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- [00:00]
Cole Smead
Foreign.
- [00:03]
Max Froomes
You're listening to A Book with Legs, a podcast presented by Smead Capital Management. At Smead Capital Management, we advise investors who fear stock market failure. You can learn more@smeedcap.com or by calling your financial advisor.
- [00:21]
Cole Smead
Welcome to A Book with Legs podcast. I'm Cole Smead, CEO and Portfolio Manager here at Smead Capital Management. At our firm, we are readers and we believe in the power of books to help shaped informed investors. In this podcast we speak to great authors about their writing. The late, great Charlie Munger prescribed using multiple mental models and analysis. We analyze their work through the lens of business markets and people. Hosting this alongside of me is our newly minted Chief Operating Officer who comes from Wall Street. Sure enough, Conrail Callahan.
- [00:52]
Connor Callahan
Good to be here.
- [00:53]
Cole Smead
Glad to have you, man. You ready to jam and have some fun?
- [00:55]
Connor Callahan
You know it. I'm ready. Let's do it.
- [00:56]
Cole Smead
Here we go. In this episode, we will discuss deal making, financing, legal, and maybe most interesting to our listeners, the masters of the universe, Max Froomes is joining us to discuss the Caesar's palace coup that he co authored with Sajit Indap. Little background on Max. Max is the global head of distress and restructuring news at nine Fin. He previously was a global head for Left Fin Insights, part of Fitch Solutions. Max has a master's in journalism from Northwestern University, probably one of the most famed journalism programs in the country, I might add, and more importantly, maybe a bachelor's degree in cognitive science from the People's Republic of Berkeley. Max, really glad you're here with us today.
- [01:37]
Max Froomes
Thanks for having me on. Cole, good to be on here with you and Connor.
- [01:41]
Cole Smead
Yeah, this will be fun. And just for our listeners, this book is there's a lot, it's fast pace, lots of people. And I think, Max, you did a really good job of keeping structure in people's mind. And we'll look at some of that structure discussion. Also just the opening where it's like, hey, remind me of who is who and who's tied to what. You did a wonderful job. So let me just kind of kick it off. What caused you and Sajit to come together? Obviously, Sajit was a writer at the Financial Times, I think at the time. How did you guys connect and how did this story become your story? You guys write together.
- [02:15]
Max Froomes
It's a great meet cute. And also I'll say in reference to your opening that the Caesar's palace coup was Charlie Munger's pick of the year, unveiled at the Berkshire Hathaway conference.
- [02:28]
Cole Smead
I agree. In fact, I'll Add to that. So we have a listener his last.
- [02:32]
Max Froomes
Year or second to last year?
- [02:34]
Cole Smead
Yeah, second to last year. So we have a listener. To your point, we call him super fan Steve know, a personality I guess, in the podcast. And he said, oh, Charlie Munger recommended this book. You guys have to do it. And I thought, well, if super fan Steve and Charlie Munger agree on it, then we better do it. So I agree. And that was, I think, what, that's four years ago now that Charlie mentioned that three years ago, something like that.
- [02:59]
Max Froomes
Yeah, yeah. So we appreciate, appreciate him, appreciate Steve for, you know, for, for reading the book and recommending it. And yes, we would be remiss not mentioning just the, you know, extraordinary, extraordinary business journalist Sajit, who, who co authored the book with me. And, and the way we met was on the social media platform formerly known as Twitter. I, you know, I, I like my career has been very niche in, in journalism, specialized journalism. You know, like, probably the most general interest I got was reporting on private equity for, for the Deal and the Deal magazine in, in New York. And there I, I specialized more and more into corporate finance for a publication out of Standard and Poor's and, and, you know, covering distressed debt where I got the attention of, you know, the businessman who actually he, he helped invest in, in debt and high yield for an insurance company. And he had the idea to start up a company that focused on distressed debt investing for an audience of hedge funds.
- [04:11]
Cole Smead
Okay.
- [04:11]
Max Froomes
And so we, you know, we, we launched that company together in 2013. And then my, you know, my reporting became a lot more technical. We hired former bankruptcy attorneys and credit analysts and, and ultimately produced like, highly specialized content for an audience of hedge funds and then investment bankers, lawyers, et cetera, and trying to get at, you know, all the complexities of these, of these distressed companies and then the ult, the trading prices of the debt securities throughout the course of a chapter 11 restructuring. And so while I was doing, you know, after, after four years of that, that company wanted to be a great success. My shares invested. I always wanted to write a book. I thought it was a super interesting industry. So I put together a proposal and started shopping it around and, and you know, at the time Sajit was writing for the Financial Times as the editor of the Lex column, and he'd been super interested in, in the Caesars story from the perspective of the intersection of, you know, corporate finance and corporate law. Right. And he's like, he's, oh well, you know, and he used to be an investment banker at Lazard and so He. He wrote this great capstone piece for the Financial Times that, that really kind of got into some of the behind the scenes of like, the angry negotiations between and Oak tree and others. And I had been covering Caesars from like, the front lines of like, live, you know, live blogging the, the bankruptcy hearings and litigation and reporting on the, you know, the. The groups that were forming behind the scenes. He heard about me writing, you know, proposing this book from one of his sources, a mutual source, reached out on Twitter and said, hey, look, I heard you're writing this book. I love this story. Any way I can be helpful, like, you know, be great, right? So he slid into my DMs. I messaged back, I'd be like, man, I'm, you know, big fan. Let's meet up. We did. It was clear he was. He was amazing. And I said, let's just write it together. He said, yes, and the rest is history.
- [06:27]
Cole Smead
Nice. That's really fun. So you start out with Gary Loveman. At the beginning, you kind of give his background at Harvard. Can you just, you know, kind of briefly touch on some of that background that brought him really to the casino business ultimately?
- [06:41]
Max Froomes
Right. You know, this is, this is a, you know, an M. I. MIT trained economist. You know, Gary Loveman, extremely smart, actually, you know, came from much more of a blue collar background and like, it made a name for himself in economics and then went on to teach at Harvard and you know, while there, did some consulting work on the side for, you know, what was, what was then Harris and then, you know, he was brought on by the CEO at the time, like where the, the CEO of the. Of Harrah's Start really identified that. Okay. You know, this, this industry, like the, the casino industry is. Is kind of in, you know, like just olden times. Right? Like the movie Casino was going on that's at the time and.
- [07:36]
Connor Callahan
Great, great movie.
- [07:37]
Cole Smead
Yeah.
- [07:38]
Max Froomes
Yeah, it is. Right. Like, and we, we. I researched that and you know, watched it and read it. But, but like, because I was like, I was hoping when we were like, looking into the Caesars and like, you know, what became Caesars and this, this grand casino operating company that I would find a bunch of ties to the, to the mob, right? There's got to be, there's got to be something in here, right? Like, you know, Loveman, oh, he must have struck a bunch of backroom deals. And no, like, the truth was by that, by that time it had transitioned from this illicit industry with a lot of shady dealings going on to one that is upfront about what it's doing with a bunch of MBAs running it. And so this was where they started bringing in mathematicians. And Harris was really the first to do this. And Gary Loveman was really a pioneer in taking all the data and the numbers that they were getting from the casino business because they could track it to a T of how many people were using which machines, what their ages were, what their demographics were, what their day jobs were, how often they went and what brought them in. So he took all of this data and turned it into the total rewards program, hired a couple of other, you know, really, you know, really smart mathematicians to, to do that work and then pioneer what, what is now de rigueur. And then, you know, in any industry really in sending like targeting people with the, the, you know, the promotions that are most likely to bring them in and keep, keep them loyal. And that, that wound up being very, you know, very successful for, for Harrah's, you know, not attracted Apollo and other private equity investors that ultimately wound up doing, you know, doing this deal at, you know, at the time, you know, between 2006 and 2008, when there's private equity firms were writing humongous checks to, to load up, you know, relatively healthy investment grade companies, even public companies with, you know, with debt in order to just grow into that debt and make, you know, make a huge return on investment. So that, you know, like Loveman was, was the attraction there. He could turn, you know, if they just kept on buying casinos and, and plugging it into the total reward system, he didn't have to compete with the Venetian and like the big, you know, attractive box model that, that some of the, you know, some of the other ostentatious competitors would apply.
- [10:27]
Connor Callahan
Yeah, it, it was pretty cool reading about Loveman. It was, it was a captivating read. And, and by the way, as Cole mentioned, I have about 20 years of, of background and so your book was fantastic. Even for me though, understanding all these things, understanding all the terms of art, I still found myself going back, referencing the players in the front and trying to keep it all straight in my head because it was no doubt very complicated. So. So yeah, Loveman was basically kind of doing AI like before I, you know, he was sort of like a forerunner of big data and using that to his advantage. So what I'm curious about though is more on the corporate side. So the 90s, I think for all of us unfortunately feels like not that long ago, but it was a long time ago. Can you just talk a little bit about how the industry as a whole was transforming. It seemed like it was tied in with legacy businesses like Holiday Inn. How did that evolve? Obviously you talked about MBAs coming in and being more involved and making it more technical. Talk to us a little bit about the landscape and then also how that looks different from today. Clearly back then it was just Vegas and Atlantic City. And that's clearly changed a lot too over the last 30 plus years.
- [11:32]
Max Froomes
The casino industry, you're saying, or like the hospital, the hospitality industry?
- [11:35]
Connor Callahan
Both, both. Like, how. How did casino ownership evolve and the business model evolve?
- [11:42]
Max Froomes
Disclaimer. Not a, not a casino analyst whatsoever. But like, for the, you know, for, for this, you know, for this book, we, we tracked the transition and it was kind of a twofold transition from, right, like, you know, just, just high school grads, buddy, you know, buddy system, non professionals running, you know, running the industry who, who, you know, new people could break some legs. Two MBAs and then from MBAs to PhDs. Right? So that was kind of, that was like the transition and Loveman really led like that, you know, the, the transition into, like the, the PhDs who would put the most complicated, you know, like formulas into practice in, in. In, you know, in order to, you know, really make sure that anyone, anyone who liked gambling would be loyal to their brand and like. And then since then, I, I think that it, there's been another transition to more like entertainment. Right. So it's like, you know, at that, the height of it, you know, the, it was, there was a big, you know, like, there was, there was a way to draw people for the, the gambling itself and, you know, like, get people who were really hooked on it to come back time and again. And then, you know, there was this understanding that they wanted to bring in, you know, families, events, you know, start the residency over at Planet Hollywood. You know, we talked about a little bit, right. They brought in Britney Stairs, wound up being incredibly successful, and then building the, you know, the, the big, like, attractions across the street from Caesars as well. Sure. So, you know, that, that, that was a transition as well. So I, I kind of like described that as, as being, you know, how the, the casino industry changed over time. You know, about the time that it became legitimate. Right. It's like then it's, it's a, it's an LBO target. All right? And this is like, and this was the interesting thing. Whereas private equity firms, they're so sophisticated, they have so much money to throw around. They like, they, they, they pretty much think that they can overcome anything and the licensing process to, to become an owner of casinos, you know, in, in Las Vegas and elsewhere, is very, very, very rigorous. Right. Like we, we describe how they had to go through this process of, you know, getting, getting interviewed by like the, you know, the local authorities there and in Louisiana, criminal background mistaken for somebody with tattoos. So it was, you know, it, it was, it was a very high bar to break into that industry. But as you'll notice right now that they have, you know, Blackstone, you know, owned a bunch of those casinos. Apollo has come back and they, you know, they own the, they own the Venetian. And, you know, it. It became something that was. Was very investable from non, you know, not like non specific casino investors.
- [15:07]
Connor Callahan
So, so let's talk a little bit, if we can, about Drexel, because on its surface, this is a story about Apollo, but really everything has its roots pretty much in Drexel Burnham Lampert in this story. So in some respects, Cole and I were joking. You could call it Predator's Ball Part 3 or Barbarians at the Gate Part 2. But if you could just tell us sort of a little bit about Drexel. Obviously that was kind of going back to the 80s, but that really felt like the nexus, that all of this really proliferated.
- [15:36]
Cole Smead
Well, in full disclosure, Max, my dad, who we obviously work with, was a retail broker at Drexel. So I grew up a Drexel kid. So it's like one of those things where everything tied to Drexel. I was like, in your book, I was like, ah, this is amazing.
- [15:50]
Connor Callahan
Well, and just a quick, quick point on that. You know, Bill Smead talks about how when Drexel went under, that was one of the toughest times of his life. He thought his career was over, his life was over. You know, it's an age old. Once one door closes, another opens. And clearly things have gone very well for Bill Smead in the ensuing decades, but it was quite a time. So if you could elaborate on that a little bit, that'd be awesome.
- [16:13]
Max Froomes
Yeah, it was, you know, it was a fascinating rabbit hole to dig into. And like, really, you could trace a lot of the entire first, the high yield and the junk bond market, as well as distressed debt investing and like the explosion of just corporate credit and all the facets of it back to Mike Milken and Drexel really being the ones that pioneered, you know, arranging and trading these, these, these bots for riskier and riskier companies as, you know, even and, you know, can study it at Berkeley. Right? Yep, yep. You know, so and it was like it was something where, and you know, Howard Marks, you know, of Oaktree recognized it and, and you know, left to start, to start Oaktree with this thesis that if you, you know, if you buy a critical mass of these riskier bonds, then you'll actually, even with the additional defaults, you'll wind up making more money because not all of them are going to default. Right. And so that really created this like this world. And they were of the favorites of Milken who, you know, you know, the junk bond king giving people these huge amounts of high yield debt including you know, barbarians at the gate, right to, to complete humongous LBOs. And you know, and when it blew up, it's it, it didn't go away. It like it spawned a bunch of successors including Apollo, right. And Leon Black was one of, you know, one of the major lieutenants of, of Mike Milken. He went on to, he was, he's really like the senior founder of what became Apollo with some distressed assets after, you know, after they started trying to relaunch a firm and, and then he brought on Mark Rowan and Josh Harris as well, who are named co founders. But they were a little bit junior at the time. But they're, you know, so brilliant in and of themselves. They, they got, they got titles being co founders of Apollo, but they all came out of, out of Drexel, you know, and as, as did, you know, Bruce Karsh and others at, you know, at Canyon and across a number of different firms that knew how to invest in risky debt and then ultimately that knew how to invest in distress debt and how to navigate a chapter 11. And before, you know, before a lot of the information in chapter 11 has been, you know, democratized by various services including you know, Fitch and Debt Wire and nine Fin where I work right now, making it really easy to access court documents and people summarizing them and in live blogging court hearings like all that stuff was not accessible to most people. And so you know, firms like Apollo or Oaktree or you know, eventually Canyon and we're able to silverpoint a number of the firms that are mentioned in the books, make a dis. Like a much better risk return than other funds for quite some time because they understood the process of bankruptcy and then where to buy into a capital structure at a huge discount in order to either, you know, come out of a bankruptcy with a company, you know, owning debt of a company that has been delevered and de. Risked or owning that company at a discount to what its actual value is. And that, you know, that that is like the crux of the distressed debt investing industries, you know, like origins.
- [20:22]
Cole Smead
And when Max. The other thing it made me think of was I think Milken's first job at Drexel, he was a REIT analyst. So it's like, funny that in this deal we effectively have a REIT in the Propco opco structure that I'm sure we'll talk about later. But again, this like, it's like you can see, you know, it's like you use a black light and you see Milken's name on the wall everywhere, but in broad daylight, it's just a wall. So.
- [20:46]
Connor Callahan
Well, the other thing that's amazing is to be the number three person effectively at a, at a firm like Josh Harris, you know, kind of like the junior co founder and you end up owning multiple sports teams. That's a pretty good sign that the company, it went pretty well.
- [21:00]
Cole Smead
Yeah. Hi, I'm Cole Smead, CEO and portfolio manager here at Smead Capital Management and host of this podcast. If you enjoy this podcast, I'd like to invite you to check out smeecap.com at our firm. We are stock market investors. We advise investors who fear stock market failure with a discipline that has proven success over long periods of time. Learn more about our funds@smeedcap.com past performance is not indicative of future results. Investing involves risks, including loss of principal. Please refer to the prospectus for important information about the investment company, including objectives, risks, charges and expenses. Read and consider it carefully before investing. Smead funds distributed by UMB Distribution Services llc. Not affiliated.
- [21:45]
Connor Callahan
There's also some interesting tie ins here. Right, so it was really Bondurman via Tom Barrick, who clearly became more nationally known during the first Trump administration. That's what really got Bonderman into the casino business. Because if I'm not mistaken and Tom Barrack at one point had bought a casino from Donald Trump. Is that, is that, am I remembering that correctly?
- [22:06]
Max Froomes
It sounds right, yeah. You know, Trump is, you know, he gets, he gets a couple mentions here for the, you know, casinos and restructurings.
- [22:12]
Connor Callahan
Well, and I think it's part of the overall arc of the sort of book to your point about knowing when to buy in, where to buy in, where to play in the capital structure. Because I think Trump's, you know, foray into the casino business didn't go great, you know, but overall casinos did well. It was really a timing and a capital structure.
- [22:28]
Cole Smead
And just so you know, Max, we also talked to Wilbur Ross on his book Risks of Return and how he got to know Trump was via the Atlantic City Casino, that they actually, he was part of the restructuring in that. And the reason why their incentives aligned was back to this idea you had in your book, which was that you have to sit in front of the gaming Commission to get approved to be the owner. And so like Wilbur said, we were the capital, he was the license. Okay. And that's what made this work. And that's how some of these oddly symbiotic relationships began or accrued over time.
- [23:00]
Connor Callahan
Should we talk about the timing a little bit?
- [23:02]
Cole Smead
Yeah, timing. I think it's a good question.
- [23:04]
Connor Callahan
It's interesting. It feels like 2006 kind of when this got going, clearly the timing ended up being bad. But it was sort of a golden era for LBOs. Obviously TXU was around the same time that went horribly badly as well. But talk to us a little bit about what the market looked like in the lead up to the financial crisis, you know, and obviously the relativity of it too because I think what was happening then seemed huge at the time and record setting at the time. But in a modern construct, these are relatively small, I guess compared to what.
- [23:32]
Cole Smead
We see, including like what were the credit spreads at the time, because that's something we think a lot about right now.
- [23:37]
Connor Callahan
And interest rates.
- [23:37]
Max Froomes
Yeah, well, I mean, I think they're lower now than they were then. Right. But it's, you know, there had been, you know, relatively cheap debt for, you know, for quite some time, you know, under Greenspan and you know, like with the, with the thesis that continued, you know, subsequently as well, that you know, eventually that's, it's going to be, it's going to be good to keep the capital markets flowing. If so, you know, at this time it really like this, this whole process even kicked off in 2005. And then it was the, like the, you know, there was, there was the bid and then the agreement in, in 2006 where it was ultimately the Apollo TPG team bid over the strategic competitor that, that wound up winning out at an extraordinary number, you know.
- [24:39]
Cole Smead
Sure.
- [24:40]
Max Froomes
$32 billion valuation at the time it.
- [24:42]
Cole Smead
Was $90 a share I think was the deal price.
- [24:44]
Max Froomes
Yeah.
- [24:45]
Cole Smead
For the public stock.
- [24:46]
Max Froomes
Great, great, you know, great thing for the, the, the, the, the shareholders at the time. And you know, and they thought that, that like this was a no brainer, that even, even with all the leverage, it was ultimately going to be like $25 billion in debt that they would be able to pay it off with the, you know, with the excess cash flows and Then grow it by acquir applying the total rewards program to it. So at the time, you know, they did have to stretch quite a bit with a combination of loans, you know, keeping the investment grade debt that was already on the company there in place, that wound up getting primed by all the other secured debt and priority debt. And then in order to really juice the like the, the leverage they had to use CM, like the CMBs financing, that's the, the, you know, the OPCO propco structure that was created in order to get financing off of the real estate itself, the underlying real estate of the casinos. And so the, the buildings wound up being the, the collateral for these, these CMBS structures that gave it the, the total leverage that it needed. And, and at the time it was cheap because that was, that was bubble financing. Right.
- [26:14]
Cole Smead
Housing. Housing was asset backed. People's minds.
- [26:16]
Max Froomes
Exactly. It was just like, you know, oh wow. Yeah, this is, you know, real estate's gonna do nothing but increase in value. Right. That was, that was the era that we were dying to.
- [26:25]
Cole Smead
Let's see.
- [26:26]
Connor Callahan
Well, by the way, AAA spreads on CMBS in that era were in the 20s, like 27 over.
- [26:32]
Cole Smead
Yeah.
- [26:33]
Connor Callahan
That gapped out to like a thousand.
- [26:35]
Cole Smead
Yeah.
- [26:35]
Connor Callahan
At the height of the credit question. Put that in perspective. Right.
- [26:38]
Cole Smead
Yeah. When you also do a really good job of just explaining some of the mechanics of this from a structural perspective. So you talk about, for example, you explain a hung bridge. Obviously these banks that were financing a lot of the leverage tied to this, they were getting an origination fee. They made some nice fees at the start of the deal. The question is, will they make money in the end? Which is tends to be at the bankers dilemma, as they say. It actually remind me of Twitter's buyout. Like, I mean we're still looking right now. Yeah. It's like it's a hung bridge on Twitter and they're starting to market the debt finally.
- [27:09]
Max Froomes
It's hot right now. I mean it's amazing that it's that they think that they're going to sell it at 90 cents. Maybe they already have. We've been in the market.
- [27:17]
Cole Smead
I agree, but again like let's like analogously to your point, spreads are tighter now. Now spreads are tighter, but the nominal cost of money is much higher today. Right. But the spread's tight. And so you know, we were, as we were reading through your book, it was, it was such a helpful thing to think about because it's like, okay, where are we at in the cycle? And you know, like the idea of like you know, payment in kind, which you introduce to your readers to make sure they understand how that's used. That just elongates the Runway. But that's all it does. You know, sooner or later things have to be dealt with. And so yes, spreads can help get things financed. The amount of demand, as you pointed out with like a Twitter's debt right now can help things, but it still has to get sold to someone.
- [28:03]
Max Froomes
Yeah, yeah, well, I, you know, in, in the secondary at a discount generally. Right. So I mean, you know, investment banks, they're gonna, they're gonna get their big fees and they're gonna, you know, commit, give like a commitment letter. Right. Not. Not just a highly confident letter.
- [28:19]
Cole Smead
Yeah.
- [28:19]
Max Froomes
Which, you know, come from the, the Drexel days. The Drexel days by. And, and they have to follow through with it or they have to deal with Apollo, never get in Apollo's business again. So they, they did, they, they, they funded, they funded this and, and they couldn't syndicate it all out because the deal closed right, in 2008, you know, before, before Lehman's bankruptcy and you know, and the market fell out, right, and they had, they had all this paper on their books and they, they, they ultimately did sell it to a lot of investors. You know, they took, took big losses on it, held on to some, exchanged some, and then that, you know, that gave Apollo the ability to, to start capturing discount, right? Like, you know, exchanging debt at discounts with those who had bought it at even a lower discount. And in. Extend the Runway so that you can do anything, right, to, to, to push it off. If you think, if you push off a reckoning, if you think the business is going to recover, which they did. And you know, they, they were right. It was just like this business is solid, it is cyclic. You know, this is cyclical. This is not a fundamental change. And so for the most part that was true, except for in Atlantic City, because Atlantic City that, you know, EBITDA was cut slash by 60% never came back because all the casino licenses that came on board in, in New England, in the Northeast after, after the Mohican sun.
- [29:57]
Cole Smead
Right. I think of like, I don't think.
- [29:59]
Max Froomes
That that was, that was already, you know, that was already permitted because I think that was on reservation.
- [30:04]
Cole Smead
But that was a successful casino operation that competed, you know, a prior year, didn't, didn't. Atlantic City didn't have any competition. I think the other thing too, you talk about the idea of assets or a, is equal to equity plus liabilities. And so when they're exchanging this debt. What they're doing is actually reducing their liabilities, which makes the value obviously of the equity bigger, hopefully. And it's a little bit of a math game of like, what is your value? And that becomes obviously a contention point in this. Do we want to jump ahead to looking at structure?
- [30:39]
Connor Callahan
Yeah, I think we should do that. As you were talking there, Max, it's funny to think about, and you're completely right. The banks had no choice but to go through with this financing or Apollo would have been, for lack of a better term, so pissed and they never would have done business with them again. Blah, blah, blah. I think Apollo's breakup fee was $350 million. There is a deep irony that they should have just paid the $350 million. In hindsight, everybody would have saved a lot of money. It's just funny to think about sometimes how these things end up working out versus the emotions at the time.
- [31:11]
Cole Smead
We'll jump to the first slide that we have here just so our, our listeners can kind of look at this while Connor mentions it.
- [31:18]
Connor Callahan
So this is, this is post LBO for, for those of you watching, watching at home. And so you had, you know, opco, propco, which was pretty typical, you know, somewhat pioneering at the time, but had been done before. And we're seeing this now even to this day, like literally as we speak. Lennar, the home builders doing the same thing, they're setting up a propco for their land called Milrose. But can you talk to us a little bit about the basics behind these models, what they are, why people like these and why Apollo and TPG wanted to try this as their first structural foray. First of many, but their first one.
- [31:58]
Max Froomes
Yeah. The short answer is the financing is cheaper and the tax treatment is favorable. All right, so with a real estate investment trust, you know, you get, you'll get, you'll get better tax treatment than the corporation that is the operating company. And then you'll get cheaper financing as well through the CMBS market. And that's the gist of it. And that's still true, you know, through to today, even though there was some loophole that was closed off for some of the tax treatment that Caesar's her grandfather in for.
- [32:41]
Connor Callahan
Yes, if it was already in the pipeline. Yeah, they were going to allow it.
- [32:44]
Cole Smead
Well, yeah, because that to your point, because just to note for our listeners, a REIT by, you know, IRS definition has to distribute 90% of its income. It can retain 10%, but because they pay no corporate level taxes from a Veil perspective. It can service a lot of debt because it's all cash flow and it's not, you know, there's no tax taken out until the investor collects the, you know, obviously the taxable statement the end of the year. Correct.
- [33:13]
Max Froomes
You're the expert. Yeah, I, that's.
- [33:15]
Cole Smead
I got why you wrote the book. I was hoping. You're the expert.
- [33:18]
Max Froomes
I got into it for the Brook. But I am not a REIT expert by any stretch of the imagination. But I do like the basics. The basics was, though, that, that, you know, like you said, you can, you can, you can take a lot more leverage as a REIT relative to your, you know, the same exact amount of revenue.
- [33:36]
Cole Smead
Totally. So let. We'll jump. Max. Let's go. We'll jump to the next slide here because obviously as they're going through this, things deteriorate. You know, they do this deal, the old banker's dilemma is you borrow the money when the bank will give it to you because when you really need it, they won't give it to you.
- [33:53]
Max Froomes
Okay.
- [33:53]
Cole Smead
And that, that reminds me of this deal to a certain perspective. Perspective. So they then do this. Things get bad in the OPCO propco model and then they're like, hey, we're going to go to a growth model. Let's take core assets. But they were really aggressive. They went out and got Planet Hollywood. That's a deal they did. And we show the next slide here, which shows Planet Hollywood, the. The Horseshoe in Baltimore and then Caesar's Interactive Entertainment. I don't think we have a question here, but I, I do want to. Can you maybe mention, like, how interesting was this asset? Because this might have been, you know, beyond the Planet Hollywood story. It's really one of the more interesting assets that kind of.
- [34:27]
Connor Callahan
It ended up being the crown jewelry in some respects.
- [34:29]
Cole Smead
Well, yeah, for the, for the final deal.
- [34:31]
Connor Callahan
Cash. Yeah.
- [34:32]
Cole Smead
I would say yes.
- [34:33]
Max Froomes
Yeah, I was. It was a solution. Yeah. The season actor. Same was actually. It was the rebranded Platika that I think is now been changed back to play Tika. And it was meant to be, you know, it was meant to be online gaming. And they hired this, you know, tremendous entrepreneur from, From Canada to take advantage of what they thought was going to be legalization of online gaming. And then when they realized that that wasn't happening, they weren't even, you know, they weren't going to be able to get, you know, online gaming legalized for quite some time. They pivoted to just video games.
- [35:12]
Connor Callahan
Pretend using the world.
- [35:15]
Max Froomes
Yeah. Brand to mate, to play Online, like gambling, you pay for extra access to you know, like coins or whatever. What. So there was no, there was no money at stake in, in the gambling form, but it was, you know, became wildly popular in, in like the, the Candy Crush era. And it's like that, that was moved over at the time, you know, without the hope of it being, you know, as valuable as it wound up being into this growth structure and yeah, when the growth was, yeah, to your point.
- [35:49]
Cole Smead
In the online gambling. I mean, I know I'm an old man for one second here at the age of 41, but you know, like to you young bloods out there, you know, when Chris Moneymaker won the World Series of Poker, that's what caused online gambling to explode. And to your point, it's like it wasn't legal in every jurisdiction. So I remember being in college, let's just say I might have played some online poker. These were still very emerging business models. They were not set. Today. Gambling is accepted to your point, it's institutionalized, it's very invested in. But at, at this point, these were emerging ideas not known.
- [36:25]
Max Froomes
Yeah, it, you know, it's, it's now sports betting. Everything, all these, all these things are, are in motion much bigger and less, you know, less regulated as they, as they were. Right. I, you know, even go back into casino days. You're like, you're like, what, what the hell are they? What was so illegal that everything. It was cross border sports gambling. That's the, it was like the crux of the mafia's business. That was like so illegal and now it's just like perfectly legal. It's crazy.
- [36:52]
Cole Smead
So yeah, it's funny. It's funny. Yeah. When Reggie Bush gets his Heisman Trophy back, we all can kind of laugh because it's insane to think about this part time. Let me when they start. So again, structurally, parent companies, Apollo, TPG and their investors, most of that's their investors. But again they're present in that stack. If you go below that, you got the opco, you know, bondholders, you have the propco bond holders.
- [37:15]
Connor Callahan
Okay, can we throw that slide back up again?
- [37:17]
Cole Smead
Yeah, let's, because I just want to show this like when this growth transaction comes up, this is where the incentives for various parties get very perverse because obviously this new growth company causes a new shareholder, or I'll call it equity owner class to show up. And this is really what opens Pandora's box of the idea of fraudulent conveyance. I would say, I think is what I took away from your book. Can you Explain briefly what the idea of fraudulent conveyance is and how applicable it was. Beginning with this.
- [37:43]
Connor Callahan
And I would say in addition to that too, there was almost like a comical aspect to this, you know, that that might not be the right word, but I was sort of like mentally rolling my eyes when you'd see like, oh, the new structure, the news and it just kept getting more and more ridiculous.
- [37:57]
Cole Smead
Yeah.
- [37:57]
Connor Callahan
So, yeah, if you could talk about fraudulent conveyance and just sort of overall this like really was pushing the boundaries.
- [38:02]
Max Froomes
I think I, in, you know, in retrospect, you know. Yes, at the time, I mean, like it was so opaque and so complicated. But yeah, on a high level, fraudulent conveyance is the concept that a company that is insolvent is not permitted to transfer assets away for anything less than reasonably equivalent value or sell assets. And if they do that and then they file for bankruptcy, then that, that, that that asset should be clawed back, you know, for, for the benefit of all the creditors underneath the, you know, the company. And so what, what happens here, who that's relevant for are all the creditors at that OPCO structure, The original, the original structure you saw there, it was, you know, parent company Caesars, the, you know, the operating company with a lot of the, the bonds, the low, the high yield debt and then the rest of the investment grade debt and then the Propco that has the CMBS debt. Right. But ultimately all the assets are together and all the creditors at OPCO would get the protection of the excess value of the real estate in Propco were the company to file for bankruptcy and all the CMBS recovered. What started to happen was Apollo, you know, led by my Mark Rowan and his, his lieutenant David Samber were ultimately the architects of this, this brilliant strategy to like, okay, the company is struggling under the weight of an enormous amount of debt and we're not going to get more money to invest in the existing structure right now. So we're going to create the Caesar's Growth, right. And this is great title and, and under. And we're going to put new money into Caesars growth, right. And we are going to move the best assets or some really like valuable assets that we believe with additional investment can float all the boats. Right. And that's the idea. And if they had, you know, if they had done that and been like, okay, well we're going to give, you know, X amount of money, we're going to raise a billion dollar and we're going to pay for these assets and we're going to give that, you know, the amount of Money that, that they're worth at the time, then that still would have been fine. Right. It'd been reasonably equivalent value. The problem was that they were moving some of these very valuable assets at what was ultimately determined to not be near what their value was, including the whole, like the, the all of Planet Hollywood that, you know, that they were using the numbers that didn't include the Britney Spears residency, which was like, you know, just incredibly valuable. And then, yeah, they moved the four properties over there, which was kind of the. The last. The last straw along with the, you know, this, this. This refinancing of the term loan. And that, that. That's what created this. This potential argument for fraudulent conveyance when the company ultimately did file for bankruptcy.
- [41:27]
Connor Callahan
Well, well, the Britney Spears residency, to your point, was so transformative that. That somebody on this podcast actually went to see Britney Spears at.
- [41:36]
Cole Smead
Plan style inflation in this.
- [41:38]
Connor Callahan
In this era.
- [41:39]
Cole Smead
Yeah, but it's a big draw. It's your point. I mean, I think you. How much were tickets?
- [41:43]
Max Froomes
It was.
- [41:44]
Cole Smead
So I, I did not know. I mean, I knew it was a popular show. As a man who married a millennial woman who was born in 1983, I know that that was a massive draw for that, you know, call it category. And to your point, millennials started to go to Vegas really precipitously with that. But they way underpaid her in some respects because she was worth a lot more than that. But she became a meaningful EBITDA contributor to the growth company, which is funny to say that, like, Britney Spears in some respects, made the growth company work.
- [42:15]
Connor Callahan
So if Mark Rowan is listening, just let it be known that Cole Smead did his part. Keep Caesars afloat as long as possible.
- [42:24]
Cole Smead
Well, you know, but you touched on something that I wanted, because this is a nuance in your world. This is not crazy. And we've ran into this in the public markets, but you want to touch on the idea of, like, special committees and whatnot.
- [42:36]
Connor Callahan
Yeah. So, you know, this is sort of an underpinning, I feel like, or an undercurrent of the book, where, you know, a special committee was put together to value the growth company, and they also needed a fairness opinion. So can you kind of talk to us as somebody who's seen a lot of these transactions? What does that all really mean? I think we all know what a fairness opinion is, but the takeaway that Cole and I both had is those things aren't even worth the paper they're written on. And curious for your view as somebody who's clearly seen a lot more of these than we have.
- [43:06]
Max Froomes
Yeah, these investment banks are very sophisticated, but sometimes they'll only perform the analysis on the financials that they're given. Right. So, you know, in this case, if they're given old financials that don't include, you know, like the, the growth of a company, then they can only, you know, they can only give a Ferris opinion saying, well, you know, it's, it's only worth X amount. And, you know, they're giving, they're giving, you know, fair value for, for these assets that are being moved over. So that's news. That's, that's what, that's what's needed for, you know, these types of transactions that are intercompany transactions or, or, you know, or, or others that are even for, you know, M A if it's required for the expenditure of, you know, major amounts of capital. And yeah, if, like, if they have current financials and it's a lot more transparent, then, then like it's, it's important for a board to make the decision to proceed with a certain transaction. In this case, I think they came under scrutiny because they, you know, they, they, they cited a lot more with Apollo's valuation work than they did with the, you know, the independent directors that were appointed to negotiate the transaction on behalf of Caesars. Yeah, the Remain co. And then I think the other thing that became problematic about this was that the OPCO creditors did not have representation. Right. Like, there was no. For, for the longest period of time, there weren't independent directors for, for, you know, for OPCO. Sure.
- [44:59]
Cole Smead
Well, because to your point, Apollo TPG's council was the OPCO, which is Paul Weiss, and I think we have a little. You're. We'll come to your footnote later. Your footnote was very interesting, but I.
- [45:09]
Connor Callahan
Think what Max just said was that was the crux of the whole case really, is that the OPCO creditors didn't have any representation and they should have many years before they got well.
- [45:17]
Cole Smead
And to your point, and this is. This kind of rolls into our next question and actually I want to put up our third slide, which is kind of the final structure slide that you show in your book Apollo and tbg at this point, they can't say this. So like Sambur, he's playing bulldog in every conversation with everyone, when in reality they're just buying time. They're trying to buy time to realize the value of their equity and trying to, in every way, you know, do that. The oddity is, as this story Gets more perverse. The asset structure actually gets bigger. In other words, like by the end of this look at all the casinos. They have the link. You know, you got the Cromwell in there, by the way. Life hack, 100 to 1 odds behind the pass line at the Cromwell. Probably my favorite place to throw dice, you know, but like Dre's nightclub at the Cromwell is getting thrown into this because Mark Rowan knows Dre and therefore the nightclub comes about. The asset base is getting bigger and bigger and bigger. But those are all transactions to buy time. Is that fair?
- [46:19]
Max Froomes
Well, they wanted, you know, they wanted to go, right? Like, I think that's the, you know, the interesting thing about this was that you had CPG and you had Apollo, right? You had like. And they, they are connected. They have a, they have all these ways of adding value, right? And they do, they do create a ton of value. They, they push for these. The, you know, the, you know, the Dre's nightclub, those connections. TPG brings in all of its operating experts to maximize the efficiency of like, you know, changing the rooms, right? We have like, they, they called, they called the, you know, getting strong guys to, to go in and change the sheets to make it quicker, right?
- [47:01]
Cole Smead
Stripper.
- [47:02]
Max Froomes
They'd strip it. Strip.
- [47:04]
Cole Smead
It's like a, it's like a McKinsey solution that you'd get, right?
- [47:06]
Max Froomes
And it was, you know, that's exactly right. You know, and, and those things are, those things are helpful. They, they made the, the organization more efficient. They made it grow. You know, you have the Caesars Interactive Entertainment growing. It's, you know, its user base and, and value this whole time so that you'll. Those things do create, they create a ton of value while they're, while they're doing this. And that's been the whole idea. While they're doing all this liability management so that they don't lose control of it before that value rebounds from.
- [47:40]
Cole Smead
Sure.
- [47:40]
Max Froomes
You know, from the big hit that they took for, for a number of reasons during the great financial crisis.
- [47:46]
Cole Smead
We hope you're enjoying the podcast. You know, we work hard putting together this show, but we work even harder for our investors at SMEAD Capital Management. At smead, we believe in disciplined investing, which is why the SMEAD funds have a proven track record of long term outperformance. If you're an investor who fears stock market failure like I do and want to invest in wonderful companies to build wealth, we invite you to visit smeedcap.com Past performance is not indicative of future results. Investing involves risks, including loss of Principal, please refer to the prospectus for improvement. Important information about the investment company, including objectives, risks, charges and expenses. Read and consider it carefully before investing. Smead funds distributed by UMB Distribution Services llc. Not affiliated.
- [48:31]
Connor Callahan
Yeah, I mean, I do agree that it was a time game insofar as I think the strategy was to your point, max add value, kick the can down the road. You know, we all know from basic options that an out of the money option, time is your friend. And so the longer they could stretch it out, maybe they got lucky and they almost did.
- [48:48]
Cole Smead
And also, markets are a confidence game.
- [48:50]
Connor Callahan
Yeah.
- [48:50]
Cole Smead
And as long as you showed confidence, people wouldn't question you. It's when people had a lot of facts against you that they questioned your confidence.
- [48:57]
Connor Callahan
That's right. That's right. So another interesting again story is fascinating and they're all these like sidebars.
- [49:03]
Cole Smead
Yeah.
- [49:03]
Connor Callahan
Just when you thought it couldn't get weirder, it got weirder. And Max, if you had written this as a Hollywood script fiction, you know, you would have gotten laughed out of the, the office. They would have been like, this is too ridiculous. This could never happen, were a pass. So let's talk a little bit about the Trust Indenture act of 1939 and one kind of what that was about, what those sort of lawsuits there were about, and then how this really reached the highest levels of politics in Washington.
- [49:31]
Max Froomes
Yeah, this was interesting. Right. You came into play in part because of like a very aggressive deal that the David Samber structured in order to, to, to deal with the investment grade bonds that had been at Harrah's at the, you know, at the time before the lbo. And so all of these were, you know, essentially unsecured debt and they had just been, you know, decimated by getting primed. And then the great financial crisis. They're all trading at a discount and a lot of them wind up trading in the hands of a bunch of distressed debt investors. And, and so, you know, when, when, you know, when time comes to try to like refinance them or take, take them out. David Sanders trying to do it a way that can they, can you take out as many as possible with as little money as possible? And, and, and, and Caesars itself had actually been buying some of these up at a disc.
- [50:42]
Cole Smead
Whack a Mole. He was playing Whack a Mole, I think. Is Whack a movie.
- [50:45]
Max Froomes
Yeah, yeah. And so like, like the investment grade bonds, you know, had, they weren't secured, but they, they did have this depression era protection called the, you know, under under the Trust Indenture Act. And so when like when Sambra orchestrated this transaction that essentially was done with two thirds of. Of the bondholders leav third exchanging for you know, for new debt into like a better, a better piece of paper at you know, at growth. Like they, they went to almost zero, right? These 1, the 11 3rd of the bondholders just went all you know, completely completely to zero. Meehan Combs at the time led the charge in. In like organizing hiring H. Jim Millar from drinker Biddle at the time, now faker drinker to, to look at what what, what you know, what can we do here to, to try to capture. Get some more money back. Right? You know, maybe I don't know, it was like $94 million left was. It wasn't that much. Right? That was the, that was the irony of this. And there was this, there was this argument that you know, like the the Trust Indenture act made it so these, these, these bonds should still avail themselves of the parent guarantee of the parent company. And so at the time that the like all these different transactions happened, Apollo did a number of things to remove the parent guarantee. At least they thought that they did. Sure. And so you know, they try to strike this deal with two thirds of those creditors in order to get it. And you know, you made this like Jim Millar made this argument that was kind of a long shot argument that you know, you're not able to. To treat one portion of these bondholders different than the others because we have, you know, we have the, because the Trust Indenture act. And it was a long shot, right? It like it hadn't, you know, they didn't think it was going to it go anywhere. But at the, at the time, right, there was actually, you know, another lawsuit going on with Education Management, you know, with a similar argument that had been made by Marblegate who had bought up the debt of this for profit education company and that had actually made it past a motion to dis. Like to dismiss or it made it to like the next phase in the lawsuit where it was. It seemed as if the courts were going to honor the, you know, the debt that had been left behind in these types of transactions. And so all of a sudden like you have, you have this, you know, this argument that pops up and, and so like Apollo is looking at this and they're thinking, you know, like where did this come from right? Like this is like, you know, what if that's all that's holding us back from, you know, from completing these Discounted coercive transactions and leaving some of our creditor mind, well, let's go change the law. Right. So they get lobbyists together to you know, to, to go to Congress. And at the time, I mean there's, there's no actual lawmaking that's being being done besides the must pass legislation, right. Like transportation funding or Zika like funding to fight the Zika virus or whatever. And so that's, that's what they wind up doing. And and this is, I learned how, you know, things are done in, in Washington is they just, they, they lobby whoever to put in these riders in must pass legislation that don't have anything to do with that legislation, like a transportation act, like a, you know, virus act, like, you know, whatever.
- [54:47]
Connor Callahan
The budget. The budget.
- [54:48]
Max Froomes
Exactly. The omnibus budget, right. That must pass all they, they put all these little riders in. They're supposed to be non controversial. You know, they, they, they got, you know, they got one senator, one couple congressmen, you know to say like, like oh sure, I, I'll put it in as a favor to, you know, these people. Like Apollo's super important. Harry Reid wound up being one of the, you know, the supporters of of it. And, and you know, Elizabeth Warren at the time had been suspicious of inserting the language, but you know, she backed off when it was, it in fact came from, from Harry Reid. Shelby was the Republican congressman who was initially like found to, to be backing it.
- [55:29]
Cole Smead
Senior senator from Alabama, right?
- [55:31]
Max Froomes
Yeah yeah, exactly. So it was like it was, it was, you know, it was one of these things it was almost about to, to go through until well, this other, this, you know, this other case that was going on in Education Management, Marble Gate. You know, he found out about it Andrew Milgram at Marblegate and he had a friend who had, you know, actually owned some of the bonds at Brigade who had gone to college with one of the congressmen and he, he alerted them to it. He got, they, he, he got a lobby, he, you know a lobby firm, Oak Tree got some lobbyists together and they, they like convened on anybody that they could to say that this is bad law, this is bad. You know, like you can't include this language and it was about ass. But they, they ultimately got enough, you know, people to, to listen to them to just cut it from, you know from those, those must pass pieces of legislation. And therefore, you know, they, and so, and so the argument still held what right like that that law was still a threat to Apollo in, in the Caesar's case because of this this lobbying right so they're trying to change the law in order to, you know, continue to perform the restructuring, you know, the way that they wanted to.
- [56:49]
Connor Callahan
There's a little bit of a spoiler alert here, but for, for those of you at, at home who may not read the entire book, something that's super fascinating is that this whole threat of the tia, the Marble Gate lawsuit, that's what really scared Apollo and TPG ultimately. Because had that kind of gone all the way through and become sort of settled law, they would have been on the hook for double digit billions of dollars. They found out literally the day they were signing off on everything and moving forward that actually Marblegate was going to be unsuccessful. And so this fear, this sort of Damocles sword they had hanging over them this entire time ended up being nothing. And they found out at the 11th hour and they're like, you know what, it's over, let's throw it the time.
- [57:33]
Cole Smead
The other odd, you know, again, this has been talked about in the last five years. So this is not unique to discussion in, I'll call it legal forums or in credit forums. But the other thing that you talk about is what Elliot did through the cds. You called it, I think it was your chapter on it was called first derivative. And they bought cds. They obviously owned bonds as well, but they bought cds and they, you went to the company said, you know, you, you should go into bankruptcy. Well now you're not required by law at this point in our lives to go out and say, oh by the way, I'm long the cds so I make a killing if you do that. And so it's this whole idea of like insider dealing. Is it insider dealing or not? And is there any ethical standards for that? That that's been debated a lot the last five years because there's more instances of this coming up. But isn't that an inherent issue? That's, you know, maybe since the Bankruptcy act of 1978 really has not codified the rules around a derivative like that. Is that fair?
- [58:36]
Max Froomes
Yeah. And to my, to my knowledge, I don't think there's no, there's no rules against insider trading in CDS right now. So you know, it, it, that's not.
- [58:45]
Cole Smead
A joke, that's actually true.
- [58:48]
Connor Callahan
And again, just to expand on that, what, what EL really did was it was all a timing play. I think the markets kind of knew that a bankruptcy was coming, but the markets were pricing it in much later than it ended up happening. But Elliot had debt that needed to be restructured and so they kind of Had Apollo right where they wanted them. They loaded the boat on the timing of the cds, betting that it was going to be sooner rather than later on the bankruptcy filing. Then went to Apollo and said, hey, we're willing to cut you a deal and renegotiate this debt that contingent on you filing for bankruptcy. Now, it was sleight of hand and they. And they did that and it ended up paying off to the tune of hundreds of millions of dollars. And so, yeah, I agree with what both of you are saying. It feels like insider trading, but legally, it's the rules.
- [59:31]
Cole Smead
It's the rules as they're set.
- [59:33]
Max Froomes
Yeah. So this, you know, there was some. There's been some pushback around that. And you know, the counterparty to Elliot for a lot of that at the time, you know, was, was. Was gso. And then they later got into a big fight over another seat in Manu Default and in Havanian is what they became called. Yeah, like it was it. It. Yeah. You know, this is, this is what hedge funds do. All right. It's. It was a very, you know, very ballsy but very savvy move to, to, to. To buy into the first lean bonds as Elliott Management by Paul Singer and the. The investment professional who was doing a lot of this is Dave Miller. You know, he's now one of the. The heads of distress investing that there and it like to. To then become Apollo's only friend. Right. And that's what happened is that they. Caesar's wound up filing with just one creditor class, signed on to a restructuring support agreement and that was the first lien bonds. Oh, there was a lot of them. It was $5 billion plus in, in, you know, in first lien bonds. But, but, you know, out of an $18 billion capital structure, it wasn't going to be enough to get the thing done.
- [60:48]
Cole Smead
Hey, I want to give a big shout out to everyone who's been working so hard on the show. You know, we recently hit the top 10 investing podcasts on Apple Podcasts and even number one in the business category in several countries. As you may know, this show is brought to you by Smead Capital Management. Smead Capital Management understands how frustrating and illogical the stock market can be if you are searching for funds with a proven track record. Give the smead funds a look. Or better yet, reach out@smeedcap.com and don't forget to mention that you're a fan of the podcast. Past performance is not indicative of future results. Investing involves risks, including loss of principal. Please refer to the prospectus for important information about the investment company, including objectives, risks, charges and expenses. Expenses. Read and consider it carefully before investing. SMEAD Funds distributed by UMB Distribution Services llc. Not affiliated.
- [61:41]
Connor Callahan
Well, the other thing that's, that struck both Cole and I when we read this was there was a lot of sort of personalities in the story, obviously, but there were also a lot of personal relationships that went back in some cases many decades. You know, you had Howard Marks trying to rein in Ken Liang because he was friends with, with Leon Black. If you could talk a little bit just about how you feel like that impacted it. And things also got deeply personal too. I mean there was that one time where Samber wanted to do something very graphic to Ken Liang's oatmeal. Just curious how the personalities and the interpersonal relationships behind the scenes had an impact for better or worse on this entire affair.
- [62:25]
Max Froomes
Yeah, that was part those, the most gratifying as a journalist and you know, being able to, to delve into the personalities behind these transactions. Business journalism, a lot of it's oh, you know, there's XYZ company, you know, does this, that or the other thing. Right. And, or you know, like a lionizing profile of a master of the universe in this case we really like because you know, both Sajid and I, you know, have had such good reputations and sources. And then like there we, there was a group of winners that really wanted to talk about how brilliant they were. And then like once we got that story, the other side was, was like, well, it wasn't quite like that. We got to get into a lot of these, you know, these personalities and, and like the relationships, you know how like three of the, the main players here went to the same finals club at Harvard. Right. Two of them, you know, between Chaney and Dave Miller were like really good friends from, you know, from boarding school.
- [63:27]
Cole Smead
Sure.
- [63:28]
Max Froomes
So, you know, and, and, and then yeah, there's like the whole connection between everyone who is at Drexel at one point and, and, and, and it is a, you know, it's a small world in some ways, but it's, you know, it's very impactful and it has like these, these you know, far reaching connections as well. And this was the book was an opportunity to, to, to get into those and like draw them together and see how they did make an impact. Right. Like it, you know, there, there are personalities there, there are, you know, think people that take things personally or a lot of things are irrational and, and that's, you know, that, that's Part of, of doing, you know, of doing business in this industry and, and all industries. I think.
- [64:11]
Cole Smead
Yeah, to your point, it just gets messy, as Jim Milstein put it. And this might be my favorite quote in the book quote, this mess had many fathers. End quote. Which is his way of explaining it is my client's fault. But there's a lot of faults in effect is what he was saying because he didn't want to admit that Apollo and TPG had done something wrong necessarily. Milstein is this very tenured, successful person in his field and what he does and even he at some point ends up looking, I don't wanna say foolish, but just not ready for the moment that he's in. And I feel like everyone that, you know, at one point someone looked like an idiot and they ended up looking like a genius and some other people started looking like geniuses, ended up looking like idiots. Was it just the fact there was so much competition in the intellect of these people and that's why, why there was such movement during your story?
- [65:10]
Max Froomes
Yeah, I mean I'm like, hopefully we just captured people fairly. Right. I think that good. Our book is not Manichean. It's not, you know, it's not like there's good and bad people. Yeah, it's not like that. It's not that anybody was like an unqualified, you know, success or winner and somebody was an unqualified, you know, like failure or loser. Right. Like, yeah, Apollo was, you know, ostensibly an antagonist here who got called out by the examiner for, or orchestrating along, you know, along with its, its co investors and executives, potentially upwards of $5 billion in like very strong claims for fraudulent conveyance and breaches of fiduciary duty, et cetera. And at the end of everything, all they had to do is get back their equity check and they raised the largest fund in private equity history and they've gone like continuing like biggest, like large. One of the largest, most successful investment firms in history. Right. So it's like we wanted to capture all the nuance and like the individuals for, you know, for who they were in this industry to the extent that we could and in their history. Right. Like, you know, Jim Milstein, he did become like, you know, an important pioneer in the, in the structuring industry. But he was also the son of Ira Milstein. It was like a, you know, a PI, like a domineering figure at Weill in like leading that firm to become what was once the dominant debtors council practice. And you know, and he was interesting because he had he worked for the Obama administration, served as essentially like, you know, function advising on how to deal with the great financial crisis. So, so it was, you know, it was one of those things where you come out of like doing these things on a big picture level to what the hell, like what this petty squabbling between, you know, two funds that actually have the same LPs, the same, the same pensions or insurance companies might like. It was, you know, it seemed kind of small time in some ways. And so it was, we tried to capture that was the context that he's dealing with it. While you have a lot of younger, ambitious, aggressive, mid level executives that are trying to prove themselves and this is their whole world and so they don't care or respect anybody who's come before them.
- [67:53]
Connor Callahan
Yeah, Max, I appreciate you saying that because Cole and I talked about this a lot as we were reading the book. To your point, I know it wasn't your intention. Apollo kind of comes off as the villain. They're the evil empire in the story. But then when you really take a step back and think about it, some of the original investors in the LBO financing, like the Michael J. Fox foundation that you mentioned in the book, they were sort of genuine victims, if you will, in all this. But the players to your point, that were left standing in the end, as they say, there's no honor among thieves. And these are all the sharpest elbows, brightest minds in the room, including the lawyers. Yeah. Going at it. So in the end, and I don't mean this in a bad way, it was sort of like hard to feel bad for anybody. Everybody was sort of reaping what they sowed, for better or worse. So you talked about Richard Davis, the examiner. Curious. That was clearly sort of like the pivotal point in this case. Do you think that he was fair in his work and his assessment? Do you think he was biased going in? Because I think there's little doubt that if Davis had had different findings, this whole affair probably would have turned out quite differently.
- [69:01]
Max Froomes
Yeah, very much so. I, we, you know, Sajit and I joke that Richard Davies, the former Watergate prosecutor, I kind of very, very respect, you know, respected, you know, professional, was our, was, you know, was our third co author and because we, we relied heavily on his, you know, 1800 page examiner's report and you know, because he, like, he had the, you know, the, the sway to get every interviews with everybody who was involved and he didn't require Sabina. People did it voluntarily, but, you know, they were not going to not talk to him. So everyone kind of treated him as the judge to begin with. And so he got access to everybody. And then that the, his report was the result of, you know, these hundreds and hundreds of interviews and you know, reviewing millions of pages and having his own team of lawyers pouring through all these documents and understanding the transactions. So that, you know, and like, obviously, you know, we think that his, you know, his work was, you know, was, was, was done, was done. Fair minded, right? I think that there's legitimate criticisms of, you know, some of the, you know, some of the valuations here, conclusions there. But I, it was very helpful, very revelatory and you know, and then re reporting some of. Seems like he made, you know, fair criticisms. Right. And he. The smoking gun for him with Apollo was that like in their mindset, it was they had this slide that was presented internally where it said, okay, well we're gonna move all these assets so we can grow, you know, the, the good ones and like, we'll be able to, right, like maybe save the company, but like, you know, in the case that things don't go well, we'll be in a better position like negotiating position with creditors in the event of a bankruptcy. So we can have our cake and eat it too. Right? And like this was all being done without there being anyone that was looking out for the creditors of opco at time where ostensibly that, you know, it was insolvent, which, that, you know, you need, you have a fiduciary responsibility to the creditors of the company at the point that the, you know, it might be insolvent. So he, you know, he, he put those together, you know, fairly thoroughly. Wasn't afraid to, to take positions on it and. Yeah, right. Was a really interesting, like, interesting character. Like his motivations too. He just wants to do a good job.
- [71:43]
Cole Smead
Well, to your point, an interesting character. At this point in the book, book, we know who the winners are, right? So for example, if someone says, walking away from your book, you know, there's no good, there's no evil, but who, who won a lot. Okay. And I will dub this. I don't think anyone's done this, but I'll call it the Yellowstone Club rule. It's not the first owner that wins, it's not the second owner that wins, it's the third owner that wins. And that third owner most magnanimously was ultimately Appalooza. Like they come out with such an obscene reward from this, even relative to oak tree or others, was what I took away from your book.
- [72:17]
Connor Callahan
Percentage return.
- [72:17]
Cole Smead
Percentage return. And I was thinking like, well, I wonder if David Tepper hadn't done this, would he be the owner of the Panthers right now? I was kind of like playing that out through my mind, but this was a massive winner in the billions for Appaloosa. And they weren't involved very long compared to others.
- [72:32]
Max Froomes
Yeah, probably. Probably around a billion. Yeah, exactly. And like I, you know, but it's, it's so we, we. I tried to, I'm like, so this is just, this is just pure kind of speculation by memory. Right. But like we, we tried to quantify everyone's like absolute do dollar amount. So we, we estimated that that like Appaloosa, Elliot and. And Silver Point actually all made, you know, upwards of a billion plus right on this.
- [73:07]
Connor Callahan
And, and Canyon. Canyon, in the end probably IRR was.
- [73:10]
Max Froomes
A little bit better because he, he was invested for a shorter, shorter amount of time, you know, in the second. Yeah, oak tree. Because they were par investors for like that their IR might have been lower, but they still want to. They, they bought in when things were distressed and they got more than par. Eventually. 1 Ironically, the, like, the bonds that were represented by like White and Case, the senior guarantee notes wound up having some of the best returns relative to where they were trading. Not too many people bought in at that, at that level, but maybe there were some. But might have just gotten better returns.
- [73:44]
Cole Smead
Sure.
- [73:46]
Max Froomes
So, you know, there was enormous amount of value here because the, the company was valuable.
- [73:51]
Cole Smead
Right.
- [73:52]
Max Froomes
And it did wind up being, you know, worth more than the entirety of its, of its debt eventually. So Paulo's thesis was right and that just timing was, was, you know, not good.
- [74:03]
Connor Callahan
I, I think that's super well said. And Cole and I were talking about that this morning. You know, TPG and Apollo thought they could make billions off this trade. Trade. It turns out there were billions to be made off this trade. To your point, several firms and even individuals ended up making billions, but it just wasn't Apollo and tpg. To that end, there's a lot of players in this story, a lot of names in the book. What struck me, just a cursory looking people up on LinkedIn. It seems like a lot of people, most people in the story are still at the same firms they were at. If anything, they're more senior, more wealthy now. So I'm curious, both from the investment firm's perspective, the lawyers, the bankers, how did this impact people and their careers? Because to a large degree this was a debacle, but it doesn't seem like it had a profoundly negative influence really on anybody professionally so curious for your thoughts on that.
- [75:03]
Max Froomes
Yeah, I think one of the interesting things about this book now is that it's still so relevant. Relevant because like, it's, you know, we, we hear that there are trading desks, right, and law firms and investment banks that like, hand it out to their juniors and just like, look, each one of those people, those are our, you know, those are our potential clients and colleagues right there. And like, everyone acquitted themselves well, really. And like, David Sambra is the co. Head of private equity at Apollo. And it's like, like, you know, you, you look at what he had, what he did. It was like, okay, well, he's, he was going into board rooms with a bunch of other aggressive investors. A lot of them were, you know, older, senior, and, and he's like, all right, maybe the best strategy was to throw, you know, like, throw a tantrum and walk out, right? It's like, you know, you're not going to get anything by just sitting there and negotiating rationally. You know, Daniel Kahneman even says that, right. In thinking fast and slow. And some of his subsequent studies, these. So I, you know, like all these, all the, all like the characters and the people in there, right? Nobody dies, nobody goes to jail. It was, you know, a highly interesting, you know, like, discrete period of time where there were winners and losers monetarily, but like, you know, but ultimately everyone's. A lot. Most of the people are still in the same industry and continuing to make money off of it in other ways.
- [76:41]
Connor Callahan
You said that you tried to not take shots at firms or individuals in the book, and I agree, you did a good job of avoiding that. You did take a parting shot on the very last page of the book at Paul Weiss, and I think it's relevant. Today we talk about disinformation. The right thinks the legacy media is liberal biased. The left thinks X is. Was all conservative bias. And you kind of touch on that indirectly on that last page where you felt that you and your co author were stifled from sort of telling the story and trying to tell the truth. So I was wondering if you could expand on that because I think it's really quite relevant today.
- [77:23]
Max Froomes
Yeah, again, I guess, I don't. It was Paul Weiss and they're at the behest of. Maybe at the behest of Apollo, maybe not. I don't know. It was just, it was. I think it's a standard thing to do when, you know, like, you're powerful, influential and worth a lot of money to try to control the narrative, right. In the media and in the media space. And part of the strategy of doing that, right, is to cut short and potentially negative coverage or a narrative that, that doesn't favor you. And so, and you know, so Paul Weiss would, you know, like did send some, some menacing letters over, you know, asking to see our, our manuscript. And you know, that if we published anything that was, you know, untoward, there could be consequences. And, and you know, I think, I know, I do know a lot of that, a lot of that happens, right? The intimidation of, of, of the media. There's a power imb. And most, you know, most journalists are not making a lot of money and they're just trying to get to the heart of things. And so I, you know, and I think that, that like, I hope that people are discouraged from intimidating journalists. Like the one thing the journalists can do is, is report on what you've just done accurately. And if you're sending threatening letters, then there's, there's nothing to prevent us from publishing them. So I, you know, I, I, I, it's an endless like tons of, you know, tons of great relationships with people who work at Paul Weiss, you know, then and presently. And so I, you know, I think that that was something that happened. I think it's, I think, I don't think, you know, I think it's misguided. I don't think that firms should do it. I think it is inevitable that they're going to try to, if they think that it's going to help them shape the narrative or prevent negative coverage.
- [79:25]
Cole Smead
Another kind of parting question. The nominal level of rates is obviously higher today. We just use the 10 year treasury right now as an example. Okay. Spreads like we talked about, a really tight junk bond offerings, way over subscribed right now. So even though it seems like the money's tighter, things are fairly loose out there in credit markets from what can be seen and exhibited. Do you have any view on that as we move forward? In other words, we would say here that there's a big risk the government might have some trouble in their own funding over the next, say two to three years with our deficits. So again, we would say maybe tenure wakes up at five and a half or six. How do you look at the lax covenants, lax spreads, lax underwriting right now? Because in some respects I can say it looks more like 06 in certain parts of these markets than I would say it looks like the bottom in 09.
- [80:25]
Max Froomes
Yeah, well, I mean especially in private credit, right. If there's a bubble anywhere. Look, my day job is I am the head of a team of analysts, lawyers and journalists that cover distress debt investing, restructuring and the most invoke thing is liability management management exercises. And that, that is essentially taking advantage of this, this like covenant light era and this, this era of really like you know, open loose capital markets. Because regardless the quantum of fixed income is just growing like you know, trillions in high yield debt, leverage loans, private credit and, and, and, and more. All these, you know, derivatives, other creditor facilities. That's the largest asset class there is it, you know, more than there is equities at this point. And you know 9thin and what I do is, is to cover when there is alternative financings or restructurings in those, those, those credit facilities.
- [81:24]
Cole Smead
Sure.
- [81:24]
Max Froomes
So the loose covenants, they give sponsors the opportunity to, to kick the can capture discount, pit creditors against each other and do innovative things in you know, in order to you know, keep their equity options alive. And you know that, that provides opportunity and that, that makes things super interesting. Provides a lot of jobs for lawyers and, and you know, and bankers.
- [81:55]
Cole Smead
Yeah. Yeah.
- [81:57]
Max Froomes
So like that, that's gonna, that's the cons. That, that's, that's what's happening right now. There's not, there's not gonna be in this environment there's fewer chapter 11s like, like you know, free fall like defaults.
- [82:09]
Cole Smead
Yeah.
- [82:09]
Max Froomes
And there's a lot more negotiation and out of court debt restructuring. It's not traditional. It's just like ultimately you got too much debt and you have to do something about it and you have all these options.
- [82:21]
Cole Smead
Yeah. I was talking to a former colleague of mine who's a banker now and he was talking about how you know, the cram downs, I mean the cram downs are happening and the only thing that usually stops you know this mechanics mechanistically is these are contractual obligations. So it would be contract law and courts that would decide. And so to your point, that's the arbiter of these ultimately is what the contracts do and don't allow for and hence the covenants are super important. Outside of your work, are you active on X? Where can our listeners follow your, your work? Max?
- [82:54]
Max Froomes
I, I not too terribly active but I, I'm there. You know Max Brumas, you know LinkedIn and you know and 9fin right9fin.com go there. We have, we have free insights that we post all the time and if you know anyone wants to reach out, it's max.frumas9fin.com I have a weekly newsletter that goes out about all the interesting liability management restructurings called the default notice. Happy to send it to you, that'd be great.
- [83:23]
Cole Smead
And Max, I know Connor and I, speaking for both of us, we really thank you for your time and also appreciate you and Sajit's work. Our tribe should go out and buy a copy of the Caesar's palace coup to understand how big pools of capital and different incentives can cause sustainable businesses. Like we talk about with temporary crises. Munger said one time that there are three ways to go broke, Liquors, ladies, and leverage. We definitely learned how leverage can cause that.
- [83:54]
Connor Callahan
That and I think in in future editions of the podcast we might explore the liquor and ladies side of that equation as well.
- [84:00]
Cole Smead
So maybe we'll have you back for that. Max. If if you enjoyed this podcast, go to Apple, Spotify, YouTube or wherever you listen to A Book With Legs podcast, give us a review, tell others about the books and great authors like Max that we have the chance to study the world with and through for our tribe. If you have a great book you'd like to recommend, email podcastmeedcap.com that's podcastmeatcap.com you can also send your suggestions to us on X. Our handle is Meatcap. Thank you for joining us for A Book with Legs podcast. We look forward to the next episode.
- [84:34]
Max Froomes
Thank you for listening to A Book With Legs, a podcast brought to you by Smead Capital Management. The material provided in this podcast is for informational use only and should not be construed as investment advice. You can learn more about Smead Capital Management and its products@smeedcap.com or by calling your financial advisor. It.