed to new investors. SVF began investing capital in June 2006 and is currently open to new investors. The Value Funds had a combined net asset value of approximately $880.5 million as of December 31, 2010, and had a net return of 65.9% since inception and 12.2% for the year ended December 31, 2010. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Historical Investment Performance of Our Funds” for reasons why future performance by the Value Funds might fall short of their historical performance.

 

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The Value Funds’ flexible investment strategy primarily focuses on investments in distressed companies before, during, or after a restructuring, as well as undervalued securities. Investments are executed primarily through the purchase or sale of senior secured bank debt, second lien debt, high yield debt, trade claims, credit derivatives, preferred stock and equity. In addition to owning the companies that manage the Value Funds, the Apollo Operating Group holds the general partner interests in the general partners of each of these funds. As of December 31, 2010, the Value Funds’ investments were primarily located in North America. North American investments comprised approximately 72% of the portfolio, with the remaining 28% of the total portfolio being investments made internationally.

The following charts break down the Value Funds’ portfolio by investment type and industry as of December 31, 2010:

 

Value Funds Portfolio by Investment Type

  

Value Funds Portfolio Investments by Industry

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SOMA.  SOMA is a private investment fund we formed to manage for one of our Strategic Investors. SOMA seeks to generate attractive risk-adjusted returns through investment in distressed opportunities, primarily in North America and Europe. This fund’s primary mandate is a very similar investment strategy to our Value Funds and is currently managed by the same investment professionals. SOMA began investing capital in March 2007 and represents a commitment by one of our Strategic Investors of $800.0 million. The fund had a net asset value of approximately $1,062.5 million as of December 31, 2010, including $833.5 million in the primary mandate, which had a net return of 40.7% since inception and 16.9% for the year ended December 31, 2010.

Asian Credit-Oriented Hedge Fund (AAOF) . AAOF is an investment vehicle that seeks to generate attractive risk-adjusted returns throughout economic cycles by capitalizing on investment opportunities in the Asian markets, excluding Japan, and targeting event-driven volatility across capital structures, as well as opportunities to develop proprietary platforms. AAOF began investing capital in February 2007. We believe our experienced Asia team has unique access to private deals throughout Asia. The fund primarily invests in the securities of public and private companies in need of capital for acquisitions, refinancing, monetization of assets and distressed financings and other special situations. AAOF primarily focuses on two core strategies, event driven investments and strategic opportunity investments. We believe the investment team’s local expertise is complemented by Apollo’s global reach across its core industry verticals. The fund’s first investment was made in February 2007. The fund had a net asset value of approximately $313.6 million as of December 31, 2010, and had a net return of 15.8% since inception and 12.5% for the year ended December 31, 2010.

Mezzanine Funds

We manage U.S. and European-based mezzanine funds and related investment vehicles with total AUM of $4.5 billion as of December 31, 2010, including: (i) AIC, a U.S.-based permanent capital vehicle, is a publicly traded, closed-end, non-diversified management investment company that has elected to be treated as a business development company under the Investment Company Act and to be treated for tax purposes as a regulated investment company under the Internal Revenue Code; (ii) AIE I, which is an unregistered private closed-end

 

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investment fund formed in June 2006; and (iii) AIE II, which is an unregistered private closed-end investment fund formed in April 2008, that seek to capitalize upon mezzanine and subordinated debt opportunities with a focus on Western Europe.

Apollo Investment Corporation . AIC’s common stock is quoted on the NASDAQ Global Select Market under the symbol “AINV” and is currently a component of the S&P MidCap 400 index. AIC raised over $900 million of permanent investment capital through its initial public offering on the NASDAQ in April 2004. As of December 31, 2010, AIC had a total AUM of $3.7 billion. Since that time, AIC has successfully completed several secondary offerings and raised approximately $1.9 billion of incremental permanent investment capital. Since inception in April 2004 through December 31, 2010, the annualized return on AIC’s net asset value was 5.3%, and as of December 31, 2010, AIC’s net asset value was approximately $1.9 billion. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Historical Investment Performance of Our Funds” for reasons why future AIC returns might fall short of its historical performance. AIC has the ability to incur indebtedness by issuing senior securities in amounts such that its asset coverage equals at least 200% after each such issuance.

Set forth in the chart below are the market values and yields of the AIC portfolio since inception.

AIC Portfolio Growth and Yield Since Inception

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For comparison purposes, the average yield of the Bank of America Merrill Lynch US High Yield CCC and Lower Rated index and the Bank of America Merrill Lynch US High Yield B rated index was 9% as of December 31, 2010. The AIC portfolio growth and yield information above is also as of December 31, 2010 and is presented for illustrative purposes only and is no guarantee of the future success of AIC.

 

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The charts below break down AIC’s portfolio by investment type and industry as of December 31, 2010.

 

AIC Portfolio by Investment Type

 

AIC Portfolio Investments by Industry

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European Mezzanine Funds (AIE I and AIE II) . AIE I and AIE II are unregistered private closed-end investment funds formed in June 2006 and April 2008, respectively, that seek to more fully capitalize upon mezzanine and subordinated debt opportunities with a primary focus on Western Europe. As of December 31, 2010, AIE I and AIE II had an investment portfolio of approximately 70% in secured and unsecured subordinated loans (also referred to as mezzanine loans), senior secured loans and high-yield debt.

As of December 31, 2010, AIE I had an investment portfolio of approximately $124 million at market value, based on an exchange rate of €1.00 to $1.34 as of such date. Due to market conditions in 2008 and early 2009, AIE I’s investment performance was adversely impacted, and on July 10, 2009, its shareholders approved a monetization plan, the primary objective of which is to maximize shareholder recovery value by (i) opportunistically selling AIE I’s assets over a three-year period from July 2009 to July 2012 (subject to a one-year extension with the consent of a majority of AIE I’s shareholders) and (ii) reducing the overall costs of the fund. The reduction of costs included a management fee waiver of $12.6 million for the year ended December 31, 2008 and an additional $2.0 million for the year ended December 31, 2009. Furthermore, management fees from AIE I are currently based on a reduced rate of 1.5% of the net assets of AIE I. Prior to the approval of the monetization plan, management fees were based on 2% of the gross assets of AIE I. The company has no future plans to reserve for additional management fees charged to AIE I or to lower the current management fee arrangement. Subject to compliance with applicable law and maintaining adequate liquidity, available cash received from the sale of assets will be returned to shareholders on a quarterly basis once all leverage in the fund is repaid.

The investment objective of AIE II is to generate both capital appreciation and current income through debt and equity investments. Within a flexible overall investment approach, AIE II utilizes a disciplined approach that seeks to evaluate the appropriate part of the capital structure in which to invest based on the risk/reward profile of the investment opportunity. AIE II invests primarily in European mezzanine investments, with a primary focus in Western Europe. AIE II participates in both the primary and secondary credit markets based on the relative attractiveness of each at any given time.

 

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As of December 31, 2010, AIE II had an investment portfolio of approximately $409.9 million at market value based on an exchange rate of €1.00 to $1.34 as of such date, and had a net return of 64.7% since inception and 28.9% for the year ended December 31, 2010. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Historical Investment Performance of Our Funds” for reasons why AIE II’s returns might decrease from its historical performance and the historical performances of our other funds. The net return since inception for AIE II is based on the net cumulative change in net assets from the inception of the fund through December 31, 2010 as a percentage of aggregate capital contributions and is not a geometric return. AIE II’s net returns are net of all fees and expenses and exclude performance allocations, if any, to the general partner. The charts below break down the portfolio of AIE II by investment type and industry as of December 31, 2010.

 

AIE II Portfolio by Investment Type

 

AIE II Portfolio Investments by Industry

 

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Senior Credit Funds

We manage seven senior credit funds with total AUM of $11.2 billion as of December 31, 2010. We began to establish these funds, which are primarily oriented towards the acquisition of leveraged loans and other performing senior debt, in late 2007 and 2008, in order to capitalize upon the supply-demand imbalances in the leveraged finance market. Since that time, we have been actively investing these funds and have established new senior credit funds. Our senior credit funds together with our private equity funds and certain other capital markets funds, as of December 31, 2010, have deployed approximately $27.4 billion, including leverage, in senior credit investments. We believe these funds benefit from the broad range of investment opportunities that arise as a result of our deep industry and credit expertise. As the opportunity set continues to evolve, we expect we will continue to offer this fund series to capitalize primarily upon senior credit opportunities in the market. The following funds comprise the majority of our senior credit funds’ AUM.

COF I. COF I began investing in April 2008 and, as of December 31, 2010, had aggregate capital commitments of approximately $1.5 billion, primarily from one of our Strategic Investors. COF I principally invests, through privately negotiated transactions, in senior secured debt instruments, including bank loans and bonds, as well as opportunistically investing in a variety of other public and private debt instruments such as DIP financings, rescue or “bridge” financings, and other debt instruments. COF I may use leverage to finance portfolio investments, including as incurred by the fund’s subsidiaries or special-purpose vehicles, and may enter into credit facilities or other debt transactions to leverage its investments.

Our capital commitment to COF I is equal to 1.9% of the aggregate capital commitments of COF I’s limited partners (without regard to any co-investment commitments). COF I is closed to additional investors. As of December 31, 2010, COF I had a net asset value of approximately $2.1 billion.

COF II. COF II began investing in June 2008 and has aggregate capital commitments of approximately $1.6 billion as of the date hereof. COF II principally invests, through privately negotiated transactions, in senior secured debt instruments, including bank loans and bonds, as well as opportunistically investing in a variety of other public and private debt instruments such as debtor-in-possession (DIP) financings, rescue or “bridge”

 

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financings, and other debt instruments. COF II may use leverage to finance portfolio investments, including as incurred by the fund’s subsidiaries or special-purpose vehicles, and may enter into credit facilities or other debt transactions to leverage its investments.

Our capital commitment to COF II is equal to 1.4% of the aggregate capital commitments of COF II’s limited partners (without regard to any co-investment commitments). COF II is closed to additional investors. As of December 31, 2010, COF II had a net asset value of $1.9 billion.

ACLF. ACLF began investing capital in October 2007 and held its final closing on November 13, 2007 with initial aggregate capital commitments of $681.6 million. Subsequent to the final closing, ACLF accepted additional commitments of $302.4 million, raising the aggregate capital commitments to $984.0 million by December 10, 2008. ACLF invests principally in senior secured bank debt and debt related securities in the United States and Western Europe. Additionally, up to 20% of ACLF’s capital commitments may be invested in other types of debt and debt related securities, including non-senior bank debt, publicly traded debt securities, “bridge” financings and the equity tranche of any collateralized debt obligation fund sponsored by Apollo or others. Investments may be effected using a wide variety of investment types and transaction structures, including the use of derivatives or other credit instruments, such as credit default swaps, total return swaps and any other credit securities or other credit instruments.

Our capital commitment to ACLF is equal to 2.4% of the aggregate capital commitments of ACLF’s limited partners (without regard to any co-investment commitments). ACLF is closed to additional investors. As part of the initial closing of ACLF, Apollo closed on a co-investment vehicle that has the capacity to invest alongside ACLF on a pre-determined proportionate basis in senior debt investments, which we refer to as ACLF Co-Invest. As of December 31, 2010, ACLF had net assets of $764.8 million and was primarily invested in debt-related securities and various derivative instruments.

Artus. Artus closed on October 19, 2007 with aggregate capital commitments of $106.6 million, including a commitment from one of our Strategic Investors. In November 2007, Artus purchased certain collateralized loan obligations. The collateralized loan obligations are secured by a diversified pool of approximately $0.7 billion in aggregate principal amount of United States dollar denominated commercial loans and cash as of December 31, 2010. As a result of the global credit crisis, the pace of ratings downgrades, defaults and mark-to-market volatility increased dramatically throughout 2008 and the first quarter of 2009, putting pressure on the expected performance of loan portfolios in general. The portfolio in Artus is well diversified, and contains 95% first lien bank loans.

Non-Performing Loan Fund

The Apollo European Principal Finance Fund (EPF). EPF is an investment fund launched in May of 2007 that invests principally in European NPLs. NPLs are loans held by financial institutions that are in default of principal or interest payments for 90 days or more. We estimate that the size of the European NPL market is more than €1 trillion. Investment banks have traditionally been the biggest buyers of NPLs, but almost all of these firms either no longer exist or have exited the business during the past few years. In addition, despite the market size and decrease in natural competition, high barriers to entry have limited, and we believe will continue to limit, the amount of credible competitors. We believe EPF is uniquely positioned to capitalize on this opportunity through its 14 professionals based in London, Frankfurt, Madrid and Dublin, combined with its captive pan-European loan servicing and property management platform, The Lapithus Group, or “Lapithus.” Lapithus operates in 5 European countries and is directly servicing approximately 50,000 loans secured by more than 4,500 commercial and residential properties. As of December 31, 2010, EPF has portfolio investments throughout Europe with its largest concentration in the United Kingdom, Germany, Spain and Portugal.

EPF has approximately €1.3 billion ($1.7 billion using an exchange rate of €1.00 to $1.34 as of December 31, 2010) in total equity commitments. EPF is structured with many characteristics typically associated with private equity funds, including multi-year capital commitments from the fund’s investors.

 

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Through December 31, 2010, the fund had invested approximately €935 million ($1.25 billion using an exchange rate of €1.00 to $1.34 as of December 31, 2010) in 14 NPL portfolios and three ancillary investments and has received net proceeds of approximately 37% of invested capital. EPF had a net asset value of approximately $1.12 billion as of December 31, 2010 based on an exchange rate of €1.00 to $1.34 as of such date. In addition to owning the company that manages EPF, the Apollo Operating Group holds the general partner interest in the general partner of EPF.

Real Estate

We have assembled a dedicated team to pursue real estate investment opportunities, which we refer to as AGRE and which we believe benefits from Apollo’s long-standing history of investing in real estate-related sectors such as hotels and lodging, leisure, and logistics. AGRE, which includes 38 investment professionals as of December 31, 2010, is led by Joseph Azrack, who joined Apollo in 2008 with 30 years of real estate investment management experience, serving most recently as President and CEO of Citi Property Investors.

We believe our dedicated real estate platform benefits from, and contributes to, Apollo’s integrated platform, and further expands Apollo’s deep real estate industry knowledge and relationships. As of December 31, 2010, our real estate business had total and fee-generating AUM of approximately $6.5 billion and $2.7 billion, respectively.

In addition to the funds described below, we may seek to serve as the manager of, or sponsor, a series of real estate funds that focus on other opportunistic investments in distressed debt and equity recapitalization transactions, including corporate real estate, distress for control situations and the acquisition and recapitalization of real estate portfolios, platforms and operating companies, including non-performing and deeply discounted loans.

CPI Capital Partners

On November 12, 2010, Apollo completed the acquisition of CPI, the real estate investment management group of Citigroup Inc. CPI had AUM of approximately $3.6 billion as of December 31, 2010. CPI is an integrated real estate investment platform with investment professionals located in Asia, Europe and North America. As part of the acquisition, Apollo acquired general partner interests in, and advisory agreements with, various real estate investment funds and co-invest vehicles and added to its team of real estate professionals.

Apollo Commercial Real Estate Finance, Inc.

In 2009, we launched ARI, a real estate investment trust managed by Apollo that acquires, originates, invests in and manages performing commercial first mortgage loans, CMBS, mezzanine investments and other commercial real estate-related investments in the United States. On September 29, 2009, ARI completed the initial public offering of 10 million shares of its common stock, at a price to the public of $20.00 per share, for gross proceeds of $200 million, and a concurrent private placement of 500,000 shares of its common stock to Apollo and certain of its affiliates at a price per share equal to the initial public offering price. The proceeds to ARI from the initial public offering and the concurrent private placement, net of related issuance costs, were approximately $0.2 billion. In addition, ARI has elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code commencing with its taxable year ended December 31, 2009. To maintain its status as a REIT, ARI must distribute at least 90% of its taxable income to its shareholders and meet, on a continuing basis, certain other complex requirements under the Internal Revenue Code.

During September 2010, ARI completed an offering of 6.9 million shares, which generated gross proceeds of approximately $110.4 million. The proceeds will be used for general corporate purposes, including the repayment of debt and continued investment in target assets. As of September 30, 2010, ARI had total and fee-generating AUM of approximately $1.0 billion and $0.3 billion, respectively.

 

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AGRE CMBS Fund L.P.

In December 2009, we launched the AGRE CMBS Account, a real estate strategic investment account formed to invest principally in CMBS and leverage those investments by borrowing from the TALF Program and repurchase facilities. As of December 31, 2010, the AGRE CMBS Account had total and fee-generating AUM of approximately $1.6 billion and $0.3 billion, respectively.

Strategic Investment Vehicles

In addition to the funds described above, we manage other investment vehicles, including AAA and Palmetto, which have been established to invest either directly in or alongside certain of our funds and certain other transactions that we sponsor and manage.

AP Alternative Assets, L.P. (AAA)

AAA issued approximately $1.9 billion of equity capital in its initial offering in June 2006. AAA is designed to give investors in its common units exposure as a limited partner to certain of the strategies that we employ and allows us to manage the asset allocations to those strategies by investing alongside our private equity funds and directly in our capital markets funds and certain other transactions that we sponsor and manage. The common units of AAA, which represent limited partner interests, are listed on Euronext Amsterdam. AAA is the sole limited partner in AAA Investments, the vehicle through which AAA’s investments are made, and the Apollo Operating Group holds the economic general partnership interests in AAA Investments. On June 1, 2007, AAA Investments entered into a credit facility that originally provided for a $900 million revolving line of credit, thus increasing the amount of cash that AAA Investments has available for making investments, and funding its liquidity and working capital needs. In connection with AAA’s ongoing liquidity management and deleveraging strategy, the revolving credit facility was permanently reduced to $537.5 million as of December 31, 2010. In October 2009, AAA Investments repaid $225.0 million to the lenders in return for the right for AAA Investments or one of its affiliates to purchase its debt in the future at a discount to par value, subject to certain conditions. In December 2009, February 2010 and June 2010, AAA purchased $25.0 million, $37.5 million and $75.0 million, respectively, of its own debt for a purchase price of 85% of par value. As a result of these purchases, the revolving credit facility was permanently reduced to $537.5 million as of December 31, 2010. On August 11, 2010, AAA purchased 6,777,308 of its common units and RDUs from holders participating in a tender offer announced on July 12, 2010, for an aggregate of $47.4 million.

Since its formation, AAA has allowed us to quickly target investment opportunities by capitalizing new investment vehicles formed by Apollo in advance of a lengthier third-party fundraising process. AAA Investments was the initial investor in one of our mezzanine funds, two of our distressed and event-driven hedge funds, our non-performing loan fund and one of our senior credit funds. AAA Investments’ current portfolio also includes private equity co-investments in Fund VI and Fund VII portfolio companies, certain opportunistic investments and temporary cash investments. AAA Investments may also invest in additional funds and other opportunistic investments identified by Apollo Alternative Assets, L.P., the investment manager of AAA.

AAA Investments generates management fees for us through the Apollo funds in which it invests. In addition, AAA Investments generates management fees and incentive income on the portion of its assets that are not invested directly in Apollo funds or temporary investments. AAA Investments pays management fees to Apollo Alternative Assets, L.P., its investment manager, which is 100% owned by the Apollo Operating Group, and pays incentive income to AAA Associates, L.P.

AAA Investments entered into co-investment agreements which allow it to co-invest alongside Fund VI and Fund VII. Under the co-investment agreement with Fund VI, AAA Investments initially agreed to co-invest with Fund VI in each of its investments in an amount equal to 12.5% of the total amount invested by Fund VI, subject to certain exceptions pursuant to which AAA Investments may be excluded from, or may opt out of, an investment. In the fourth quarter of 2009, the co-investment agreement with Fund VI was amended to provide

 

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that no new co-investments will be made, and only follow-on investments which are expected to protect AAA Investments’ interests in its existing portfolio companies will be made going forward. Under its co-investment agreement with Fund VII, AAA Investments has a variable co-investment commitment ranging from 0% to 12.5% of investments committed to by Fund VII during each calendar year, subject to certain exceptions pursuant to which AAA Investments may be excluded from, or may opt out of, an investment. The Fund VII co-investment percentage is set at the beginning of each calendar year by the board of directors of AAA’s managing general partner. In the fourth quarter of 2009, the co-investment agreement with Fund VII was amended to provide that where a follow-on investment is made with Fund VII for reasons other than to protect AAA Investments’ interest in an existing portfolio company, it will be made at the co-investment percentage that has been set by the board of directors of AAA’s managing general partner for the relevant year (or, if lower, at the percentage necessary to ensure that AAA Investments and Fund VII continue to hold the relevant portfolio company in the same proportions as it is then owned by each of them). AAA Investments committed to co-invest in an amount equal to 0% of new investments committed to by Fund VII during the 2011, 2010 and 2009 calendar years and 5% during the 2008 calendar year.

As of December 31, 2010, AAA Investments had utilized $537.5 million of its line of credit for certain investments and had a cash balance of approximately $350 million. The amount of loans that may be borrowed under the AAA Investments credit facility cannot exceed the borrowing base, which is calculated based on the value of investments held by AAA Investments, including temporary investments, multiplied by advance rates ranging from 100% for cash equivalents to 35% for unquoted private equity investments. As a result, a decline in the value of investments held by AAA Investments could result in a borrowing base deficiency, and such deficiency may, if not cured in accordance with the terms of the credit facility, limit AAA Investments’ ability to borrow under its credit facility and eventually result in an event of default under such facility. AAA may incur additional indebtedness from time to time, subject to availability in the credit markets, among other things.

Due to market volatility and the tightening of the credit markets, particularly during the fourth quarter of 2008 and first quarter of 2009, AAA Investments took certain steps to manage its borrowing base under its credit agreement and maintain an appropriate level of liquidity:

 

   

Beginning in the fourth quarter of 2008 and continuing into the third quarter of 2009, AAA Investments exercised the right to opt-out of new co-investments alongside Fund VI and Fund VII and their parallel investment vehicles, as permitted by its co-investment agreements described above. Opt-out decisions are each made on a case-by-case basis taking into consideration reserves and liquidity at the time of the potential co-investment transaction. Beginning in the third quarter of 2009, AAA resumed making co-investments alongside the private equity funds. In the fourth quarter of 2009, the co-investment agreements with Fund VI and Fund VII were amended. The co-investment agreement with Fund VI was amended to provide that no new co-investments will be made and only follow-on investments which are expected to protect AAA Investments’ interests in its existing portfolio companies will be made going forward. The co-investment agreement with Fund VII was amended to provide that where a follow-on investment is made with Fund VII for reasons other than to protect AAA Investments’ interest in an existing portfolio company, it will be made at the co-investment percentage that has been set by the board of directors of AAA’s managing general partner for the relevant year (or, if lower, at the percentage necessary to ensure that AAA Investments and Fund VII continue to hold the relevant portfolio company in the same proportions as it is then owned by each of them). The board of directors of AAA’s managing general partner continues to set the Fund VII co-investment percentage for new co-investments at the beginning of each calendar year.

 

   

During 2008, AAA Investments requested the redemption of a portion of its outstanding shares of SVF with a value of $475.0 million, subject to certain terms and conditions. Of the $475.0 million redeemable in 2008, $200.0 million was redeemed in 2008. The remaining $275.0 million redemption, which represented the remainder of AAA Investments’ investment in SVF, was converted into liquidating shares issued by SVF. The liquidating shares are generally allocated a pro rata portion of

 

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each of SVF’s existing investments and liabilities, and as those investments are sold, AAA Investments is allocated the proceeds from such disposition less its proportionate share of any expenses incurred by SVF. During the years ended December 31, 2010 and 2009, AAA Investments received redemptions of $35.3 million and $163.4 million, respectively, from SVF.

 

   

During 2009, AAA Investments requested redemptions of portions of its outstanding shares of AAOF with values of $140.0 million, which were converted into liquidating shares issued by AAOF. The liquidating shares are generally allocated a pro rata portion of each of AAOF’s existing investments and liabilities, and as those investments are sold, AAA Investments is allocated the proceeds from such disposition less its proportionate share of any expenses incurred or reserves set by AAOF. During the years ended December 31, 2010 and 2009, AAA Investments received redemptions of $61.8 million and $49.3 million, respectively, from AAOF. At December 31, 2010, the remainder of the liquidating shares of AAOF had a fair value of $45.0 million.

The following chart shows the breakdown of AAA Investments’ $1.8 billion in investments as of December 31, 2010.

AAA Investments

LOGO

As is common with investments in private equity funds, AAA Investments may follow an over-commitment approach when making investments in order to maximize the amount of capital that is invested at any given time. When an over-commitment approach is followed, the aggregate amount of capital committed by AAA Investments to, or to co-investment programs with, private equity funds and capital markets funds at a given time may exceed the aggregate amount of cash and available credit lines that AAA Investments has available for immediate investment. We cannot assure you that any of such commitments will be funded. As of December 31, 2010, AAA Investments was not overcommitted.

We are contractually committed to reinvest a certain amount of our carried interest income from AAA into common units or other equity interests of AAA, as described in more detail below under “—General Partner and Professionals Investments and Co-Investments—General Partner Investments.”

Strategic Investment Accounts

Institutional investors are expressing increasing levels of interest in SIAs since these accounts can provide investors with greater levels of transparency, liquidity and control over their investments as compared to more traditional investment funds. Based on the trends we are currently witnessing among a select group of large institutional investors, we expect our AUM that is managed through SIAs to continue to grow over time. As of December 31, 2010, approximately $6.6 billion of our total AUM and $4.8 billion of our fee-generating AUM was managed through SIAs.

One example of a SIA managed by Apollo is Palmetto, which we manage on behalf of a single investor. As of December 31, 2010, the total capital commitments to Palmetto were $759.0 million, which included a capital

 

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commitment of $750.0 million from one institutional investor that is a large state pension fund and $9.0 million of current commitments from Apollo. Palmetto was established to facilitate investments by such third-party investor directly in our private equity and capital markets funds and certain other transactions that we sponsor and manage. As of December 31, 2010, Palmetto had committed approximately $660.1 million for investments primarily in certain of our capital markets and private equity funds.

Competitive Strengths

Over our more than 20-year history, we have grown to be one of the largest alternative asset managers in the world, which we attribute to the following competitive strengths:

 

   

Our Investment Process and Approach to Investing Have Delivered a Strong Track Record.  In aggregate, our private equity funds have generated a 39% gross IRR and a 26% net IRR from inception through December 31, 2010. Our track record of generating attractive long-term risk-adjusted private equity fund returns is a key differentiating factor for our fund investors and, we believe, will allow us to continue to expand our AUM and capitalize new investment vehicles. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—The Historical Investment Performance of Our Funds” for reasons why our historical returns are not indicative of the future results you should expect from our current or future funds or from us. Some of the elements that have enabled us to generate these attractive returns include:

 

   

Our flexibility to invest throughout market cycles and across the capital structure—We have consistently invested capital on behalf of our investors throughout economic cycles by focusing on opportunities that we believe are often overlooked by other investors. We believe that our expertise in capital markets, focus on core industry sectors and investment experience allows us to respond quickly to changing environments. We believe our ability to invest capital through market cycles will allow us to grow our AUM consistently and generate attractive investment opportunities in various market environments.

 

   

We pay close attention to the cycles that our core industry sectors are experiencing and are opportunistic in entering and exiting investments when the risk/reward profile is in our favor. Our private equity funds have had success investing in buyouts and credit opportunities during both expansionary and recessionary economic periods. During the recovery and expansionary periods of 1994 through 2000 and late 2003 through the first half of 2007, our private equity funds invested or committed to invest approximately $13.7 billion primarily in traditional and corporate partner buyouts. In the recessionary periods of 1990 through 1993, 2001 through late 2003 and the current recessionary period, our private equity funds invested approximately $20.9 billion through December 31, 2010, $15.0 billion of which was in distressed buyouts and debt investments when the debt securities of quality companies traded at deep discounts to par value. We believe distressed buyouts represent a highly attractive risk/reward profile and allow our funds to invest at below-market multiples when historically our peer private equity firms have largely been inactive. Our capital markets funds follow the same disciplined approach to investing throughout economic cycles.

Since the onset of the current global economic downturn, we have been drawing on our credit expertise and long history of investing across market cycles to deploy our investors’ capital in ways which we believe will allow our funds to achieve attractive long-term rates of return. Between September 30, 2007 and December 31, 2010, Apollo’s private equity and capital markets funds have invested a combined $41.6 billion in debt securities with a face value of $57.1 billion. The $41.6 billion invested includes $28.4 billion of capital from the funds managed by Apollo and $13.2 billion of additional leverage.

 

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The table below summarizes our view of how our private equity business differed from that of a typical private equity firm during the U.S. economic cycles since our inception in 1990 and our view of certain market conditions during these cycles.

 

     

Recession
1990-1993

  Recovery
1994-1997
  Expansion
1998-2000
  Recession
2001-2003 3Q 
  Recovery
2003 4Q-2005
  Expansion
2006-2007 2Q
  Recession
2007 3Q-current

Liquidity

  Low   High   High   Low   High   High   Low

Valuation

  Low   Low-Medium   High   Low   Medium   Medium-High   Low

Typical private
equity firm

  Inactive   Active   Inactive or
paid high
prices
  Inactive   Active and paid
high prices
  Active and
paid high
prices
  Inactive

Apollo

  Focus on distressed buyout option   Traditional
buyouts
  Seeks to
reduce
acquisition
price through
complex
buyouts and
corporate
partnerships
  Focus on
distressed
buyout
option
  Traditional
buyouts using
industry expertise
to reduce
acquisition price
  Seeks to
reduce
acquisition
price through
complex
buyouts and
corporate
partnerships
  Focus on
distressed
investments
and
strategic
acquisitions
 

Apollo’s traditional and
corporate partner
buyouts  (1)

  $490   $1,297   $3,107   $596   $2,393   $5,845   $4,843 (2)

Apollo’s distressed buyouts and debt investments  (1)

  $2,907   $113   $50
  $1,025   $846   $3   $11,075 (2)

Fund

(Inception)

 

Fund I/II

(1990/92)

  Fund III

(1995)

  Fund IV

(1998)

  Fund V

(2001)

  NM (3)   Fund VI (4)

(2006)

  Fund VII (4)

(2008)

Apollo Net IRRs  (2)

 

37%

  12%
  9%
  45%
  NM (3)   10%
  32%

Top Quartile Returns  (5)

 

20%

  16%
  6%
  17%
  NM (3)   4%
  7%

 

Note: Characterization of economic cycles is based on our management’s views.

  (1) Dollars in millions. Amounts set forth above represent capital invested by our private equity business.
  (2) Amounts are as of December 31, 2010.
  (3) Not meaningful as no funds were launched during this period.
  (4) Both Fund VI and Fund VII have invested, in part, in debt instruments. At various times, each fund has had to satisfy margin calls in connection with some of these debt investments, all of which have been repaid. Management believes that excluding the amount of such repaid margin calls from Total Invested Capital is a meaningful measure of performance. Excluding these margin calls, as well as capital already returned to investors and including realized gains returned, results in a multiple of capital at work at December 31, 2010 of 1.7 for Fund VII and 1.5 for Fund VI.
  (5) Source: Thomson Reuters. Data as of September 30, 2010, the latest data currently available. Top Quartile benchmarks represent the Upper Quartile Net IRRs for U.S. Buyout Funds of greater than $500 million by vintage year, unless otherwise noted. Top Quartile benchmarks for “I, II, MIA” vintage represent the combined 1990 and 1992 Net IRRs for all U.S. Buyout Funds as more detailed breakdown is not available.

 

   

Our deep industry expertise and focus on complex transactions—We have substantial expertise in nine core industry sectors and our funds have invested in over 300 companies since inception. Our core industry sectors are chemicals; commodities; consumer and retail; distribution and transportation; financial and business services; manufacturing and industrial; media and leisure; packaging and materials; and satellite and wireless. Our deep experience in these industry sectors has allowed us to develop an extensive network of strategic relationships with CEOs, CFOs and board members of current and former portfolio companies, as well as consultants, investment bankers and other industry-focused intermediaries. We believe that situational and structural complexity often hides compelling value that competitors may lack the inclination or ability to uncover. For example, carveouts of divisions of larger corporations are complex transactions that often provide compelling investment opportunities. We believe that we are known in the market

 

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for having substantial corporate carveout experience, having consummated 15 buy-side carveouts since 2000, and that our industry expertise and comfort with complexity help drive our performance.

The table below lists and briefly describes the background of all proprietary carve-out deals our funds have completed since 2000.

 

Proprietary Corporate Carve-outs

 
Company    Seller    Date of Initial
Investment
   Date of
Final Exit
   Multiple  of
Invested
Capital (1)
 
Alcan    Rio Tinto    December 2010    NA      1.0x   
Evertec    Popular, Inc.    September 2010    NA      1.0x   
Prestige Cruise Holdings (Regent Seven Seas)    Carlson    January 2008    NA      0.8x   

Noranda Aluminum

   Xstrata plc    May 2007    NA      4.4x   

Momentive Performance Materials (2)

   General Electric    December 2006    NA      2.3x   

CEVA Logistics

   TNT Group    November 2006    NA      1.7x   

Verso Paper

   International Paper    August 2006    NA      1.3x   
Berry Plastics Corporation (formerly Covalence)    Tyco    February 2006    NA      1.5x   

Hughes Communications

   DirecTV Group    February 2006    NA      4.9x   

United Agri Products

   ConAgra Foods    November 2003    November 2006      7.7x   

Compass Minerals

   IMC Global    November 2001    November 2004      5.0x   

Educate

   Sylvan    July 2000    NA      3.2x   

 

  (1) Multiple of invested capital is calculated from total value (realized proceeds plus any unrealized fair value as of December 31, 2010) divided by original investment amount.
  (2) In the fourth quarter of 2010, Momentive Performance Materials Holdings Inc. and Momentive Specialty Chemicals Holdings LLC (formerly known as Hexion LLC) finalized an agreement to merge, effective October 1, 2010. As a result of this transaction, a combined multiple was calculated as of December 31, 2010.

 

   

Our investment expertise creates proprietary investment opportunities—We believe our industry expertise allows us to create strategic platforms and approach new investments as a strategic buyer with synergies, cross-selling opportunities and economies of scale advantages over other purely financial sponsors. Examples include the creation of Hexion, a chemical company that had over $6 billion in revenues during 2008, and Berry Plastics, a plastic packaging company that had over $3 billion in revenues during 2008, both of which were built through multiple acquisitions in our core industry verticals. Additionally, our expertise in complex corporate carveouts allows us to source investment opportunities in a private-to-private negotiation, oftentimes exclusively, which facilitates deployment of capital at attractive valuations. Examples include the purchase of United Agri Products from ConAgra Foods (where we realized 7.7x invested capital) and the purchase of Compass Minerals from IMC Global (where we realized 5.0x invested capital). Since our inception through December 31, 2010, we believe over 75% of the private equity buyouts completed by our funds have been proprietary in nature. We have also avoided the market trend of consortium transactions (defined as including more than one main financial sponsor), with Fund VI and Fund VII being the sole financial sponsor in 14 of their last 16 traditional private equity portfolio company buyouts.

 

   

We believe that our proprietary investment opportunities provide the ability to consistently invest capital and generate market leading returns for our funds. We believe these competitive advantages often result in our funds’ buyouts being effected at a lower multiple of adjusted EBITDA than many of our peers. For example, for the buyouts completed by our funds in 2006 and 2007 with values over $500 million, the average purchase price multiple was 7.6x of adjusted EBITDA. The average purchase price multiple of all financial sponsor transactions, as tracked by Thomson Financial, was 11.8x for deals with values over $500 million in 2006 and 2007. In addition, Apollo created these companies at a net Debt to EBITDA ratio of 5.7x and an average equity contribution of approximately 20%.

 

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Our collaboration with portfolio company management teams—We possess two decades of experience working with management teams to help create significant long-term value for the portfolio companies of our funds. We believe we add value to our funds’ investments by working closely with the portfolio company management teams. Among other things, in partnership with our management teams, we identify and execute growth opportunities including strategic mergers and acquisitions, generate cost and working capital savings, divest non-core business lines, optimize capital structures and create synergies among our network of current and former portfolio companies. For example, as of December 31, 2010, Fund VI and its underlying portfolio companies purchased or retired approximately $18.7 billion of debt and captured approximately $9.3 billion of discount to par value of debt. In addition, from the date of acquisition through December 31, 2010, Fund VI portfolio companies have implemented approximately $3.0 billion of cost savings programs on an aggregate basis, which we believe will positively impact their operating profitability.

 

   

Our Integrated Business Model.  Generally, we operate our global franchise as an integrated investment platform with a free flow of information across our businesses. See “Risk Factors—Risks Related to Our Businesses—Possession of material non-public information could prevent Apollo funds from undertaking advantageous transactions; our internal controls could fail; we could determine to establish information barriers.” Our investment professionals interact frequently across our businesses on a formal and informal basis. For example, in the course of reviewing a large buyout opportunity, a partner from our private equity business might discover an opportunity to invest in an attractive non-control debt investment and convey the opportunity to one of our capital markets partners. See “Risk Factors—Risks Related to Our Businesses—Possession of material, non-public information could prevent Apollo funds from undertaking advantageous transactions; our internal controls could fail; we could determine to establish information barriers.” In addition, members of the private equity investment committee currently serve on the investment committees of each of our capital markets funds.

LOGO

 

   

Our Strong, Longstanding Investor Relationships.  We manage capital for hundreds of investors in our private equity funds, which include many of the world’s most prominent pension funds, university endowments, financial institutions and individuals. Most of our private equity investors are invested in

 

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multiple Apollo private equity funds, and many have invested in one or more of our capital markets funds, including as seed investors in new strategies. We believe that our deep investor relationships, founded on our consistent performance, disciplined and prudent management of our fund investors’ capital and our frequently contrarian investment approach, have facilitated the growth of our existing businesses and will assist us with the launch of new businesses and investment offerings, thereby increasing our fee-generating AUM.

Investor Base of Apollo Private Equity

LOGO

Represents Investor Base of Funds III, IV, V, VI and VII. Data as of December 31, 2010.

 

   

Global Capital Base . Apollo’s overall investor base is spread across multiple geographies for our private equity, capital markets and real estate businesses. As of December 31, 2010, 76% of the total commitments of our limited partner investors to date for our private equity funds and a number of our capital markets and real estate funds, taken together with the net asset value attributable to current investors for our remaining capital market funds, excluding any publicly traded funds (AAA, AIC and ARI) and certain other real estate funds, were located in North America, 13% in Europe, 6% in Asia and 5% in the Middle East. Approximately 76% and 49% of our non-U.S. and U.S. investor base, respectively, represents commitments from investors new to Apollo during the last five years.

 

   

Long-Term Capital Base.  A significant portion of our $67.6 billion of AUM as of December 31, 2010 was long term in nature. As of December 31, 2010, approximately 91% of our AUM was in funds with a contractual life at inception of seven years or more, including 10% that was in permanent capital vehicles with unlimited duration, as highlighted in the chart below. Our long-lived capital base allows us to invest assets with a long-term focus, which we believe is an important component in generating attractive returns for our funds’ investors. We believe our long-term capital also leaves us well-positioned during economic downturns, when the fundraising environment for alternative assets has historically been more challenging than during periods of economic expansion.

LOGO

 

   

The Continuity of Our Strong Management Team and Reputation.  Our managing partners actively participate in the oversight of the investment activities of our funds, have worked together for more than 20 years and lead a team of 171 investment professionals as of December 31, 2010 who possess a broad range of transaction, financial, managerial and investment skills. Our investment team includes

 

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our contributing partners, who, together with our managing partners, have worked together for an average of 17 years, as well as exclusive relationships with operating executives who are former CEOs with significant experience in our core industries. We have developed a strong reputation in the market as an investor and partner who can make significant contributions to a business or investing decision, and we believe the longevity of our management team is a key competitive advantage.

 

   

Alignment of Interests with Investors in Our Funds and Shareholders.  Fundamental to our business model is the alignment of interests of our professionals with those of the investors in our funds and with those of our shareholders. From our inception through December 31, 2010, our professionals have committed or invested an estimated $1.0 billion of their own capital to our funds (including Fund VII). In addition, our practice is to allocate a portion of the management fees and incentive income payable by our funds to our professionals, which we believe serves to incentivize those employees to generate superior risk-adjusted investment returns. Also, the majority of our employees own RSUs which vest over time, and our managing partners and contributing partners will own 67.1% of the company after giving effect to the IPO. We expect to continue to increase the equity ownership of our employees over time through additional grants of RSUs in lieu of cash compensation. We believe that the alignment of interests with our shareholders and fund investors helps us to raise new funds, execute our growth strategy and deliver earnings to our shareholders.

 

   

Stable and Growing Management Business Revenues. We have shown strong management business revenue growth during the past seven years, as presented in the table below. During the year ended December 31, 2010, our management business revenues were 1.24% of average fee-generating AUM for the same period. In addition, we have also had stable growth in both total AUM and management fees since our Reorganization in 2007. Total AUM grew from $40.8 billion as of December 31, 2007 to $67.6 billion as of December 31, 2010, resulting in an approximate CAGR of 18%. Total management fees on a combined segment basis grew from $249 million during the year ended December 31, 2007 to $431 million during the year ended December 31, 2010, resulting in an approximate CAGR of 20%. Management business revenues include management fees, advisory and transaction fees and carried interest income from certain of our mezzanine funds.

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Growth Strategy

Our growth and investment returns have been supported by an institutionalized and strategic organizational structure designed to promote teamwork, industry specialization, longevity of capital, compliance and regulatory excellence and internal systems and processes. Our ability to grow our AUM and revenues depends on our performance and on our ability to attract new capital and fund investors, which we have done successfully over the last 20 years.

The following are key elements of our growth strategy.

 

   

Continuing to Achieve Long-Term Returns in Our Funds .  Continued achievement of superior long-term returns will support growth in AUM. We believe our experienced investment team, value-oriented investment strategy and flexible investment approach will continue to drive superior returns. We will emphasize creating long-term value for our shareholders with less focus on our quarter-to-quarter or year-to-year earnings volatility.

 

   

Continuing Our Commitment to Our Fund Investors .  We intend to continue managing our businesses with a strong focus on developing and maintaining long-term relationships with our fund investors. Our fund investors include many of the world’s most prominent pension and endowment funds as well as other institutional and individual investors. Most of our private equity investors are invested in multiple Apollo private equity funds, and many invested in one or more of our capital markets funds. We believe that our strong investor relationships facilitate the growth of our existing businesses and the successful launch of new businesses.

 

   

Raising Additional Investment Capital for Our Current Businesses .  We will continue to utilize our firm’s reputation and track record to seek to grow our AUM. Our funds’ capital raising activities benefit from our more than 20-year investment track record, the reputation of our firm and investment professionals, our access to public markets through entities such as AIC and AAA and our strong relationships with our investors.

 

   

Expanding Into New Investment Strategies, Markets and Businesses .  We intend to grow our businesses through the targeted development of new investment strategies, such as real estate, that we believe are complementary to our existing businesses and to expand our investment platforms in London and Asia, including India. In addition, we expect to continue expanding into new businesses, possibly through strategic acquisitions of other investment management companies or other strategic initiatives and to continue expanding distribution channels, such as through retail closed-end loan funds and an increased focus on high net worth platforms.

 

   

Capitalize Upon the Benefits of Being a Public Company, including the Pursuit of Complementary and Strategic Acquisitions.  We believe that being a public company will help us grow our AUM and revenues. We believe that fund investors will increasingly prefer to trust their capital to publicly traded asset managers because of the corporate-governance and disclosure requirements that apply to such managers, as well as the more efficient succession-planning and reduced “key man” risk that we believe result from becoming a public company, as we become more institutionalized. As a public company we expect to become less dependent on a small number of individuals and better able to attract senior talent with the backing of public investors and with the ability to provide senior talent with more liquid equity incentive income. We also believe that we can utilize our currency as a public company to broaden our industry verticals and capital markets products and expand into new product offerings and strategies.

Performance Results

Our revenues and other income consist principally of (i) management fees, which are based upon a percentage of the committed or invested capital (in the case of our private equity funds and certain of our capital markets and real estate funds), adjusted assets (in the case of AAA), gross invested capital or fund net asset value (in the case of the rest of our capital markets funds), stockholders’ equity (in the case of ARI) or the capital

 

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accounts of the limited partners (in the case of AGRE CMBS Account); (ii) transaction and advisory fees received from private equity and certain capital markets portfolio companies in respect of business and transaction consulting services that we provide, as well as advisory services provided to a capital markets fund; (iii) income based on the performance of our funds, which consists of allocations, distributions or fees from our private equity funds, AAA and our capital markets funds; and (iv) investment income from our investments as general partner and other direct investments primarily in the form of net gains from investment activities as well as interest and dividend income. Carried interest from our private equity funds and certain of our capital markets and real estate funds entitles us to an allocation of a portion of the income and gains from that fund and is as much as 20% of the net realized income and gains that are achieved by the funds net of fund expenses, generally subject to an annual preferred return for the limited partners, which varies by fund, with a “catch-up” allocation to us thereafter. The general partner of each of the funds accrues for its portion of carried interest at each quarter-end balance sheet date for any changes in value of the funds’ underlying investments. For example, if one of our private equity funds were to exceed the preferred return threshold and generate $100 million of profits net of allocable fees and expenses from a given investment, our carried interest would entitle us to receive as much as $20 million of these net profits less appropriate compensation expense for our investment professionals.

Carried interest from most of our capital markets funds is as much as 20% of either the fund’s income and gain or the yearly appreciation of the fund’s net asset value. For such capital markets funds, we accrue carried interest on both realized and unrealized gains, subject to any applicable hurdles and high-water marks. Certain of our capital markets funds are subject to a preferred return. Our ability to generate carried interest is an important element of our business and has historically accounted for a very significant portion of our income. For the year ended December 31, 2010, transaction and advisory fees, management fees and carried interest income represented 3.8%, 20.4% and 75.8%, respectively, of our $2,109.9 million of revenues.

Management further evaluates our segments based on our management and incentive business within each segment. We believe this information provides enhanced transparency with respect to our financial performance. Our management business is generally characterized by the predictability of its financial metrics, including revenues and expenses. This business includes management fee revenues, advisory and transaction revenues, carried interest income from certain of our mezzanine funds, and expenses exclusive of profit sharing, which we believe are more stable in nature. The financial performance of our incentive business, which is dependent upon quarterly mark-to-market unrealized valuations in accordance with U.S. GAAP guidance applicable to fair value measurements, includes carried interest income and profit sharing expense in connection with our investment funds, and is generally less predictable and more volatile in nature.

For more information regarding the financial performance of our segments, refer to “Prospectus Summary—Summary Historical and Other Data” which includes our statement of operations information and our supplemental performance measure, ENI, for our reportable segments and the management business and incentive business, as well as further reconciliation of ENI to Adjusted ENI to identify non-recurring or unusual items for the years ended December 31, 2010, 2009 and 2008.

Fundraising and Investor Relations

We believe our performance track record across our funds has resulted in strong relationships with our fund investors. Our fund investors include many of the world’s most prominent pension funds, university endowments and financial institutions, as well as individuals. We maintain an internal team dedicated to investor relations across our private equity, credit-oriented capital markets and real estate businesses.

In our private equity business, fundraising activities for new funds begin once the investor capital commitments for the current fund are largely invested or committed to be invested. The investor base of our private equity funds includes both investors from prior funds and new investors. In many instances, investors in our private equity funds have increased their commitments to subsequent funds as our private equity funds have increased in size. During our Fund VI fundraising effort, investors representing over 88% of Fund V’s capital committed to the new fund. During our Fund VII fundraising effort, investors representing over 84% of Fund

 

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VI’s capital committed to Fund VII. The single largest unaffiliated investor represents only 6% of Fund VI’s commitments and 7% of Fund VII’s commitments. In addition, our investment professionals commit their own capital to each private equity fund.

During the management of a fund, we maintain an active dialogue with our fund investors. We host quarterly webcasts for our fund investors led by members of our senior management team and we provide quarterly reports to our fund investors detailing recent performance by investment. We also organize an annual meeting for our private equity investors that consists of detailed presentations by the senior management teams of many of our current investments. From time to time, we also hold meetings for the advisory board members of our private equity funds.

AAA is an important component of our business strategy, as it has allowed us to quickly target attractive investment opportunities by capitalizing new investment vehicles formed by Apollo in advance of a lengthier third-party fundraising process. In particular, we have used AAA capital to make initial investments in AIE I, SVF, AAOF, a senior credit fund and EPF. The common units of AAA are listed on Euronext Amsterdam by NYSE Euronext and AAA complies with the reporting requirements of that exchange. AAA provides monthly information and quarterly reports to, and hosts quarterly conference calls with, our AAA investors. See “—Strategic Investment Vehicles—AP Alternative Assets, L.P. (AAA)” for information regarding AAA’s liquidity condition.

In our capital markets business, we have raised capital from prominent institutional investors, similar to our private equity and real estate businesses, and have also raised capital from public market investors, as in the case of AIC. AIC provides quarterly reports to, and hosts conference calls with, investors that highlight investment activities. AIC is listed on the NASDAQ Global Select Market and complies with the reporting requirements of that market.

Similar to our private equity and capital markets businesses, in our real estate business we have raised capital from a prominent institutional investor for the AGRE CMBS Account, and we have also raised capital from public market investors with respect to ARI. ARI provides quarterly reports to, and hosts conference calls with, investors that highlight investment activities. ARI is listed on the NYSE and complies with the reporting requirements of that market.

Investment Process

We maintain a rigorous investment process and a comprehensive due diligence approach across all of our funds. We have developed policies and procedures, the adequacy of which are reviewed annually, that govern the investment practices of our funds. Moreover, each fund is subject to certain investment criteria set forth in its governing documents that generally contain requirements and limitations for investments, such as limitations relating to the amount that will be invested in any one company and the geographic regions in which the fund will invest. Our investment professionals are thoroughly familiar with our investment policies and procedures and the investment criteria applicable to the funds that they manage, and these limitations have generally not impacted our ability to invest our funds.

Our investment professionals interact frequently across our businesses on a formal and informal basis. In addition, members of the private equity investment committee currently serve on the investment committees of each of our capital markets funds. We believe this structure is uncommon and provides us with a competitive advantage.

We have in place certain procedures to allocate investment opportunities among our funds. These procedures are meant to ensure that each fund is treated fairly and that transactions are allocated in a way that is equitable, fair and in the best interests of each fund, subject to the terms of the governing agreements of such funds. Each of our funds has primary investment mandates, which are carefully considered in the allocation process.

 

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Private Equity

Private Equity Funds . Our private equity investment professionals are responsible for selecting, evaluating, structuring, diligencing, negotiating, executing, monitoring and exiting investments for our traditional private equity funds, as well as pursuing operational improvements in our funds’ portfolio companies. These investment professionals perform significant research into each prospective investment, including a review of the company’s financial statements, comparisons with other public and private companies and relevant industry data. The due diligence effort will also typically include:

 

   

on-site visits;

 

   

interviews with management, employees, customers and vendors of the potential portfolio company;

 

   

research relating to the company’s management, industry, markets, products and services, and competitors; and

 

   

background checks.

After an initial selection, evaluation and diligence process, the relevant team of investment professionals will prepare a detailed analysis of the investment opportunity for our private equity investment committee. Our private equity investment committee generally meets weekly to review the investment activity and performance of our private equity funds.

After discussing the proposed transaction with the deal team, the investment committee will decide whether to give its preliminary approval to the deal team to continue the selection, evaluation, diligence and negotiation process. The investment committee will typically conduct several lengthy meetings to consider a particular investment before finally approving that investment and its terms. Both at such meetings and in other discussions with the deal team, our managing partners and partners will provide guidance to the deal team on strategy, process and other pertinent considerations. Every private equity investment requires the approval of our three managing partners.

Our private equity investment professionals are responsible for monitoring an investment once it is made and for making recommendations with respect to exiting an investment. Disposition decisions made on behalf of our private equity funds are subject to careful review and approval by the private equity investment committee, including all three of our managing partners.

AAA . Investment decisions on behalf of AAA are subject to investment policies and procedures that have been adopted by the board of directors of the managing general partner of AAA. Those policies and procedures provide that all AAA investments (except for temporary investments) must be reviewed and approved by the AAA investment committee. In addition, they provide that over time AAA will invest approximately 90% or more of its capital in Apollo funds and Apollo sponsored private equity transactions and, subject to market conditions, target approximately 50% or more in private equity transactions. Pending those uses, AAA capital is invested in temporary liquid investments. AAA’s investments do not need to be exited within fixed periods of time or in any specified manner. AAA is, however, generally required to exit any co-investments it makes with an Apollo fund at the same time and on the same terms as the Apollo fund in question exits its investment. The AAA investment policies and procedures provide that the AAA investment committee should review the policies and procedures on a regular basis and, if necessary, propose changes to the board of directors of the managing general partner of AAA when the committee believes that those changes would further assist AAA in achieving its objective of building a strong investment base and creating long-term value for its unitholders.

Capital Markets and Real Estate

Each of our capital markets funds and real estate funds maintains an investment process similar to that described above under “—Private Equity.” Our capital markets and real estate investment professionals are responsible for selecting, evaluating, structuring, diligencing, negotiating, executing, monitoring and exiting

 

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investments for our capital markets funds and real estate funds, respectively. The investment professionals perform significant research into and due diligence of each prospective investment, and prepare analyses of recommended investments for the investment committee of the relevant fund.

Investment decisions are carefully scrutinized by the investment committees, who review potential transactions, provide input regarding the scope of due diligence and approve recommended investments and dispositions. Close attention is given to how well a proposed investment is aligned with the distinct investment objectives of the fund in question, which in many cases have specific geographic or other focuses. At least one of our managing partners approves every significant capital markets and real estate fund investment decision. The investment committee of each of our capital markets funds and real estate funds generally is provided with a summary of the investment activity and performance of the relevant funds on at least a monthly basis.

Independent Valuation Firms

We are responsible for determining the fair value of our private equity fund portfolio investments on a quarterly basis in good faith, subject to the approval of the advisory board for the relevant private equity fund. We have retained independent valuation firms to provide third-party valuation consulting services to the company which consist of certain limited procedures that the company identifies and requests them to perform. Upon completion of the limited procedures, the independent valuation firms generally assess for certain investments whether the fair value of those investments subjected to the limited procedures do not appear to be unreasonable and for other investments the independent valuation firms assess whether the fair values of those investments are reasonable. The limited procedures do not involve an audit, review, compilation or any other form of examination or attestation under generally accepted auditing standards. In accordance with U.S. GAAP, an investment for which a market quotation is readily available will be valued using a market price for the investment as of the end of the applicable reporting period and an investment for which a market quotation is not readily available will be valued at the investment’s fair value as of the end of the applicable reporting period as determined in good faith. While there is no single standard for determining fair value in good faith, the methodologies described below will generally be followed when fair value pricing is applied.

Valuation of Our Private Equity Funds

We calculate the aggregate realized value of a private equity fund’s portfolio company investments based on the historical amount of the net cash and marketable securities actually distributed to fund investors from all of the fund’s investments made from the date of the fund’s formation through the valuation date. Such amounts do not give effect to the allocation of any realized returns to the fund’s general partner pursuant to carried interest or the payment of any applicable management fees to the fund’s investment advisor. Where the value of an investment is only partially realized, we classify the actual cash and other consideration distributed to fund investors as realized value, and we classify the balance of the value of the investment as unrealized and valued using the methodology described below.

We calculate the aggregate estimated unrealized value of a private equity fund by adding the individual estimated unrealized values of the fund’s portfolio companies. We determine individual investment valuations using market prices where a market quotation is available for the investment or fair value pricing where a market quotation is not available for the investment. For debt securities, if no sales occurred as of year-end and there is no closing price (i.e. the date of determination), we value the securities at the “bid” price at the close of business on such day. Since December 31, 2008, we have valued the securities based on the average of the “bid” and “ask” (the “mid”) price. Fair value pricing represents an investment’s fair value as determined by us in good faith. Market value represents a valuation of an investment derived from the last available closing sales price as of the valuation date. Market values that we derive from market quotations do not take into account various factors which may affect the value that may ultimately be realized in the future, such as the possible illiquidity associated with a large ownership position or a control premium.

 

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There is no single standard for determining fair value in good faith and, in many cases, fair value is best expressed as a range of fair values from which a single estimate may be derived. We determine the fair values of investments for which market quotations are not readily available based on the enterprise values at which we believe the portfolio companies could be sold in orderly dispositions over a reasonable period of time between willing parties other than in a forced or liquidation sale. The portfolio companies are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses comparable public company multiples such as the ratio of terminal enterprise value to earnings before interest, taxes, depreciation and amortization, and the ratio of terminal enterprise value to revenue, as well as other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. These estimated unrealized values may not be realized for the amount provided.

Valuation of Our Capital Markets Funds

Capital Markets Funds other than AIC. For our capital markets funds other than AIC, we generally value securities that are listed on a recognized exchange or a computerized quotation system and that are freely transferable at their last sales price on the relevant exchange based on the last sale recorded on such exchange as of the valuation date. When a security is not traded on an active market exchange, we seek market pricing data from at least two brokers, collateral agents or market makers. In cases where there is only a single broker quoting a specific security, we seek to corroborate any quote received by attempting to obtain quotes on similar securities from independent pricing services. In most cases, the average of mid prices will be used; however, if no ask price is obtained, the bid price will be used in valuing the investment. Since the end of 2008, all capital markets funds, except AAOF, are pricing their securities based on the mid broker price. For most private illiquid investments, we seek an opinion from a third-party valuation firm that will either determine the appropriate value or provide a supporting opinion to our internally modeled valuation. We value all other assets of the fund at fair value in accordance with the valuation policies of the funds. We may change the foregoing valuation methods if we determine in good faith that such change is advisable to better reflect market conditions or activities. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the value of investments by certain of our capital markets funds may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

AIC. Under procedures established by its board of directors, AIC’s investments, including certain subordinated debt, senior secured debt and other debt securities with maturities greater than 60 days, for which market quotations are readily available, are valued at such market quotations (unless they are deemed not to represent fair value). AIC also utilizes independent third-party valuation firms to assist in determining fair value if and when such market quotations are deemed not to represent fair value. Investments purchased within 60 days of maturity are valued at cost plus accreted discount, or minus amortized premium, which approximates fair value. Debt and equity securities that are not publicly traded or whose market quotations are not readily available are valued at fair value as determined in good faith by or under the direction of AIC’s board of directors. Such determination of fair values may involve subjective judgments and estimates. With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, AIC’s board of directors has approved a multi-step quarterly valuation process. AIC’s quarterly valuation process begins with each portfolio company or investment being initially valued by the investment professionals of AIC’s investment advisor that are responsible for the portfolio investment. Preliminary valuation conclusions are then documented and discussed with senior management of AIC’s investment advisor. Independent valuation firms engaged by AIC’s board of directors conduct independent appraisals and review the investment advisor’s preliminary valuations and make their own independent assessment. The audit committee of AIC’s board of directors then reviews and discusses the preliminary valuation of the investment adviser and that of the independent valuation firms. Finally, the board of directors discusses valuations and determines the fair value of each investment in AIC’s portfolio in good faith based on the input of AIC’s investment advisor, the respective independent valuation firm and the audit committee.

 

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AIC’s investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that AIC may take into account in fair value pricing its investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of AIC’s investments may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

Real Estate Investments

For ARI and the AGRE CMBS Account, we seek market pricing data from brokers, collateral agents or market makers, when available, and corroborate quotes received by attempting to obtain quotes from independent pricing services. We value all other assets of the fund at fair value in accordance with U.S. GAAP. For our opportunistic real estate funds (in the case of CPI), valuations of non-marketable underlying investments are determined using methods that include, but are not limited to (i) discounted cash flow estimates or comparable analysis prepared internally, (ii) third party appraisals or valuations by qualified real estate appraisers, and (iii) contractual sales value of investments/properties subject to bona fide purchase contracts. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the value of investments by certain of our real estate funds may differ significantly from the values that would have been used had a readily available market value existed for such investments, and the differences could be material.

Fees, Carried Interest, Redemption and Termination

Our revenues from the management of our funds consist primarily of:

 

   

management/monitoring fees, which are based on committed or invested capital (in the case of our private equity funds and certain of our capital markets funds), gross invested capital or fund net asset value (in the case of most of our capital markets funds) and gross asset value of structured portfolio vehicle instruments, which includes the leverage used by such structured portfolio vehicles;

 

   

carried interest based on the performance of our funds; and

 

   

transaction and advisory fees relating to the investments our private equity and certain capital markets funds make.

In addition, we earn management fees based on the adjusted assets (as defined below) of AAA and are entitled to a carried interest based on the realized gains on each co-investment made by AAA pursuant to a committed co-investment facility and other opportunistic investments. We also earn incentive income from the underlying investments of AAA in our capital markets funds, calculated per the terms of the applicable funds. In addition, with respect to Artus we earn an investment advisory fee based on the sum of the average principal amount of the underlying collateralized loan obligations.

We also receive investment income from the direct investment of capital in our funds in our capacity as general partner, which is described below under “—General Partner and Professionals Investments and Co-Investments—General Partner Investments.” Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a more detailed description of our revenues.

 

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Overview of Fund Operations

Investors in our private equity funds make commitments to provide capital at the outset of a fund and deliver capital when called by us as investment opportunities become available. We determine the amount of initial capital commitments for any given private equity fund by taking into account current market opportunities and conditions, as well as investor expectations. The general partner’s capital commitment is determined through negotiation with the fund’s investor base. The commitments are generally available for six years during what we call the investment period. We have typically invested the capital committed to our funds over a three to four year period. Generally, as each investment is realized, our private equity funds first return the capital and expenses related to that investment and any previously realized investments to fund investors and then distribute any profits. These profits are typically shared 80% to the investors in our private equity funds and 20% to us so long as the investors receive at least an 8% compounded annual return on their investment, which we refer to as a “preferred return” or “hurdle.” Our private equity funds typically terminate ten years after the final closing, subject to the potential for two one-year extensions. After the amendments we sought in order to deconsolidate most of our funds, dissolution of those funds can be accelerated upon a majority vote of investors not affiliated with us and, in any case, all of our funds also may be terminated upon the occurrence of certain other events, as described below under “—Redemption and Termination.” Ownership interests in our private equity funds and certain of our capital markets funds, are not, however, subject to redemption prior to termination of the funds.

The processes by which our capital markets funds receive and invest capital vary by type of fund. AIC, for instance, raises capital by selling shares in the public markets and it can also issue debt. Our distressed and event-driven hedge funds sell shares or limited partner interests, subscriptions for which are payable in full upon a fund’s acceptance of an investor’s subscription, via private placements. The investors in SOMA, EPF and AIE II made a commitment to provide capital at the formation of such funds and deliver capital when called by us as investment opportunities become available. COF I and COF II invest in a wide variety of public and private debt and debt-related securities and the limited partners subscribe for interests in each of the funds by making commitments through subscription agreements. Limited partners of COF I and COF II respond to capital calls as they arise. As with our private equity funds, the amount of initial capital commitments for our capital markets funds is determined by taking into account current market opportunities and conditions, as well as investor expectations. The general partner commitments for our capital markets funds that are structured as limited partnerships are determined through negotiation with the funds’ investor base. The fees and incentive income we earn for management of our capital markets funds and the performance of these funds and the terms of such funds governing withdrawal of capital and fund termination vary across our capital markets funds and are described in detail below.

We conduct the management of our private equity and capital markets funds primarily through a partnership structure, in which limited partnerships organized by us accept commitments and/or funds for investment from investors. Funds are generally organized as limited partnerships with respect to private equity funds and other U.S. domiciled vehicles and limited partnership and limited liability (and other similar) companies with respect to non-U.S. domiciled vehicles. Typically, each fund has an investment advisor affiliated with an advisor registered under the Advisers Act. Responsibility for the day-to-day operations of the funds is typically delegated to the funds’ respective investment advisors pursuant to an investment advisory (or similar) agreement. Generally, the material terms of our investment advisory agreements relate to the scope of services to be rendered by the investment advisor to the applicable funds, certain rights of termination in respect of our investment advisory agreements and, generally, with respect to our capital markets funds (as these matters are covered in the limited partnership agreements of the private equity funds), the calculation of management fees to be borne by investors in such funds, as well as the calculation of the manner and extent to which other fees received by the investment advisor from fund portfolio companies serve to offset or reduce the management fees payable by investors in our funds. The funds themselves do not register as investment companies under the Investment Company Act, in reliance on Section 3(c)(7) or Section 7(d) thereof or, typically in the case of funds formed prior to 1997, Section 3(c)(1) thereof. Section 3(c)(7) of the Investment Company Act excepts from its registration requirements funds privately placed in the United States whose securities are owned exclusively by persons who, at the time of acquisition of such securities, are “qualified purchasers” or “knowledgeable employees” for purposes of the Investment Company Act. Section 3(c)(1) of the Investment Company Act excepts from its registration requirements privately placed funds whose securities are beneficially owned by not more than 100

 

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persons. In addition, under current interpretations of the SEC, Section 7(d) of the Investment Company Act exempts from registration any non-U.S. fund all of whose outstanding securities are beneficially owned either by non-U.S. residents or by U.S. residents that are qualified purchasers.

In addition to having an investment advisor, each fund that is a limited partnership, or “partnership” fund, also has a general partner that makes all policy and investment decisions relating to the conduct of the fund’s business. The general partner is responsible for all decisions concerning the making, monitoring and disposing of investments, but such responsibilities are typically delegated to the fund’s investment advisor pursuant to an investment advisory (or similar) agreement. The limited partners of the partnership funds take no part in the conduct or control of the business of the funds, have no right or authority to act for or bind the funds and have no influence over the voting or disposition of the securities or other assets held by the funds. These decisions are made by the fund’s general partner in its sole discretion, subject to the investment limitations set forth in the agreements governing each fund. The limited partners often have the right to remove the general partner or investment advisor for cause or cause an early dissolution by a majority vote. In connection with the Private Offering Transactions, we have amended the governing agreements of certain of our consolidated private equity funds (with the exception of AAA) and capital markets funds to provide that a simple majority of a fund’s investors will have the right to accelerate the dissolution date of the fund.

In addition, the governing agreements of our private equity funds enable the limited partners holding a specified percentage of the interests entitled to vote not to elect to continue the limited partners’ capital commitments in the event certain of our managing partners do not devote the requisite time to managing the fund or in connection with certain Triggering Events (as defined below). This is true of Fund VI and Fund VII on which our near- to medium-term performance will heavily depend. EPF, COF I and COF II have a similar provision. In addition to having a significant, immeasurable negative impact on our revenue, net income and cash flow, the occurrence of such an event with respect to any of our funds would likely result in significant reputational damage to us. Further, the loss of one or more our of managing partners may result in the acceleration of our debt. The loss of the services of any of our managing partners would have a material adverse effect on us, including our ability to retain and attract investors and raise new funds, and the performance of our funds. We do not carry any “key man” insurance that would provide us with proceeds in the event of the death or disability of any of our managing partners.

Management Fees

During the investment period, we earn semi-annual management fees from our private equity funds and EPF ranging between 1.0% to 1.75% per annum of the capital commitments of limited partners, other than designated management investors and certain other investors. Upon the third anniversary of the final closing for EPF, the management fees from EPF will step down to 1.75% of the acquisition cost of unrealized investments. Upon the earlier of the termination of the investment period for the relevant fund and the date as of which management fees begin to accrue with respect to a successor fund (the “Management Fee Step Down Date”), the percentage rates of the management fees from our private equity funds are reduced to a percentage ranging from 0.65% to 0.75% of the cost of unrealized portfolio investments. Private equity management fees are reduced by a percentage of any monitoring, consulting, investment banking, advisory, transaction, directors’ or break-up or similar fees paid to the fund’s general partner, management company, “principal partners” ( i.e. , those of our named partners who are principally responsible for the management of the fund) or any of their affiliates, or “Fund Special Fees.” In the case of Funds IV, V, and VI this reduction applies only after deducting from Fund Special Fees the costs of unconsummated transactions borne by us. In Fund VII, such unconsummated transaction costs will be borne by Fund VII, but reimbursed to Fund VII by an offset against the management fee of Fund Special Fees in an amount up to the amount of such costs, and thereafter the management fee will be offset by the applicable percentage of Fund Special Fees. In the case of Funds VI and VII, management fees are also reduced by an amount equal to any organizational expenses (to the extent they exceed those that the fund is required to bear) and placement fees paid by the fund.

 

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The Management Fee Step Down Date has already occurred with respect to Funds IV, V and VI and the percentage rates of their management fees have been reduced. Fund VII will transition from the investment period rate to the post Management Fee Step Down Date rate upon the earliest of (i) August 30, 2013, (ii) the permanent termination, pursuant to certain provisions of the Fund VII partnership agreement, of the Fund VII investment period, and (iii) the date as of which management fees begin to accrue that are payable by another pooled investment vehicle with investment objectives and policies substantially similar to those of Fund VII and formed by us or by Fund VII’s partners.

Management fees from AAA and its affiliates range between 1.0% and 1.25% of AAA’s adjusted assets, defined as invested capital plus proceeds of any borrowings of AAA Investments plus its cumulative distributable earnings at the end of each quarterly period (taking into account actual distributions but excluding the management fees relating to the period or any non-cash equity compensation expense), net of any amount AAA pays for the repurchase of limited partner interests, as well as capital invested in Apollo funds and temporary investments and any distributable earnings attributable thereto. There are no reductions to AAA Investments’ management fees for Management Fee Offsets.

Management fees for most of our capital markets funds generally range between 0.75% and 2.0% per annum of the applicable fund’s average gross assets under management or net asset value and are paid on a monthly or quarterly basis, depending on the fund. Unlike our private equity funds, which have fixed, limited lives, most of our capital markets funds have unlimited lives, so there is no investment period or mandatory reduction in the percentage charged over time. There are also generally no reductions for financial consulting, advisory, transactions, directors’ or break-up fees, although such fees are not typically charged in respect of our capital markets investments. During the years ended December 31, 2010 and 2009, our capital markets management fees were 1.02% and 1.05% of average fee-generating AUM for such periods, respectively. By contrast, our private equity management fees were 0.93% and 0.92% of average fee-generating AUM for the years ended December 31, 2010 and 2009, respectively.

Management fees for AIE II are paid quarterly. Through June 30, 2009, and depending on the percentage of drawn capital commitments, management fees are based on either 1.5% of the capital commitments of limited partners or 1.5% of the net asset value attributable to the limited partners, in either case plus 1.0% of the partnership leverage attributable to the limited partners. Beginning in July 2009, management fees stepped down to the sum of 1.25% of the net asset value attributable to the limited partners and 0.75% of the partnership leverage attributable to the limited partners. The net asset value of the fund equals the gross assets of the fund less liabilities of the fund. The partnership leverage of the fund equals the gross assets of the fund less the net asset value of the fund.

Management fees for COF I and COF II are 0.75% and 1.25%, respectively, per annum of the aggregate capital contributions of limited partners, other than designated management investors and certain other investors, invested in unrealized portfolio investments. Such management fees are reduced by Management Fee Offsets, similar to the reduction to private equity management fees described above.

With respect to our real estate business, we receive management fees from ARI, which are calculated and payable quarterly in arrears in an amount equal to 1.50% of ARI’s stockholders’ equity (as defined in its management agreement) per annum.

We also receive a management fee from the AGRE CMBS Account, which is calculated as a percentage of the capital accounts of the limited partners and payable monthly in advance.

Management fees for CPI are primarily based on a specific percentage of committed or net invested capital or net asset value.

Transaction Fees

We receive transaction fees in connection with many of the acquisitions and dispositions made by our private equity funds, certain of our capital markets funds and by AAA Investments in its co-investments

 

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alongside our private equity funds. These fees are generally calculated as a percentage of the total enterprise value of the entity acquired or sold. Except in the case of AAA Investments, discussed above, a specified percentage of these fees reduce our management fees.

We generally do not receive transaction fees in connection with the investments of our capital markets funds.

Advisory Fees

We receive advisory fees for consulting services that we perform for certain private equity and capital markets funds’ portfolio companies. The fees vary between portfolio companies and for certain portfolio companies, the fees are dependent on EBITDA. Except in the case of AAA Investments, Artus and the Value Funds, a specified percentage of these fees reduce our management fees.

Carried Interest

Carried interest for our funds entitles us to an allocation of a portion of the income and gains from that fund and, in the case of our private equity funds and certain of our capital markets and real estate funds, is as much as 20% of the cash received from the disposition of a portfolio investment or dividends, interest income or other items of ordinary income received from a portfolio investment or the value of securities distributed in kind, after deducting the capital contributions, organizational expenses, operating expense and management fees in respect of any realized investments. In the case of each of our private equity funds and certain of our capital markets and real estate funds, the respective carried interest is subject to annual preferred return for limited partners, which varies by fund, subject to a catch-up allocation to us thereafter. Carried interest is normally distributed upon the disposition of a portfolio investment. Carried interest is normally distributed on an annual basis and under certain circumstances upon the disposition of a specific investment. With respect to dividends, interest income and ordinary income received from a portfolio investment, carried interest is distributed no later than a specified period after the end of a fiscal year of the relevant fund.

Carried interest for most of our capital markets funds ranges between 15% and 20% of either the fund’s income and gain or the yearly appreciation of the fund’s net asset value. For such capital markets funds, we accrue incentive income on both realized and unrealized gains, subject to any applicable hurdles and high-water marks. Certain of our capital markets funds are subject to a preferred return.

If, upon the final distribution of any of our private equity funds or certain of our capital markets funds, the relevant fund’s general partner has received cumulative carried interest on individual portfolio investments in excess of the amount of carried interest it would be entitled to from the profits calculated for all portfolio investments in the aggregate, the general partner will return the excess amount of incentive income it received to the limited partners up to the amount it has received less taxes. With respect to our private equity funds and certain of our capital markets funds, an escrow account is required to be maintained, such that upon each distribution, if the fair value of unrealized investments (plus any amounts already in the escrow accounts) is not equal to 115% of the cost of the unrealized investments plus allocable expenses and management fees, the general partner will place the portion of its carried interest into such escrow account as is necessary for the value of the account, together with the fair value of the unrealized investments, to equal 115% of the cost of the unrealized investments plus allocable expenses and management fees.

As of December 31, 2010, based on the inception-to-date performance of our private equity and capital markets funds, none of the general partners of such funds had an obligation to return carried interest or incentive income distributions based on realization of investments. In Funds IV, V, VI and VII, the obligation to return carried interest income distributions is guaranteed by the partners of the fund’s general partners. Although our managing partners and contributing partners remain personally liable for their obligations under the guarantees, pursuant to the Managing Partner Shareholders Agreement, we agreed to indemnify our managing partners and certain contributing partners against all amounts that they pay pursuant to any of these personal guarantees in

 

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favor of our funds (all including costs and expenses related to investigating the basis for or objecting to any claims made in respect of the guarantees) with respect to the interests that they contributed or sold to the Apollo Operating Group.

See further discussion related to the potential reversal of carried interest income in note 14 to our consolidated and combined financial statements included elsewhere in this prospectus.

Our carried interest from AAA Investments entitles us to 20% of the realized gains (net of related expenses, including any allocable borrowing costs) from each co-investment made by AAA Investments pursuant to a committed co-investment facility (such as its agreement with Fund VI) after its capital contributions in respect of realized investments made pursuant to that committed co-investment facility have been recovered, subject (in the case of AAA Investments, co-investment with Fund VI) to a preferred return of 8%, with a catch-up allocation to us thereafter. There is no similar preferred return requirement in respect of AAA Investments, co-investment with Fund VII. Distributions in respect of our carried interest in investments made pursuant to AAA Investments, co-investment facilities are made as investments are realized. We are also allocated 20% of the realized gains on AAA Investments opportunistic investments (meaning ones that are not temporary, a co-investment with a private equity fund or a direct investment in an Apollo fund), with no preferred return (net of related expenses, including allocable borrowing costs).

Redemption and Termination

AIC and AIE I, with a combined AUM of $3.9 billion as of December 31, 2010, are not subject to mandatory termination and do not permit investors to withdraw capital through redemptions. Our other funds are subject to termination or redemption as described below. Additionally, AIE I shareholders have agreed to a monetization plan discussed elsewhere in this prospectus.

Private Equity Funds.  Our private equity funds, with a combined total of $38.8 billion of AUM as of December 31, 2010 (including the portion of the AAA Investments’ co-investment alongside Fund VI and Fund VII), generally terminate 10 years after the last date on which a limited partner purchased an interest in the fund, subject to extension for up to two years if certain consents of the limited partners or the fund’s advisory board are obtained. However, termination can be accelerated:

 

   

six years after the applicable fund’s general partner or advisory board gives written notice to the fund’s limited partners that the requisite number of key persons have failed to devote the requisite time to the management of the fund, if at a specified number of days after such notice the limited partners holding a specified percentage of the limited partner interests entitled to vote fail to elect to continue the investment period, subject to extension for up to two years with the same consents as are required to extend the fund at the end of its scheduled 10-year term;

 

   

upon a “disabling event” (as defined below), unless within 90 days after such disabling event, a majority of the limited partner interests entitled to vote agree in writing to continue the business of the fund and to the appointment of another general partner;

 

   

upon the affirmative vote of a simple majority in interest of the total limited partner interests entitled to vote;

 

   

except in the case of Fund VII, upon the affirmative vote of 50% to 66.6% of the total limited partner interests entitled to vote, upon the occurrence of a triggering event (as defined below) with respect to the fund’s general partner or management company, or some specified number of the fund’s key persons;

 

   

after the commitment period, upon a good faith determination by the general partner of the applicable fund that the fund has disposed of substantially all of its portfolio investments;

 

   

in the discretion of the general partner of the applicable fund to address certain circumstances where the continued participation in the fund by certain limited partners would violate law or have certain adverse consequences for such limited partner or the fund;

 

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the entry of a decree of judicial dissolution under Delaware partnership law; or

 

   

any time there are no limited partners, unless the business of the applicable fund is continued in accordance with Delaware partnership law.

“Disabling event” means (i) the occurrence of an event set forth in Section 17-402 of the Delaware Revised Uniform Limited Partnership Act, which include the withdrawal of the applicable fund’s general partner, the assignment of the general partner’s interest, the general partner’s removal under the applicable fund’s limited partnership agreement and certain events of bankruptcy, reorganization or dissolution relating to the general partner, and (ii) in the case of one of our private equity funds, the termination of the investment period by the limited partner in connection with a Triggering Event. With respect to the general partner or management company of the fund, a “Triggering Event” generally means with respect to any person, the criminal conviction of, or admission by consent (including a plea of no contest or, in the case of certain of our private equity funds, consent to a permanent injunction prohibiting future violations of the federal securities laws) of such person to a material violation of federal securities law, or any rule or regulation promulgated thereunder or any other criminal statute involving a material breach of fiduciary duty; or the conviction of such person of a felony under any federal or state statute; or the commission by such person of an action, or the omission by such person to take an action, if such commission or omission constitutes bad faith, gross negligence, willful misconduct, fraud or willful or reckless disregard for such person’s duties to the applicable fund or its limited partners; or the obtaining by such person of any material improper personal benefit as a result of its breach of any covenant, agreement or representation and warranty contained in the applicable partnership agreement or the subscription agreement between the applicable fund and its limited partners.

Capital Markets Funds.  Equity interests issued by SVF, VIF and AAOF may be redeemed at the option of the holder on a quarterly or annual basis after satisfying the applicable minimum holding period requirement (ranging from 12 months to 60 months depending on the particular fund and class of interest). Certain classes of interests in certain funds provide for the imposition of redemption charges at declining rates for interests redeemed on any of the first four quarterly redemption dates from the expiration of the minimum holding period requirement (ranging from 1% to 6% of gross redemption proceeds, depending on the terms of the applicable fund and class). Aggregate redemptions on any redemption date may be limited by a gating restriction to a maximum of 25% of net assets. An investor’s allocable share of certain investments designated as “special investments” generally is not eligible for redemption until the occurrence of a realization or liquidity event with respect to the underlying investment. Holders of a majority of the outstanding equity interests in each fund also have the right to accelerate the liquidation date of the fund.

The investor in SOMA may elect to withdraw its capital as of January 31 of each year, commencing January 31, 2010. We have the right to terminate SOMA at any time. In addition, SOMA will dissolve automatically upon the occurrence of certain events that result in the general partner ceasing to serve or to be able to serve in that capacity (such as bankruptcy, insolvency or withdrawal) unless the investor elects to continue SOMA and to appoint a new general partner.

Under the terms of their respective partnership agreements, COF I and COF II will terminate 8 years after the first date on which a limited partner purchased an interest in the fund and certain other capital markets funds will terminate within five to eight years after the last date on which a limited partner purchased an interest in the fund, in each case, subject to extensions for further periods if certain consents of the limited partners or the fund’s advisory board are obtained. However, termination can be accelerated in similar circumstances to those set out under “—Private Equity Funds” above. Under the terms of its partnership agreement, Artus can be terminated only upon the determination of its general partner; however, a majority in interest of its unaffiliated investors may remove the general partner at any time with or without cause.

 

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General Partner and Professionals Investments and Co-Investments

General Partner Investments

Certain of our management companies and general partners are committed to contribute to the private equity and capital markets funds and affiliates. As a limited partner, general partner and manager of the Apollo private equity funds and capital markets funds, Apollo had unfunded capital commitments of $140.6 million, $201.3 million and $175.7 million at December 31, 2010, 2009 and 2008, respectively.

Under the services agreement between AAA and one of our subsidiaries, we are obligated to reinvest into common units (which may be in the form of RDUs) or other equity interests of AAA, on a quarterly basis, 25% of the aggregate after tax distributions, if any, that the Apollo Operating Group entity receives in respect of carried interests allocable to investments made by AAA Investments, including co-investments with Fund VI and Fund VII. Accordingly, we expect to periodically acquire newly issued common units of AAA (which may be in the form of RDUs) in connection with AAA’s investments in our funds. Such common units will be subject to a three-year lockup period.

Managing Partners and Other Professionals Investments

To further align our interests with those of investors in our funds, our managing partners and other professionals have invested their own capital in our funds. Our managing partners and other professionals will either re-invest their carried interest to fund these investments or use cash on hand or funds borrowed from third parties. On occasion, we have provided guarantees to lenders in respect of funds borrowed by some of our professionals to fund their capital commitments. We do not provide guarantees for our managing partners or other senior executives. We generally have not historically charged management fees or carried interest on capital invested by our managing partners and other professionals directly in our private equity and capital markets funds. Our managing partners and other professionals are not contributing the investments made in their personal capacity in our funds, or as co-investments.

Co-Investments

Investors in many of our funds as well as other investors may receive the opportunity to make co-investments with the funds. Co-investments are investments in portfolio companies or other assets generally on the same terms and conditions as those to which the applicable fund is subject.

Regulatory and Compliance Matters

Our businesses, as well as the financial services industry generally, are subject to extensive regulation in the United States and elsewhere.

All of the investment advisors of our funds are affiliates of certain of our subsidiaries that are registered as investment advisors with the SEC. Registered investment advisors are subject to the requirements and regulations of the Investment Advisers Act. Such requirements relate to, among other things, fiduciary duties to clients, maintaining an effective compliance program, solicitation agreements, conflicts of interest, recordkeeping and reporting requirements, disclosure requirements, limitations on agency cross and principal transactions between an advisor and advisory clients and general anti-fraud prohibitions.

In addition, AIC has elected to be treated as a business development company under the Investment Company Act. The entity that serves as AIC’s investment advisor is subject to the Investment Advisers Act and the rules thereunder.

In order to maintain its status as a regulated investment company under Subchapter M of the Internal Revenue Code, AIC is required to distribute at least 90% of its ordinary income and realized, net short-term

 

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capital gains in excess of realized net long-term capital losses, if any, to its shareholders. In addition, in order to avoid excise tax, it needs to distribute at least 98% of its income (such income to include both ordinary income and net capital gains), which would take into account short-term and long-term capital gains and losses. AIC, at its discretion, may carry forward taxable income in excess of calendar year distributions and pay an excise tax on this income. In addition, as a business development company, AIC must not acquire any assets other than “qualifying assets” specified in the Investment Company Act unless, at the time the acquisition is made, at least 70% of AIC’s total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” In late 2006, the SEC adopted rules under the Investment Company Act to expand the definition of “eligible portfolio company” to include all private companies and companies whose securities are not listed on a national securities exchange. The rules also permit AIC to include as qualifying assets certain follow-on investments in companies that were eligible portfolio companies at the time of initial investment but that no longer meet the definition. In addition, the SEC recently adopted a new rule under the Investment Company Act to expand the definition of “eligible portfolio company” to include companies whose securities are listed on a national securities exchange but whose market capitalization is less than $250 million. This new rule became effective July 21, 2008.

In addition, ARI has elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code commencing with its taxable year ended December 31, 2009. To maintain its status as a REIT, ARI must distribute at least 90% of its taxable income to its shareholders and meet, on a continuing basis, certain other complex requirements under the Internal Revenue Code.

The SEC and various self-regulatory organizations have in recent years increased their regulatory activities in respect of asset management firms.

Certain of our businesses are subject to compliance with laws and regulations of U.S. Federal and state governments, non-U.S. governments, their respective agencies and/or various self-regulatory organizations or exchanges relating to, among other things, the privacy of client information, and any failure to comply with these regulations could expose us to liability and/or reputational damage. Our businesses have operated for many years within a legal framework that requires our being able to monitor and comply with a broad range of legal and regulatory developments that affect our activities.

However, additional legislation, changes in rules promulgated by self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules, either in the United States or elsewhere, may directly affect our mode of operation and profitability.

Rigorous legal and compliance analysis of our businesses and investments is important to our culture. We strive to maintain a culture of compliance through the use of policies and procedures such as oversight compliance, codes of ethics, compliance systems, communication of compliance guidance and employee education and training. We have a compliance group that monitors our compliance with all of the regulatory requirements to which we are subject and manages our compliance policies and procedures. Our Chief Legal Officer serves as the Chief Compliance Officer and supervises our compliance group, which is responsible for addressing all regulatory and compliance matters that affect our activities. Our compliance policies and procedures address a variety of regulatory and compliance risks such as the handling of material non-public information, position reporting, personal securities trading, valuation of investments on a fund-specific basis, document retention, potential conflicts of interest and the allocation of investment opportunities.

As an element of our platform, we generally operate without information barriers between our businesses. In an effort to manage possible risks resulting from our decision not to implement these barriers, our compliance personnel maintain a list of issuers for which we have access to material, non-public information and for whose securities our funds and investment professionals are not permitted to trade. We could in the future decide that it is advisable to establish information barriers, particularly as our business expands and diversifies. In such event our ability to operate as an integrated platform will be restricted.

 

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We anticipate our annual incremental cost of complying with regulatory requirements once we are a public company will be approximately as follows:

 

   

Board of Directors and Audit Committee Member Fees—$700,000; and

 

   

Internal Audit Function—$1.0 million.

We also may make grants of RSUs to independent directors that we appoint in the future.

BROKERAGE PARTNERS