Episode 56: Jordon Kruse and Matt Wilson of Oaktree Capital on Opportunities in Special Situations Investing

Episode Transcript  

 Shiv: All right, Matt and Jordon, welcome to the show. How's it going?

Jordon: Doing great, thanks.

Shiv: Excited to have you on. So Jordon, why don't we start with your background and experience and then Matt, we'll go to you.

Jordon: Sure, Jordon Cruz, I'm a co-porfolio manager, managing director of Oaktree Capital Management, where I run with Matt, the special situations group. I'm a native of the Chicago area, grew up in the Northern suburbs, went to college at the University of Virginia, where I majored in history and government with a plan to go to law school, which I did in 1994. I attended Northwestern University School of Law, graduating in 97. I spent three and a half glorious years at Kirkland and Ellis doing corporate and M&A, about 10 life years. That's where I met Oaktree Capital. They were a client of mine and I got a really unique opportunity in 2001 to move to California, to Los Angeles, and join this group at Oaktree as a vice president and slowly but surely moved up the chain. Matt and I were named co-portfolio managers in 2014 and we took over this group entirely in 2015. So we've been running it together for close to 10 years. So 23 years at Oaktree, three and a half years at Kirkland and one summer as a day camp counselor during my last year of college.

Shiv: Awesome. And Matt?

Matt: Yeah, Shiv, thanks for having us on this morning. You know, similar background to Jordon in the sense I'm from the Midwest as well. I grew up in Northeast Ohio. I also attended the University of Virginia. I also studied history and economics. A little more traditional path into finance. I moved to New York after college, did a couple of years in investment banking, doing all sorts of things from M&A to public and private financings. I got into private equity in the late 90s, very different world than it is today. Did a couple of years there before the dot-com bubble blew up and the markets got really ugly. Decided at that point to go back to business school. I attended HBS I graduated there in 2003 and I've been back at it since then I joined Oaktree in 2007 so a little bit after Jordon and he gave you the rest of our history It's been a great partnership We've been partners now for almost 18 years here at Oaktree and as he said we've been running this group together for the last decade.

Shiv: That's awesome. Which one of you wants to explain what you mean by the special situations group?

Jordon: Well, I'll take a crack at it and Matt will invariably correct me. But yeah, I'll tell you, our business is not easily definable. You hear a lot of different titles applied to it from special situations to special opportunities and the like. At its core, it's a deep value private equity strategy. So our goal is to build a portfolio of middle market names where we have in most cases absolute control and if we don't have absolute control significant influence over the day-to-day strategic and operational approach to the company. It's a concentrated portfolio. For us, middle market means companies with anywhere from 15 to 100 million of EBITDA or whatever the right earnings definition is for the business. We're deploying as little as 50 and as much as 300 million into any specific name or average is probably around 150 million. And what we're trying to find is situations, whether it's idiosyncratic or macro driven, that provide us the opportunity to invest at an attractive valuation. So we're trying to find bargains. And the idiosyncratic can run from specific issues that the company is having. The macro can be driven by things like economic shutdown during COVID or what we're seeing right now. We'll probably talk a lot about today, interest rates elevated relative to the last 20 years. But it really, at the end of the day, is about value. We really want to try to find opportunities where the risk of loss is low because we bought the asset the right way and then we drive returns through very active ownership. So it's not easily definable. I sort of think of special sits as a spectrum of opportunity from highly, highly financially distressed companies that need to restructure to more stressed capital structures to frankly, very healthy businesses that are growing. There's a lot of what we're seeing right now that just needs some help, both financially and operationally. So it's not easily defined, but you kind of know it when you see it.

Shiv: And Matt, are a lot of these companies that Jordon's describing, are they usually under financial distress of some kind where they need a financial backer to come and support or pull them out of whatever situation that they're in?

Matt: You know, not always. I mean, certainly we do play in that world of stressed or distressed companies. We've got a real DNA atnd Oaktree of that over the last 30 plus years. But I would tell you that, you know, what I like about our model and what probably is the cornerstone of oura success is the ultimate flexibility we have to invest in different parts of the capital structure, either debt or equity, and to participate at any part of the economic cycle. So, you know, obviously in times of recession or a tougher market, there are more distressed businesses out there and we'll participate in that. We like those because you can usually buy them cheaply and you can buy them at a point in their life cycle where something's gone wrong. And so the opportunity to buy them at a depressed level of earnings where you can do something different with the business to improve it and grow it is there. But, you know, make no mistake where we are doing very healthy deals, you know, where we partner with founders, for example, that are looking to diversify, right? You've got a lot of founders that have businesses they've built to scale. They've taken it as far as they can go. They want to take some money off the table for ea state planning or other purposes. And they're looking for a partner that's going to come in and help them drive to the next level of growth. And so, you know, to Jordon's point, there is no one definition. I think that that flexibility and that ability to pivot, depending on where we are in the cycle and depending on what we see and be flexible with our capital, as long as we have some of the core tenants of our philosophy around influence, control, and ability to sort of affect change on the operational trajectory of the business. We can do it on both healthy and distressed companies.

Shiv: Are you seeing more of a demand for this type of an investment model or solution in the marketplace with the way the market has been currently going and interest rates that have climbed and companies that are maybe missing growth projections and looking for alternative solutions?

Jordon: Yeah absolutely our pace of investing has been very fast the last two years driven. Pprimarily by the interest rate environment and it's just math at the end of the day. Yyou had a lot of deals. T That were done immediately prior to covid in ‘18 and ‘19 and then, you ’21 and ‘22 that were based on the idea that base interest rates would be around zero to two and a half percent over the life of the deal. And SOFR right now is at 4.8%. It's been as high as five and a half percent. And effectively, you have a lot of capital structures whose cost of capital, their cash interest cost has effectively doubled over that period of time. And some capital structures will work. Some businesses will perform and earn enough free cash flow or EBITDA to service that debt, but a lot of businesses cannot and that's created a huge opportunity for us. You know, the way we think about our model is intended to be all weather. It's not reliant on any particular environment. It can take advantage of situational opportunities that are company driven. It can take advantage of macro opportunities, which are more market driven like we're seeing right now. It's just about pace of investing. We always raise funds on the assumption we'll be in a non-distressed environment where the economy is growing very quickly. We happen to be in an environment where the economy is growing, businesses are actually performing, but interest cost has effectively doubled for many capital structures and that creates a lot of opportunity for us. It's the closest thing to what we call a good company bad balance sheet that we've frankly seen since the early 2000s.

Shiv: And how common is that? Wwe've had other investors on the podcast where they've mentioned that there are a lot of assets available at a discount right now. And so are you seeing that as well? And Matt, maybe you can talk about your value creation philosophy in terms of how you're structuring these companies or restructuring them as Oaktree comes in. How do you create the most amount of value for your LPs?

Matt: Sure. I listen, think about it this way. In 2019-2021, you had overall market multiples at all time highs. If you look at the LBO market, right? That market was paying on average 13 times for LBOs and leverage was exceeding seven times in over two thirds of those deals by the end of the cycle. And by the way, seven times on a cashflow number that wasn't all cash, right? A highly adjusted EBITDA number as they would call it. So when you think about the setup for where we are today, you had a time where peak multiples were paid and for the best companies out there, the highest prices were paid because they were the best companies. Peak leverage was employed to facilitate those peak prices because debt at the end of the day, the amount of debt you can raise on a business is the underpinning of that asset valuation. And so, you know, ultimately what nobody figured out or nobody assumed would happen was the Fed would move so quickly and raise rates. It was not a steady state progression of interest rates. It was a very delayed reaction than a very meteoric reaction that caught a lot of people by surprise. And not surprisingly, a lot of these deals that were used to finance these LBOs were done with floating rate debt. And nobody bought swaps, nobody bought caps, nobody bought the insurance because there was no reason to for the last decade and half to do that. And so what you have right now, to Jordon's point, and a lot of good businesses that were bought at very high prices, they're still good businesses. They're still producing cash flow, but they're living in a balance sheet that doesn't work for what they have today because they can't deliver. The cash the owners believe what is going to come out of the business and become equity returns and pay down debt has effectively gone to the lenders in the form of interest expense. And so what we're seeing a lot of right now are companies that are good companies that are operationally not distressed, but their balance sheets are stressed because the world is very different today in terms of what you can refinance in terms of quantum of debt. That ratio of seven times doesn't exist today. As well as the cost of that debt. In some cases, it's double what they underwrote in the cycle of ‘19, ‘20 and ‘21. So when you think about what that means, there's a need for new capital to come in and help right-size the balance sheet. There's a need for money to come in and help get them to the next level where they can kick the can down the road with the refinancing. And we've seen a huge amount of opportunities in this market to come in and be that provider of structured capital. How we protect ourselves? We typically come in in a priority position. We're coming in with something that has a little bit of leverage in front of it, but not anywhere near five, six or seven times, we get the equity upside of participating, helping them grow that business from there, and we get a coupon along the way. So for us, it's a very nice place to be because we're coming in almost as rescue financing, if you want to call it that, in a way to help them reset their balance sheets and allow them to have a chance to win back at least a portion of their equity value over time.

Shiv: Can you explain that in more detail? You gave some sort of an example there, but just to illustrate it further, how are you right-sizing the balance sheet? How are you protecting yourselves? And what does, because obviously there are investors or LPs that put money into a business even five years ago or seven years ago that are looking for a return. They're running close to the end of their hold period. So they need liquidity. So you have interested parties that want to liquidate. So I get that part, but how do you protect yourselves and get enough for the upside? And what does that process look like?

Jordon: Yeah, I mean, a really simple example is, you know, take a 2019 LBO and let's say the business was acquired at 10 or 11 times EBITDA and finance was six times debt. In a zero interest rate environment, you know, the math will work over time, particularly if you grow the earnings of the business. But if you get to 2024 and let's say you've been through COVID, and you went up before COVID and you went down during COVID and you're starting to get up again. But let's say that the earnings profile of that business is exactly what it was in 2019. So it's not at a loss, it's not a problem. But with substantially higher interest costs, the six times debt may be a big challenge. Your same leverage level, but you may not free cash flow or you may not be able to pay down any debt. You may just be able to make your interest costs. And you've got a maturity company or you got a cash flow issue. What we would come in and do is provide that company with dollars to pay down the traditional first lien debt, say down to three times. And we would step in and have like a convertible preferred instrument or an unsecured debt instrument or a warrant. And that would value the company through that six times leverage level. So you're just swapping out cash paying debt with in our case more likely than not picking structured investment through a convertible preferred or a debt with some kind of warrant. That interest cost for us or that dividend rate for us is going to be in the teens. It's going to be anywhere from 12 to 18% again depending on the situation. And then it's going to convert at some equity valuation that gives credit to the equity value currently held by that sponsor. So we're gonna share the equity upside from there, but we're also gonna collect the 15, 16% on that. So what we're doing is we're de-levering the traditional balance sheets that the company can afford its cash interest, swapping it out for more expensive paper, and kicking the can down the road for that sponsor.

Shiv: And just for the audience, what is the difference in your coupon rate versus whatever floating rate interest that the company would get?

Jordon: Well, mean, most first liens are going to be priced at anywhere from SOFR plus 450 to SOFR plus 550. Again, depends on the credit. So you're talking about swapping out mid-teens type pick interest for, you know, call it 9%, 10%, 11% cash interest.

Shiv: Right. that can be the difference in millions of dollars.

Jordon: Yeah, most importantly, it's the difference in having to come up with the cash to pay the interest versus accreting it, right? Our structure generally does not get paid in cash. It accretes and adds to the balance of the structured investment.

Shiv: Right. But then are you taking preferred stock versus the other shareholders of the business as well?

Jordon: Yeah, and so what you're basically the way you think about it is infrastructure in the beginning was first lienly debt and equity held by the sponsor. Now the structure is first lienly debt, preferred equity held by us, common equity shared between us and the sponsor. So they're giving up potential upside in order to avoid a total restructuring or having to come up with money themselves to pay down the traditional debt.

Shiv: Are they getting liquidity along the way from you as well as part of that?

Jordon: You know, in some cases, yes. In some cases, you can structure a deal that both deleivers the balance sheet and allows the owner to take some money out. Matt referred before to founder deals. A lot of times in a founder deal, it's not really about capital structure or stress, but there's a need for capital for a dividend or to buy out a minority shareholder or whatever the case may be. Same exact structure. It's just the use of proceeds is a little bit different. One thing we're seeing a lot of in the last, you know, call it six to nine months is longer in the tooth private equity owned businesses that are performing great, don't have capital structure issues. But because of where the sponsor bought the business back in ‘19, ‘20, ‘21, the market, you know, Matt made the point, the market is not where it was back then from a multiple perspective. So if you bought a business in 2019 for 13 times, you cannot sell it today for 13 times. But it's marked on your books, what you're showing your LPs at 13 times current earnings, right? That's the natural progression of marketing your investments. So, and there's a dire need to get money back to LPs. If you want to go fundraise, you can't go back and have delivered no DPI at all. So we can do the same kind of structure to solve that problem for the sponsor by putting dollars in where they take the money out in the form of dividend and we now share equity ownership, but our invested cost sits in front of their common equity.

Matt: And Shiv, I think what you have to understand here is that the traditional M&A market, particularly for sponsors for the last almost 24 months now, has been really decimated. One, rates are much higher. Two, valuations are lower. If you think about what a multiple is of EBITDA, it's the inverse of a discount rate. Discount rates have gone way up as interest rates have gone up. And so you've had a lot of boardrooms for the last two years, where the board of a company wants to sell the company, but they want a price they can't get. And so buyers and sellers are looking at each other and the gap between valuation where the buyer wants to pay or can pay based on a debt available to them is far below where the seller wants to transact and sell. Now with rates coming down, that should loosen up a bit and should see more activity over the next several quarters. But what you're hearing us tell you about our model is it's very bespoke, right? We're not in a box when we come to approaching a transaction. These deals by definition are crafted as capital solutions that when we sit down with the counterparty, whether it be a founder, whether it be a sponsor firm or somebody else, it's an opportunity to go in and try to address whatever challenge they're facing. And challenge may be liquidity. Challenge may be they need to de-lever. Challenge may be they want to diversify their risk somewhere else. Whatever it may be, we sit down and we talk to them. Ffind ways to create something that works for us on the downside and protecting our downside going in with new money, but allows them the opportunity to continue to own that business in some form. And we're okay doing minority deals. I think the difference between us as a special situations investor and a lot of traditional PE is a lot of traditional private equity firms must control the business. And while we like to control the business, we are comfortable in structured deals taking a minority position at the table because we know how to do these things. We know how to have the right board representation. We pick our partners correctly and we have contractual protections that look out for us. But ultimately what you're hearing us tell you is in this market, where we've been so effective is because we have a very bespoke solution that is not cookie cutter, that is not just a LBO financial engineering, it's been very effective at helping address some of these needs or problems or issues with some of these other counterparts we see.

Shiv: Right. Yeah, we work with a lot of these big private equity groups on our side and a few of them have told us like for companies that are north of 100, 200 million in revenue that were bought or invested into in 2019, 2020, their debt service per year has in some cases gone up by 30 to $50 million. So it is a sizable impact to whatever the cashflow situation is of a business. So are you seeing it more at those kinds of levels where the amount of cash we're talking about is really high that's needed by the business or even smaller companies as well?

Jordon: Across the board, yeah.

Matt: Everybody, I mean, listen, here's the thing. You know, I guess, and I'll say it again, everybody who in the middle market in particular uses bank debt, which is a floating rate instrument, right? As opposed to the bond market, which are for bigger companies typically, which is a fixed rate coupon. If you had floating rate debt, you had an option when you made the deal in a long way to hedge that interest rate exposure. You could buy caps, you could buy swaps on the base rate. Nobody did. I mean, something like 80% of bank loans were unhedged when they were made because folks just didn't see the need to buy insurance. cost money to hedge. And what happened was because the Fed, you remember in ‘22 and ‘23, moved so aggressively after being late to the game, it became almost impossible to hedge that point because things moved up so quickly and expectations were they were going to move up quickly. And that precluded for people from taking that defensive posture. That cashflow that everyone expected to deliver the balance sheet and hence create equity value, then went out in the form of interest expense. In a lot of cases, it doubled, right? If you had an S-450 loan in 2021, you were paying 4.5% interest. By the end of 2022, 2023, you're paying 9% interest, 10% interest at that point. The cost of that capital is doubled on that part of your balance sheet. And therefore, the cash you expected to either reinvest in your business to grow as CapEx or to fund new initiatives, or that capital you want to take out as a distribution or use to deliver the balance sheet to create equity value, wasn't there for that purpose. It went to the lenders, which was completely unexpected. We believe that the private equity vintage is ‘19, ‘20, ‘21, I mean, tough vintages for a lot of firms. I mean, I the market expects that given what has happened because nobody expected their underwriting to see that kind of rate acceleration the way we did. And I think ultimately that's going to come back to haunt a lot of these, either because they're going have to hold these assets for eight, nine, 10 years to get back to where they want to, or in a lot of cases, that there's not going to pan out the same way they were going to because they either lose the company or they have to significant dilution to get the balance sheet refile.

Shiv: With these LPs that want to be cashed out, is that the main motivator? Because it feels like a lot of PE firms that own majority stakes or control interests in these companies, having somebody be above them in the preference stack seems like a counterintuitive or something that they would rather be dead than do.

Jordon: Yeah, it's a really, really good point. Here's what we can do. Matt and Jordon cannot walk into a conference room at XYZ private equity fund and say, hey, we're here to help. That's never a sell point. The ego's too much. So what happens is this, and I'll give you two scenarios. One, in the distress scenario where the capital structure is just not viable. The call we get is from an investment bank or restructuring firm that's been hired by the sponsor who finally, finally acknowledges they need help. And they always acknowledge it later than they probably should, you know, because a lot of cases hope is the strategy. You're going to earn your way out of the problem, but you, know, a company gets to a point where it's burning cash and that sponsor has to decide, we going to put more money in ourselves and double down on this or we're to go get help some way somehow? So when we get that call from an investment bank, it's because the sponsor has finally acknowledged they need help. And that's what allows us to do those rescue financing transactions. At the other end of the spectrum, what you're seeing a lot of, and this is why I said in the last six, nine months, we're seeing more and more of this is we're getting calls from frankly, the bulge bracket investment banks who have been hired by the sponsor to assess what they can do with a successful portfolio company investment. And it's that dynamic of they bought it at 13 times, they marketed 13 times, but the market today won't bear 13 times. And so they may not run a full auction for a business. I mean, five years ago, this was the broken auction conversation, right? Someone ran an auction, nobody was there to buy the business. And so they come talk to someone like us to see what we can do. Today, it's more of a sort of quiet discussion with potential buyers to confirm to the sponsor that there's really not a full sale opportunity there. Driven by all the dynamics Matt was talking about, the quantum of leverage available in the market today is lower, the cost of interest is higher, multiples, M&A multiples are lower. And in that circumstance, again, we're not walking in the room and saying, hey, we're here to help. It's the bank that is putting the two parties together to have a conversation about what the art of the possible is to allow that sponsor to take money off the table.

Shiv: Got it. Okay, that makes a lot of sense. And so your ICP in a way is the lender or the investment banker once they've already crossed a certain threshold until then it's almost less fruitful for you to go try to target private equity firms directly because they're still trying to meet their marks, I guess.

Matt: That's right. Llisten, the other thing is, it's not like, I for the best private equity firms, they maybe have a couple of these. think a lot of firms, they got a number of these things, right? And these are older funds now that are fully invested. They don't have the dry powder in their funds to support five companies that have broken balance sheets, right? And so the triage, they have to do. I nobody likes to get primed, as you just sort of described it before with new money from another quasi-sponsor coming in. But I sort of make the analogy, which is like, if my choice is to lose, you know, can't put money in cause I don't have the fund or I don't have the wherewithal to do it either cause I don't have the funds or I don't want to take a double down risk at this point in the cycle. Then my choices are to let go of the keys and give up a hundred percent of my upside and my basis. Or I can do something structured where yeah, I'm sitting behind someone, not necessarily at a higher attachment point, but I'm sitting behind a more expensive money, but I still have 60% of the upside going forward. And I've got a five year runway to get there now that I didn't have before I did this transaction. I think lot of very sober, smart sponsors are saying to themselves, I'd rather have 60% of the upside with the chance to grow it up and make it real value over the next five years than give up the keys today. And think that's a lot of the choices that are being made at the table right now.

Shiv: What percent, and this is a completely different point, but just on a macro level, because I think about this stuff all the time when we talk about our PE sponsors, like how, what percentage of companies are in this state? Like, if I look at the PE market out there and their portfolio companies, is it 20% of Portcos, 30% like more than that? Like, what are we talking about?

Jordon: It's almost impossible to know because all these portfolios are private and you really don't have lot of insight into how companies are performing until you get the call.

Shiv: But based on what you're seeing though, you have some idea based on the calls that you get.

Jordon: It's a high percentage.

Matt: I'm smiling because when you talk to most of them, they'll tell you they have no problems in their portfolio. It's zero. 

Shiv: That's just, we know that's not true. We know that's not true at all. Yeah.

Matt: But when you actually look at them, yeah, I understand. But I think you look under the hood. I would tell you that if you look at the vintages we're talking about, you got to talk about the vintages of the deals that were done in that kind of late cycle, ‘19, ‘20, ‘21 period of time. I think it's as much as half of those deals are in trouble because again, that was the peak of valuation and the peak of leverage. And so those two factors alone, even with a really good business, that has really strong cashflow earning power. The expectations were not met in terms of where the market would be to sell these things in terms of where the valuations are today versus where they were five years ago. And the cost of leverage was not factored in so that the leveraging that was part of the fundamental thesis did not take place. In fact, in a lot of these cases what we're seeing Shiv is they've had to borrow on revolvers to make interest payments, right? So leverage has actually gone up. i mean, forget about the EBITDA being flat down or up. Leverage has gone up because the operating cashflow of the business does not support the interest rate, the interest cost from higher rates.

Shiv: And they also have these underlying covenants that they have to meet in terms of costs and everything that they kind of have to keep under control, right? So you kind of have to downsize their teams or how much they're spending, and then that slows down growth even further.

Matt: Correct. You've got to make choices that are tough.

Shiv: So isn't that a little scary? 

Jordon: No, it's, Shiv, it's awesome.

Shiv: For your business, I get it, it's awesome. But I sometimes just think of it from a macroeconomic standpoint, like what percentage of these companies are really at risk or they're just relying on so much debt to kind of make it through. And unless the interest rates turn and the market turns, you're kind of just pushing the problem down the road, but the problem still exists.

Matt: Well, look, it's a capital structure problem, right? I mean, again, think about it this way. The reason bankruptcy was created in this country, right, the bankruptcy process was to adjudicate these matters, right? So just because an asset is over levered doesn't mean the business is going to liquidate, right? It just means that someone is going to take pain, probably the equity sponsor, probably some of the lenders for that matter in the junior part of the capital structure. They will lose capital. They will be wiped out in their investments, but the company should be okay. I mean, the company just needs to find a better recapitalized balance sheet to grow itself back. And ultimately that will come to a head one way or another. You'll either do a deal to provide liquidity in these stress or distress situations and you'll find a new investor to come in like us, or you'll take it to the brink and it'll go into bankruptcy and then there'll be a restructuring that takes place that massively levers the balance sheet.

Jordon: Yeah, I mean, the beauty of this system across the board is we have a real rehabilitative system for debt structures in this country. And it comes in the form of a statutory one and form Chapter 11. So when a company literally cannot meet its obligations, they can file Chapter 11. And the intent of Chapter 11 is to restructure the company and allow the business to continue to operate in the ordinary course. And then you have a private slash public solution in the markets to do the same exact thing just on an out of court basis. I mean, what we're doing in a rescue financing is effectively an out of court chapter 11 restructuring. We're reducing the traditional cash paying debt of the business, swapping it out for more expensive admittedly, but accret creeding debt. And we're allowing the owner of the business to continue to own the business and put the business in a better position to grow over the course of our investment.

Shiv: But then the original equity sponsors, wherever they got their capital from, the LPs or whoever, let's say the value, let's make up a number, the value of that is a billion dollars. It's shrinking. And that, so somebody is paying for that business to continue.

Jordon: Yeah, that's right. Meaning that if a private equity fund makes an investment with the intent using financial leverage to double their investment. So let's say they have a billion dollar fund and they make a billion dollars of investment and the goal is to turn that into two billion. They may not turn it into two billion. And so their returns will be worse than what they promised their LPs. But if the alternative is to lose one of those or all those investments and have zero capital return, you're better.

Shiv: Zero is way worse, I get that.

Jordon: Yeah, you're better off partnering with someone like us to effectively, using your term, kick the can down the road. Put yourself in a position to protect your invested cost to try to make a return, not the two times, and maybe you make 1.4 times, and that's a better result for your LP than just losing the investment and letting it go.

Shiv: Yeah, I had one investor tell me that if you're making 1.5 in this market, you're laughing. Like that's, that's good enough right now with how things are going.

Matt: Well, I'll tell you, that's fine.

Jordon: Well, we could get into a whole conversation about the history of private equity and returns, but yeah.

Shiv: Sorry, Matt, you were saying something there.

Matt: I was gonna say, look, it goes back to what I said a few minutes ago about I think the vintages that I'm talking about are gonna be very challenged relative to historical returns for private equity. I think to your point, when you're hearing people brag about one and a half times money, which is really like a debt-like return, right? When you think about that, that tells you what you need to know about where expectations are. By the way, let's be very clear. LPs are not unaware of this. They had a great run in the momentum trade from 2010 after the GFC all the way through ‘22. I mean, if you were in any kind of well-managed private equity funds, you got outsized returns for a ton of time. So this always happens. These are cyclical businesses. This cycle happened to be a very prolonged cycle of very low interest rates. I don't think we're going back to that anytime soon. I don't think the base rate is going back to zero. And in the scenario where it does, because it could, it's not a good economic scenario. It means we are in a very severe recession and the Fed is using its put option at that point to protect the economy and try to stimulate growth. If we're in that situation, a lot of things are going to be failing. A lot of investments will be failing. My point to you is if we do have the quote unquote soft landing, which I think a lot of people think is the base case, we think it's probably the base case, although maybe not as sanguine as others are of its surety. Because I think there are a lot of things that could go wrong in the economy. I do think that in that soft landing scenario, you're not going to see rates go below two and a half, three percent on the base rate, which implies, you know, the cost of senior debt being up in that 8%, you seven and half to eight and a half, 9% range versus that last 10 years at 5%, right? So it's going to be meaningfully, meaningfully different. Which means that as an investor, you've got to be better at owning these assets and doing something with them as opposed to being in a market momentum where things just keep going up into the right every year because more money is chasing the same number of deals. That's going to be a very different model going forward.

Shiv: Yeah, I think really that's the underlying issue, right? They're buying these companies that the whole investment thesis is that the market will continue to trend upwards versus actually creating enterprise value, regardless of what's happening macroeconomically, right? So what advice would you have? And maybe Jordon, you can start as for companies as they're looking at avoiding this type of a scenario going forward to make sure that they don't end up in a situation like this because this is, in some ways, this is like the opposite of value creation, right? It is destroying value that previously existed and now you have to catch up or prevent it from going to zero or save whatever is left in a lot of ways and then start to recover, right? So what can companies do to avoid being in a situation like this?

Jordon: Well, I don't know that I have great advice because I think there always will exist the LBO model. The LBO model is a high risk, high reward model. If you buy a company at a high multiple of EBITDA and you finance it with a high multiple of debt and you grow that business 20, 30, 40% over the four or five year period and assuming multiples are similar or greater when you go to sell it, you're gonna make a lot of money. It's a great way to make money. But. As you're seeing in the last couple years with more macro challenge environment particularly in the interest rate front. If things don't go perfectly you have a high risk of losing your money. I don't think that's ever going to change until LPs stop investing in very traditional private equity which is hard to imagine because it's such a huge chunk of the institutional investor market. I mean an individual company has to assess what their growth profile looks like against what the debt they can handle and make that assessment and not put themselves in an over levered position. Understanding that during the life of a loan, which is generally four to five years, things happen. Macro events happen. I mean, no one would have predicted as an example, the economy would shut down during COVID. That negatively affected a lot of businesses. So if you were three times levered in 2000, in March of 2020, but your entire revenue profile went to zero over a two month period, you became highly, highly levered. And there's nothing you can do about that. It just is what it is. And it's exogenous event. But one of the things we love about our model, I mean, at the end of the day, our model takes advantage of situations, whether driven by macro factors or more idiosyncratic factors, it takes advantage of situations involving highly levered businesses. And our expectation is, there's $3.1 trillion of non-investment grade debt outstanding in this country. That's not changing anytime soon. When I started at Oaktree, that number was $500 billion. So that market has grown dramatically, the LBO market has grown dramatically over that period of time. It's not going away tomorrow. What we love about our business is that raw number, that quantum of debt outstanding. There are a lot of highly levered businesses. Not everyone will have a problem, but for the ones that do, it creates an opportunity for us.

Shiv: Yeah, and there's also all of this dry powder that needs to be deployed. 

Jordon: Absolutely.

Shiv: So you've raised all this capital, you have to deploy, need debt in order to deploy it better or have better internal rates of return. So you're going to keep taking on more debt. There's no way to kind of avoid it in a lot of ways.

Jordon: No, I mean, if there's that much dry powder out there, it means there's competition for assets, which means you need to pay higher prices. In order to pay higher prices, you've got to borrow as much debt as you can. 

Matt: Or returns come down. That's the other way happens.

Jordon: Right.

Shiv: Or they come down. Yeah, I think one thing is just being more selective and being more intentional with the companies that you're investing in, having a very clear value creation plan beyond just financial engineering. I think this financial engineering as a value creation plan is not a value creation plan.

Matt: Shiv, I agree with that. Let me tell you, I use the best analogy I can here, which I think is, people talk about stock pickers market, in the public markets, this becomes sort of a stock pickers market for private equity. Those who can find the right deals and have a real operational and revenue growth creation thesis will have success in this market, right? If your model was predicated on being a me too private equity fund, and they're just, let's be very clear, the diaspora of managers that have come out in the last 25 years. Jordon and I have been in business for almost 30 years, right? I mean, when I was doing private equity in the 1990s, there were so far fewer number of firms that existed at that point, right? And this proliferation, you always thought, it's going to be a correction at some point, some of these funds are just going to go away. They haven't. When you talk to LPs today, and we talk to our LPs all the time, it's one of our favorite things to do in the business, to have close relationship with our LPs. What you're hearing them tell you today is, they're laser focused in this part of the cycle on who's giving them money back and who hasn't. Those who have really delivered DPI back to investors and those who they believe have a differentiated model in terms of value creation, they have an operational team or they have a sector focus where they have a differentiated set of operators, or they do something specific. Those companies will continue to grow and flourish, I believe, those partnerships. The ones that are sort of plain vanilla, they do generalist things, they don't have any kind of differentiated strategy. They've been playing the market momentum game or the financial engineering game for a decade and a half, they're going to struggle fundraising in this cycle,

Shiv: Right, right. think that's a really great takeaway. As we're closing off here, just a few more notes just for the audience. Where can they go to learn more about you and Oaktree and potentially working with you guys?

Jordon: Well, the website is a good starting point. We've got a lot of information on the web at oaktreecapital.com and it talks a lot about our group and our backgrounds. We are posting more on LinkedIn these days than feels comfortable for two guys that grew up in the 80s in the Midwest, but we're doing it because they've encouraged us to. So there's a lot of information about a lot of the deals we've been working on in there. I don't know, Matt, what else would you say?

Matt: I mean, look, I'm scared to talk about social media because I don't have any accounts besides my LinkedIn. I feel uncomfortable with that. Listen, I think that's exactly right. I mean, Oaktree is well known in the marketplace. We've been around for a long time. We manage almost 200 billion of assets. So we're well known. And we've got plenty of connectivity to the markets. But for anybody wanting to learn more about this, I think the website's a great place to start. We've done some industry pieces recently that are out there on the web. can read about them, give our views in more detail about what we think is going on in the broader markets.

Shiv: That's awesome. We'll be sure to include all of that in the show notes along with the website and the LinkedIn profiles and it is a good idea to post on LinkedIn. There's a lot of good stuff that happens there. So listen here. 

Jordon: It doesn't feel natural, Shiv. It doesn't feel natural.

Shiv: A lot of business decisions are made there. It's shocking, but yes, that's the right play. But yeah, thanks for doing this guys. I appreciate you coming on and sharing your insight. was a different kind of episode, but I really enjoyed it. So thanks for doing this.

Jordon: Yeah, thank you very much. Appreciate it.

Matt: Thank you, sir. Thank you.