The Exchanges

Q You started early, early with your dad, like, kind of looking at companies in the stock market. Somewhere along the way, you got into the distressed world. So what's the path? You're dabbling in emerging markets, mid nineties, now you're talking 98.

A 98, I became a workout guy. I was in London, and we weren't doing a lot of sleeping during the summer of 1998. Of course, the Asian debt crisis had preceded the year before. Long-term capital had been sort of between the Asian debt crisis and the Russia default. Simultaneously Swiss bank corporation and UBS had gone through a merger. UBS was effectively insolvent and there'd been a shotgun marriage forced by the Swiss national bank. And so we went through that merger. There was a lot of change happening at Swiss bank in those days. And that was heavily impacted then by the sort of rolling series of crises. And that put me in a position where we were buying instruments that Pennies on the dollar and looking for value and thinking about how to extract value from the sovereign or from companies protected by the sovereign where we didn't have the rule of law. And so that was my first introduction to, okay, we've got a big problem here. How do we solve it? From there, I went, uh, came back to the United States and worked for Deutsche Bank. And at Deutsche Bank, I was working in a group that was focused on finding capital market solutions for borrowers. And so, you know, that really taught me a lot about how companies think about financing themselves and how they access various forms of capital everywhere from debt to equity and everything in between and how to structure those types …

AI assessment note: “98, I became a workout guy. I was in London”

Q What is that investment philosophy you decided to pursue?

A So a lot of the investment firms that focus on distress had gotten bigger and bigger and their growth Had really mirrored the growth in the LBO market. So if you think about the leverage buyout market as the manufacturing division of the distressed market, the growth of the distressed investor mirrored the growth of the LBO investor for good reason. But the consequence of that is that as those firms got larger on each side, you left a huge swath of middle market companies that were relatively under invested by the distressed community. Meanwhile, the middle market constitutes Roughly a third of US GDP has forty eight million employees. And at the same time, the middle market constitutes about three quarters of all bankruptcies and restructurings. From our perspective, that gap between the amount of capital that was in the middle market, the amount of restructuring activity that was in the middle market and where the large distressed investors were focused, didn't make a ton of sense.

AI assessment note: “From our perspective, that gap between the amount of capital that was in the middle market”

Q How did it progress from that first set of medallions to a full portfolio?

A We did a couple of things. Once the market was reset and in some large measure by that auction we took part in, we began talking to particularly the federally chartered banks, which there were a handful that had exposure into this market. By that point, these were going to be qualified assets. We were very certain, and the banks were going to look to dispose of them for all of the regulatory capital reasons we talked about earlier. We identified one or two that had large portfolios and began discussions with them. The first large portfolio we bought was a thousand medallions or so, and that formed the real core of the portfolio we ultimately built. We followed with several smaller portfolio purchases. And then, uh, the sort of big signature portfolio that we bought was NCUA, which is the governing body, which oversees the credit unions. And a number of credit unions had failed as a consequence of their exposure to the taxi medallion industry. And so the NCUA had seized those assets on behalf of their stakeholders and were auctioning them off. And that was a long process. It was difficult only because the NCUA was Super sensitive to the treatment of the underlying borrower, which we were as well. But the reality is that these drivers who are out driving taxi cabs are super hardworking people and largely immigrants. I feel as though I have a particular connection. My father's an …

AI assessment note: “The first large portfolio we bought was a thousand medallions or so”

Q So as you took these various experiences, emerging market workouts, and now you're doing U.S. corporate right side of the balance sheet work. What was different when you took that first step onto the buy side?

A Well, you know, when I was at Swiss bank, I was a newbie right out of college. And when I wasn't sort of getting the coffee for somebody, they would let me do something that looked like responsible behavior. When I got to Epic, it was Herb, James, myself, our CFO, Judith Ottensaucer, and we were investing principal capital in the market. And in those days, we didn't have as big of a loan market. It was still very heavily a bond market, which meant disclosures were Okay. Not great. You had to do a lot of primary research. I spent a lot of time on the road, seeing companies out in the wild, talking to CEOs, CFOs, doing primary research. And that really impacted how I thought about getting out there and harken back to honestly, to what I did with my dad, get out, understand the company, really touch it, feel it, talk to the leadership, talk to the employees, talk to the stakeholders around the company, suppliers, the customers to really get a sense. The other thing that was very different at Epic as opposed to the places I worked before is we were involved in the reorganization process. And one of the interesting things about distress is we exist at the intersection of law and commerce. And so where James in particular was super impactful in how I thought was understanding that intersection and how those two pieces work together, how utilizing the tools of restructuring could impa…

AI assessment note: “we were investing principal capital in the market.”

Q What did you find in that research process that confirmed in your eyes that there was some base business where clearly there was this threat of Uber?

A Really there were three things. So number one, yellow taxis are a piece of New York City's infrastructure, and the city thinks about it that way. And so in New York City where we've got a subway system that wasn't really well thought out and last mile Transportation is a real important component of the public infrastructure system. Taxis play an immediate and important role, particularly in Manhattan, which is the bulk of their business. The second thing is the impact of the yellows on the city's budget. So they are a meaningful line item on the city's budget every year and a line item that we felt confident New York City recognized and would ultimately want to protect. The third Piece of that is that as one old hand in the taxi industry said to me when I was visiting with him in his garage, they just haven't reinvented the economics of driving a car. And so when we thought about that and we ran a bunch of surveys of Uber drivers to understand really what their net earnings were. And what we could see is notwithstanding the advertising and the glitz and all the great work that Uber was doing sort of attracting drivers and riders into its system. The profitability of a yellow taxi driver was superior to that of an Uber driver. Now Uber offers other values, but in terms of driving a taxi, it's a better job if you're treating it as a job in terms of earning power. It's a hard job.…

AI assessment note: “Really there were three things. So number one, yellow taxis are a piece of”

Q How do you think about the quality of the businesses, the underlying business? Obviously things in distress have a problem, but sometimes businesses are smaller for a reason.

A You know, one of the things we say around here is we dig a lot of dry holes. So we look at lots and lots and lots of companies and disqualify them for any number of reasons. The biggest reason we'll disqualify them is exactly what you said. They have a problem for a reason. And that problem is hard to solve, maybe impossible to solve. They might be in a industry which is in secular decline. They might be in a regulatory position that doesn't have a good outcome to it. And so we'll disqualify them. A lot of our time is spent looking at companies and assessing whether or not there even is a solve to what they're facing.

AI assessment note: “assessing whether or not there even is a solve to what they're facing”

Q Are you able to look at things, I want to say at a valuation discount, obviously there's size, there's distress, so I'm not sure what that means relative to something else, but how do you think about the relative valuation opportunity?

A It's a great question, and it's one we oftentimes think about, and the distress market can get ahead of itself. So I can tell lots of stories about where you would see something trading in the distress market at a premium from a valuation perspective, To where it's public market comps are trading, which I view is literally insane, but it happens and it happens, believe it or not, more often than you think. So we are focused on buying at the right price and at the right valuation. One of the things that we talk a lot about at MarbleGate is the source of all outcomes is the buy price. So if you don't get the buy price right, you reduce your degree of flexibility, you reduce the opportunity to create outcomes that are good for your investors.

AI assessment note: “where you would see something trading in the distress market at a premium”

Q So once you've found a potential opportunity, take me through that analytical process you go through before you even decide, is this something you want to get involved in?

A We start by bringing it to our morning meeting and talking about the company generally, just general impressions of the company, the industry, things we may or may not already know about a company or an industry or a problem facing a company or an industry. Again, most companies that we hear about Get brought to us. We disqualify, but if we're not disqualifying it at that initial stage, the analyst will start to take a look at it. Now we think about our analytical process, not as a bowling alley, but as a team sport. And so we'll generally put a handful of people on a particular company that we're looking at, looking at different aspects of it. So our portfolio operations team will start even at the initial stages of diligence, looking at What are the problems in, in their operations, and what are the value levers that you could pull potentially? And think about what's constraining the company from pulling those today. Our investment analysts are looking at the financial performance of the company, really unpacking, in particular, its working capital and balance sheet issues. Because problems at a company can persist for a very long time, they punctuate because of a liquidity problem. And at the end of the day, working capital management is a really misunderstood and undervalued portion of highly levered company management, and it can get away from a company pretty fast. So we …

AI assessment note: “We start by bringing it to our morning meeting and talking about the company generally”

Q Who do you think in that process of change of corporate balance sheets will suffer the most?

A Non-active creditors. You know, look, there's been a huge industry grown up around the restructuring process. We have armies of bankers and lawyers and turnaround professionals, all of whom will happily charge a fee to Quote, unquote, help you or help the borrower through the reorganization process. From our perspective, there are super talented individuals and companies and professional services firms that are doing that. There are a huge number that are not. And as a consequence, you could see the reorganization process, if you are not an actively engaged creditor, destroy as much value as the underlying fundamentals are destroying. And so you cannot be a passive participant in a reorganization. It is incumbent upon you as a creditor going through reorganization to be active. It's a understood predicate that in a reorganization, junior stakeholders are in a difficult place from value realization or value preservation, much like the duties of a board shift in a reorganization from the equity holder to the debt holder. So do the duties of a creditor shift from passive participant and collector of coupon to active participant and defender and creator of value.

AI assessment note: “Non-active creditors.”

Q on the other side of that are A group of hedge funds, a group of bondholders, a group of real money owners, or whatever it is that some are winning and some are losing. And that's in one example. Now there's going to be another example in another. So how do you think about participating and investing in this space when so much of it can feel like zero sum?

A Look, it's a really interesting question. And it's playing played out in a kind of interesting way in the Serta case, Serta Simmons, the betting company. So in that case, a group of secondary market purchasers, hedge funds bought up a big chunk of the debt, went to the company and said, we'd like to do what's called an up-tier exchange. So we'd like to break the credit agreement into two parts and essentially stack one half of it on top of the other half. Sort of creating a waterfall of collateral disposition, which advantaged, obviously, the folks at the top of the capital structure. And a very clever investment banker, who's a friend of mine, unfortunately, oftentimes works across the table from me on restructurings, went to the group that would likely be disadvantaged and said, well, if this were about to happen to you, would you take the offensive position, which he convinced them to do. So you ended up with the group that would typically be the villains of the story as the victims and those who were typically the victims as the quote unquote villains in the story. And it makes for a very interesting lawsuit, uh, which I encourage anybody who's looking for a sleep aid to read because the expected archetypal roles are reversed here. Look, I think that there's a belief system out there that some of the traditional participants in the credit market are Somehow less aggressive …

AI assessment note: “I think there's a much more level playing field today”

Q This is a long time coming. I'm really excited to do this. Why don't we just start with your path in the investment business and into distressed investing?

A Well, believe it or not, my path starts quite young. So I was born in Beaumont, Texas, and anybody who's ever spent much time with me knows I hold a really deep passion for my hometown of Beaumont. Growing up, my dad spent a lot of time Talking to me about investments. Every day after school we'd go on a long walk and he would talk to me about his business and talk to me about the stock market and we would talk about investment ideas and really quite early he started getting me involved in the stock market. So we would write away to a company for their annual report and we would read it together and analyze it as much as a kid can do. He would then organize taking me out to see a company. So we always look at a company near our hometown. For instance, Goodyear had a plant outside my hometown, and we'd go look at the Goodyear plant and poke around and understand the process. Then we would go to the stockbroker's office. Uh, he'd make me dress up and they'd organize some papers for me to sign. It was all obviously pretend. Uh, and then I remember vividly when we do that, the stockbroker would reach under his desk and my dad will have always planted like a little toy with the logo of the company or something connected to the company to give me. And so, uh, that was my first introduction to the stock market, to investing. And it really stuck with me. It left a lasting impression on…

AI assessment note: “Well, believe it or not, my path starts quite young.”

Q And do you try to figure that out before you buy, like the receptivity of the management team to feedback, to making changes before you go and start purchasing securities?

A Well, you know, one of the five C's of credit investing is character. And so we are very focused on character of the management team as we think about investing. Look, some of the reality of the restructuring process is that not every management team wants to go through a restructuring process. By the time we've shown up, we're there because the things that that management team has tried have not worked. And some of them are just frustrated to the point that they want to exit the business. And it's hard running a company going through distress. Responsible CEOs spend a lot of time caring for those people that work for them. And it's a stressful environment. And the punctuation of the restructuring process is sometimes, not all the time, but sometimes an opportunity for a management team to go do something else. And there is an opportunity for a new, either entire management team or partial reconstruction of the management team to come in and think about how to create value going forward.

AI assessment note: “we are very focused on character of the management team as we think about investing”