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- [00:00]
A
So there's a lot of noise about AI, but time's too tight for more promises. So let's talk about results. At IBM, we work with our employees to integrate technology right into the systems they need. Now a Global workforce of 300,000 can use AI to fill their HR questions. Resolving 94% of common questions, not noise. Proof of how we can help companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business. IBM,
- [00:33]
B
Bloomberg Audio Studios, podcasts, radio news.
- [00:38]
C
Our next guest says that highly leveraged software default rates could hit 15% in private credit. Joining us now is Bruce Richards. He's the chairman and CEO of Marathon Asset Management. And you just put out a link. Look, LinkedIn post this morning. Danny and I were reading it before the program, likening what happened in Energy in 2016, 2017, 2018 to what we're looking at it in software now. Is it fair to compare those, those two industries? Because I think Scott was saying, hey, there's a different ball of wax here.
- [01:13]
B
It is a bit different ball of wax. And Scott's right to say there's no comparison between the industries. Well, let me explain why I come to that parallel. So back in 2014, a new technological change happened for oil and gas is called horizontal drilling or fracking. And that technological change did a couple of things. Number one, it changed the pricing structure for oil and gas and oil and gas services would work. And number two, based upon all the capital that was raised now of a sudden, capital dried up because the pricing structure collapsed. And so what we have in software is very similar. We have a technological change which is forever going to change how software is going to be priced. Now we should think about that industry and based upon the technological change and how much leverage is in the broadly syndicated loan market and then more importantly in the direct lending market, leveraging these software companies, the capital is now drying up. And so what we do, what did we see as a result of that technological change in oil and gas? We saw a 15% default rate in the subsequent years 2016 and 2017. So for me to say that software, which is the biggest sector within the direct lending business, couldn't get to a 15% default rate, I think is actually missing the mark because I think that's exactly what's going to happen in years 27 and it has a chance of happening in 27 and 28 to have back to back years as a result of very different, there's a lot of similarities because of technology Technology changing how pricing structure works at a time when too much capital has been flooding into the sector. Just think about this for a Second, Matt. Only 1% of companies in the US are software companies and only 7% of all publicly listed companies are software. Yet 23% of the direct lending business is soft. How do we get there? It was a gold rush to finance the software companies and these buyouts. And the public companies are sitting in good shape because their debt, when you look at Nasdaq S And P. Russell 2000, the debt that these software companies have with really good margins, the debt that they have is only 0.5 less than 1 turn of leverage. In the broader syndicated loan market, you have five turns of leverage, 10 times the leverage. In the direct lending business, you can have 20 times leverage. So you don't have the companies that can generate the free cash flow to reposition I. They're in a very tough position.
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C
So Bruce, what is the effect of that? I think a lot of investors are reading your research and starting to wake up to the fact that this could become a reality. And as a result we're seeing redemptions. You know, people are trying to get out of these illiquid private credit funds. And what we see some of these companies doing, Blue Al for example, is okay, we're going to see sell a ton of these assets, we're going to sell these loans. And they want to be able to say we got, you know, 99%, we got 98% of the par value for that. So they can't be selling those 20 times even software loans. Right. They must be selling their best assets.
- [04:28]
B
So I can't speak to Blue Al or others.
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C
Of course not.
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B
Liquidity crisis or liquidity issue right now in their funds. It's, you know, something I'm not focused on. What I am focused on is the availability of capital on the back end of to extend these loans. And I believe that there won't be availability of capital. So I think the next round in the years 2728 when a lot of these loans come due is in the direct lending business to extend in amend or extend and pretend to pick those loans because it won't have the cash
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C
flow payment in kind financing.
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B
And so and you won't be getting won't get paid back in interest and because you've extended loans, you also won't be getting paid back in print.
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D
What does that do to an entire industry, industry that is both private credit and private equity, that has loved software, that has gotten it to 23% if all of a sudden they can't go to capital markets and they can't get those loans, the financing ceases to exist, what does that do to the industry?
- [05:29]
B
I think the industry is fine because I think direct lending is a big industry and I think that there are other sectors of the economy. Again, software is only a few percent of the overall economy.
- [05:39]
D
But it sounds like you're saying software lending is over, it's done after this episode.
- [05:43]
B
I think when you lend in software, you have to lend it very conserv the multiple because the business itself is an uncertain business. And so four times that EBITDA, not 10 times, is probably the right number. And getting paid a little bit more for that risk an extra 100 basis points on your loans. Now, the extent that financial conditions tighten a little bit on this in the direct lending space because of what's going on, we can get paid more for loans that we're making in the marketplace with tighter covenants. So I think for lenders that aren't in a bad position that actually can extend credit, it's actually a good place to a bit. And so I wouldn't let software, just like oil and gas, when you had that problem with those companies back in 2016, 2017, 2018, didn't tank the economy. The economy just fine. I think economy will just be fine without having to deal with the default rates that are coming. The problems are coming because the economy is so much bigger and diverse than this. And so it's not going to do anything to cause any kind of disruption to the broader private credit markets or the, or the broader credit markets or the ME I don't believe that at all is the case. But what it will cause is religion to come back in and discipline to come back in because quite simply, you know, Danny, and that 23% in software is just too much exposure to one industry group when it only represents a very small part of the overall, you know, equity markets. It's only 1% of all companies in the US or software companies, and only 7% of all, all publicly listed companies in the US are software companies. So it's too much exposure for them to have had. Everyone regrets it. Now we're thankful that we have 1% exposure and not that type of exposure. It's going to represent some really good opportunities for us as lenders in the years to come. Danny?
- [07:35]
C
Well, I'm wondering, you know, where those opportunities are going to be and specifically in software, because religion has already set in with some of these names. Are there some, you think that are oversold. Are there some that you think you know the debt is cheap enough to go in and pick it up? Because that's historically where you've made a lot of money.
- [07:54]
B
First of all, I think in the public credit, public equity markets, they're going to be a really good position to buy a lot of this at pennies on the dollar because they're the ones that can have the capital, the cash flow, the margins to be able to do so smart private equity will also come in and recapitalize and buy new companies and. But they'll pay a lot less. The whole ratings of where you know what multiples we pay for the company has come down substantially. And private equity traditionally doesn't pay more than 12 times for a company. Traditionally. And so getting the whole sector repriced based upon this existential risk that you have with private equity is important. And that's where we're moving towards. And the second thing is private equity has all the upside. Imagine a company for creative destruction that they can reposition. Instead of making two or three times their money, they make five or six times their money. So they can afford a few zeros, right? And still come out okay. Private credit can't afford the zeros. They only get paid that far. They don't have the upside. So what you need, Matt, is certainty when you lend. It's an uncertain business right now. And that's why capital will not come become available.
- [09:08]
D
Are you not buying anything then?
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B
Not right now. In software, what we're focused on are businesses where halo is the effect. Hard assets, low obsolescence. I'm talking about in lending. Our last private credit lending deal in deal was a concrete deal with rebar. The deal before that was signed side for commercial and residential, you lay on the lawns, right? And so these are real asset lending opportunities. And our last asset deals in our ABL business, hard assets low obsolescence are aircraft maritime assets, turbines, cranes and engines.
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C
Because you're bullish the economy, because we
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B
love the economy and we want to be able to land say the $300 million asset pool, 200 million on an LTV base basis. The 66% LTV, that nice margin of safety with that hard asset where we have a perfected interest in that hard asset. It's not software where the recovery value will be close to zero if there's a default. We get full recoveries in the event of a default on most of those assets. And so. And we very rarely have default because they're missing critical assets for these companies. And so it's a very different dynamic when you talk about Halo. And with Halo, that's what why you say industrials and you know, materials up 25% in a year with a lot of software Companies are down 25 to 40% in the year when you talk about the mid market software companies. And so we're in a very good position at Marathon as a lender with capital available to land and with how our position is currently positioned. This is Special Agent Regal, Special Agent Bradley Hall. The time is approximately 11:15am about to start consensual telephone call with Dr. Daiwa Zhang. China's Ministry of State Security is one of the most mysterious and powerful spy agencies in the world. But in 2017, the FBI got inside.
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C
I'd never seen that much evidence in my entire career and I don't think we'll ever see that much evidence again.
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B
I now have several terabytes of an
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E
MSS officer, no doubt, no question of his life, and that's a unicorn. This is a story of the inner workings of the MSS and how one man's ambition and mistakes opened its vault of secrets. Listen to the Six Bureau from Bloomberg Podcasts starting on February 13th on the iHeartRadio app, Apple Podcasts or wherever you get your podcast.