The Exchanges

Q When the investment team goes and narrows that filter, are there either certain sectors or characteristics of companies that tend to make it through relative to others?

A Yeah, I mean, we decided early on since preservation of principle was the key to us, first we start with industries. And so we decided we're not going to play in retail. We're going to avoid oil and gas. We're really going to avoid things that are going through major secular change. So you can imagine when we launched with six billion dollars, we're just getting going, every newspaper chain in America came through our office. It was a fresh pool of capital, and they need capital. Now, some of those newspaper chains are going to be fine, but the question, which we couldn't answer, if I made a five-year loan, what is the value of that newspaper chain in five years if it defaults? We don't know, and so we've decided to focus on things that are more annuity-like, so we're big in insurance. Our single biggest sector is software. Software. I think today we are probably, I don't know if we're the largest, but we are one of the largest dedicated lenders to the software space. We have 22 people focused on software, half in New York, half out in Menlo Park. So, I mean, clearly Silicon Valley Bank is the single biggest player, but we're, we're definitely, I think, you know, top two or three. And if you think about software, I think this will summarize what we look for. If you can find a piece of software that's mission critical, and so it's really involved in helping a company run, and th…

AI assessment note: “we've decided to focus on things that are more annuity-like, so we're big in insurance”

Q If you looked across your portfolio and did a composition by the couple of key factors that you look at in underwriting, what ends up being the biggest driver of the package?

A First and foremost, I would say it would be tied between The industry, and what's our view of that industry, and secondly, how it's capitalized. There are certain PE firms who want to put in as little equity as possible. That's just not going to be a good fit for us. In general, what we're striving for is to find a business in a sector we like, and we're trying to make loans at around 50% loan to value. Because at 50% loan to value, I feel pretty good that things have to go really wrong for us to lose dollar one. In a market like this, where it's a little bit frothy, it's definitely starting to tick up a little bit. Maybe it's in the low fifties, but we try to remain pretty disciplined and having a lot of equity underneath you can really get you through a lot of difficult times.

AI assessment note: “tied between The industry, and what's our view of that industry, and secondly, how it's capitalized.”

Q So if you go back in those early Wall Street years, early on you got into leverage finance, what was it that made it an attractive place to be?

A Well, if I'm being a hundred percent honest, I didn't pick leverage finance. Leverage finance actually picked me, and I pinch myself every day that I was fortunate enough to get into it. I started my career at a firm called EF Hutton, which probably most of your listeners have never heard of, but it was a pretty big firm back then, and I was in a program where I rotated around the firm, and I probably didn't make the wisest choice, but I decided that I would go into municipal finance. And at the time, this was probably 1985, maybe 86, that was one of the most profitable areas at EF Hutton. And the group I was fortunate enough to get a job with specialized in a form of public finance called industrial revenue bonds, which is a fancy way of saying they would go to companies, they would help them do a financing on a project that Would help a community, and if it was helping a community, they could get municipal status, which means interest rates were very high then, but municipal rates were much lower, so they could save a lot. So we're working with small companies, building a small factory, it would be 10 employees, we'd get it qualified for this municipal status, and we could save hundreds and hundreds of basis points. So one day, I wake up, I'm walking to the subway, I get my Wall Street Journal, and they've changed the tax code. And they have outlawed this area that I had focu…

AI assessment note: “I didn't pick leverage finance. Leverage finance actually picked me”

Q What led to you ultimately leaving and co-founding GSO?

A I started at DLJ in 92. I left in 2005. Now, in 2000, DLJ was bought by Credit Suisse. In 2005, there was a change at Credit Suisse. John Mack, who had been the CEO, was pushed out, and a guy named Ozzy Grubel, who was his co-head, took over, and then they anointed a guy named Brady Dugan, who we were friends with, to run the U.S., but We thought that was a good time to pass the reins, and we had been really intrigued with the asset management business, and so with my two partners who we had been running the business, actually Bennett Goodman ran the business. We worked for him, but the three of us said, Bennett Goodman, Trip Smith, and myself, let's go start this firm called GSO. We're going to do something that nobody really had ever done, and that was Marry both public market expertise with origination, and direct lending wasn't really a thing back then, and we thought we had originated tens of billions of product over our career, and we thought we could continue to do that and not be so reliant on Wall Street, so we left, and as you can imagine, leaving a really nice, high-paying job, it was nerve-wracking. And remember we left in oh five, oh five, oh six, oh seven were some of the best years ever for wall street. So people were calling us constantly saying you guys made the biggest mistake of your lives. Why would you leave? We're killing it. But we had a great partnership…

AI assessment note: “there was a change at Credit Suisse... we had been really intrigued with the asset management business”

Q So how did it evolve from there through the rest of your time on the south side of the street?

A So EF Hutton had some financial issues. I left Hutton and I went to a firm called LF Rothschild, and then they had some issues. At Rothschild, I had made the move after a couple of years of banking. First, I became what was called a desk analyst working on special situations. Then I moved into sales. Rothschild had some issues, so I went to Wasserstein Perella, who had started a high-yield business. Like being chosen to go into leverage finance, I decided I wanted to go to a bigger firm, and I got offers from two firms. One was Bear Stearns, and the other was a firm called DLJ, Donaldson, Lufkin, Genred. They're both great firms, but I really liked the people at DLJ more. There was just something I related to. The problem was, DLJ was offering me materially less than what Bear was offering me, but I just decided I'm gonna take a long-term approach, and I'm gonna take the offer at DLJ. So I go to Bear Stearns, I tell them, look, unfortunately, I'm gonna go across the street to DLJ. This is a true story. I'm living in a two-story walk-up, only air conditioning in the bedroom, not in the living room, just to give you an idea what it was like, but a great apartment, and so I come home. If you remember the old-fashioned answering machines, you'd have to go and hit the button, so I hit the button, you know, it makes the sound beep, and I hear the guy with a bit of a southern accent. …

AI assessment note: “I left Hutton and I went to a firm called LF Rothschild”

Q What teaching from your parents has most stayed with you?

A Well, I think my father had a very simple thing that made a lot of sense, and I've tried to get my kids to buy into this as well. He had this saying where he wanted me to be able to walk into a bar and sit down at the bar and be able to strike up a conversation with the bartender. And then if a police officer came in and sat down next to me, he wanted me to be able to have a conversation with him. And then if a athlete came in, same thing, a business person, politician, whoever sat down in that seat, he said, you've got to be able to find some common ground to have a conversation because in his view, business was so much about being able to get along with people. They have a choice who they can do business with. And if you can find some common ground, it will give you a leg up and simple, easy to understand, but it's definitely something that served me pretty well.

AI assessment note: “you've got to be able to find some common ground to have a conversation”

Q But having worked with, call it, 500 sponsors, How do you think about the part of the underwriting that involves who that ultimate owner of the business is?

A The good news is we have a bunch of people at the firm who have really senior relationships at most of the firms we work with, and we've seen their behavior over a long period of time. We are not interested in taking over anyone's company. So we're a really good partner, because you hit something like the pandemic, and if, let's say you needed a covenant waiver, if you had a public bond outstanding, you had to go negotiate with a hundred different parties, maybe 200. During the pandemic, if we were the lead on one of your deals, you just had to negotiate with us. So what we asked of a PE firm was, Shore up your balance sheet. Let's make sure you have liquidity if this crisis goes on longer than expected, and if you do that, we'll waive your covenant. Maybe we want a little more rate. Maybe we need a fee, but we'll make it reasonable, and we'll give you the ability to extend that equity option, and so we have the luxury of cherry picking because we cover a lot, and by the way, we cover 700 PE firms. We also call on a lot of large private companies. We're looking for people who want to make it a win-win. We're not looking for somebody where, when it gets tough, they're calling and saying, paragraph C, line item two, we believe there's the ability for us to put more debt or to strip out, strip out assets. There's a lot of ways to parse through an indenture. I used to run a distres…

AI assessment note: “we've seen their behavior over a long period of time... looking for people who want to make it a win-win”

Q So I want to turn to the firm and the investment side of the business. So why don't we start with when you created OutRock, what were you trying to accomplish as your own strategy?

A We started the firm in 2016, and I was lucky to be at Blackstone when I left. I think we had 80,000,000,090 billion, I don't know the exact number, but it gave me the ability to see quite a bit. I started becoming convinced that Direct lending, which is what we specialize in, was gonna become a really big asset class. Back in 14 and 15, most big institutions, they allocated to it, but in relatively small size, and it wasn't a separate asset class. And as I went out and started talking to folks, I realized that they were gonna allocate a lot more money, and at the same time, more and more private equity firms were becoming intrigued With not going to one of the big banks, but going direct to somebody like us who could provide a bespoke solution. When I looked at the world, it's pretty interesting, the competitive landscape. If you were to draw a pyramid, and you go to the bottom of the pyramid, the widest part, there were a lot of firms that could make loans of 10 to twenty million dollars. Then you work your way up to 40 to 60, and then 60 to 80, and 80 to a hundred. When you got to the top of the pyramid, the number of firms that could actually make loans of two, three, four, five hundred million and hold it was relatively small. And so I, I noticed that and I was surprised because that's where I like to invest. Because think about it. If I'm lending to bigger companies, most …

AI assessment note: “When you got to the top of the pyramid... that's where I like to invest.”

Q So how do you go from a ground start to amounting sufficient assets that you can make loans in that size and still have a diversified portfolio?

A Yeah, it's a really good question because going out with that, it'd be much easier to say, we're going to do 10 or twenty million dollar loans. You raise a half a billion dollars, you're in business. We had to go raise billions. I think we were fortunate. We put together a great team. I brought in Mark Lipschultz, who was at KKR. Craig Packer, who is at Goldman, Alan Kirschenbaum, who is at TPG, and the whole idea was, let's give everyone, our investors, that big firm experience, but as a new boutique, but highly focused, focused on one thing, and let's be best in class at it, and it resonated, and there's an element of luck to this, and trust me, when I was sitting in my lawyer's office, we were working out of a conference room, Interior conference room. No windows. There were like 12 of us. That's where we went every day for months. In fact, before I got the conference room, I used to spend every day at the Putnam Diner in Greenwich in the back booth. I was the number one customer. That was my office to save rent. When you're starting something new, it's really scary, but we were fortunate. We got a great response in the market. We raised six billion dollars. We use a turn of leverage, so we had twelve billion A firepower when we launched. You know, we had our first close at the end of the first quarter in. And we really haven't looked back since then, but you can imagine whe…

AI assessment note: “We put together a great team... We raised six billion dollars.”

Q What do you remember most of your earliest lessons in the business?

A I have to admit, having been in public finance, moving to corporate finance, I was ill prepared, and it was much more accounting focused than working for a municipality, and I remember sneaking out and getting tutored by a professor at NYU on financial modeling and just getting better at accounting, so it was A year or two of really hustling, but it was an interesting time because Drexel was still the dominant player in the marketplace. So to pick up any market share was a real challenge, but this was a really small group. So as a 26 year old associate, I had the flexibility to call on companies and pitch them. And I was very fortunate. It was exciting.

AI assessment note: “moving to corporate finance, I was ill prepared, and it was much more accounting focused”

Q So I want to fast forward. When you started Alrock, what does that culture mean to you, and what culture did you seek to replicate?

A When I left Blackstone in the summer of 2015, I started thinking about leaving in 14. And it wasn't like I was unhappy there. It's an amazing firm, and I felt really fortunate that We sold our firm to Blackstone because we sold in oh eight, so we were able to get through the crisis being part of Blackstone, and I learned a lot there. I learned a lot about culture, watching people like Steve Schwarzman and John Gray, especially watching them during a crisis. They led by example, and they were calm and cool and trying to figure out, you know, there's a lot of pain in the world, but how could we come out of this stronger? And they came out much stronger, and that Helped our business. But as I think about the culture we were trying to create, I think we saw an opportunity to create a culture that we could give people, our investors, the same experience, the investment experience as a Blackstone, a KKR, a Carlyle, Apollo, any of the big firms. So whether it's anything in our back office, compliance, legal, cybersecurity, make that As good as you would find anywhere in the world. Build an investment team. I think it's better, but as good as anyone. My real goal, though, was to create something that was a little kinder. A little more gentle. No face time. People don't believe me, but I spend a lot of time talking about this, and I really believe it. I think you can have a work-life ba…

AI assessment note: “My real goal, though, was to create something that was a little kinder.”

Q The more you talk about creating this breadth of opportunities to provide solutions to sponsors, the sponsors, companies, everything in the ecosystem, the more it starts to sound like an old school investment bank. And I'm curious, as you think about what you're building, what is it that's motivating where you want to get to in this competitive landscape?

A If you take a step back and you think about where rates are today and where they'll probably be for the foreseeable future, there's really incredible tailwinds for the alternative space. And as you mentioned, our ecosystem that we service day in, day out is the private marketplace. So we come in every day and we think about how can we get extra premium in everything that we do for our investors by servicing this group that's growing like crazy. And you'd be shocked how many PE firms and VC firms have never talked to a direct lender, never even thought about it. They think that the bank is excited to work on their 304 hundred million dollar deal. And they probably are in a good market. It's relatively easy. But when the markets get a little bit choppy, we provide certainty when you have to go in and say to a seller, your deal is done. And so we think the PE VC space is going to be super active for the foreseeable future. And as I mentioned earlier, our goal is to come in and try to be that solutions provider. And if we're missing a tool in the tool shed, we're going to either Build it organically or look to acquire it.

AI assessment note: “our goal is to come in and try to be that solutions provider.”

Q And of those add backs, if you were ballparking it, how much of it do you think is real in terms of, say, recurring, and how much of it is just being thrown in there to get a higher valuation?

A You know, it really depends on the business, but because we do private style diligence, we have the luxury of sitting down with the accounting firms and really dissecting every single number That's put in there. So it's hard for me to generalize, but I would tell you there's always a meaningful amount that is, uh, there's a real question whether or not it's recurring. And just remember, we're a creditor. And so let's say the company gets in trouble. The way it's going to be valued if we go to sell it is not off of this pro forma adjusted EBITDA with these ad backs. People are going to look at its gap cash flow and value it off of that. So we're constantly saying, okay, a year from now, what will show up in the financial statements? Some people want to get credit for something three years from now, five years from now. Great example is we looked at somebody who managed small convention spaces and small stadiums, and they were trying to get credit for a project that hadn't been built yet, And wasn't going to come to fruition to 2025. We can't include that because if it gets in trouble in 23 or 24 or even 25 and there was a delay, it will never come to fruition. So those are the kind of things we deal with.

AI assessment note: “there's always a meaningful amount that is, uh, there's a real question”

Q How does that impact your vision for what happens with the private credit markets over the next five or 10 years?

A The credit markets are massive. These are trillions of dollars, these markets, and there's hundreds of billions issued every year. And so when somebody looks at our business and says, wow, thirty billion dollars, that's a lot of money. It's really not when you think about it in the scheme of the marketplace. Here's the, the really interesting thing about Wall Street. When you hear Wall Street's making a loan to a below investment grade credit, say a single B, the type of company we would finance, they might make the commitment, but the commitment is very short lived. They fund it and they lay it off the day it hits their balance sheet. There's this concept of velocity of capital. I'll just give you a quick example. So when I was at Credit Suisse, let's just say I had five billion of capital. I made five billion of loans and I laid those off and I made three points. I made a hundred fifty million dollars. It's pretty good. You quickly realize what you want to do is use that five billion and turn it over as quickly as possible. Preferably 10 or 20 times. Instead of a 150, let's make it a billion and a half or three billion. That's what Wall Street does. And so because of that, their focus is on bigger credits. To do a three hundred million dollar deal and a three billion dollar deal, it's the identical amount of work. But the truth is, Fidelity and PIMCO and BlackRock and all the…

AI assessment note: “Means the deals that are a hundred to, say, six, seven hundred million”

Q from a perspective that they don't because you're working on deals with them. Inevitably, they have to ask you, hey, what do you think of this firm? How should I think about making a decision between private equity firms? How have you found that the unique lens you have in working with them translates to how an investor in one of those private equity firms might think about their success?

A We do have some insight into the PE firms. We have a sense of the risk they're taking, and for our LPs, we try to be a really good partner and share with them Who we think has a real competitive advantage and maybe a few who got lucky because maybe the pandemic bailed them out. So part of what we try to be is a great partner to our LPs. But in general, the firms we're working with, we think are really high quality. They've been great stewards of capital. They've generated really good returns. And I think PE is going to be a good asset class. It's going to be a great asset class going forward, but we have to realize returns are coming down, and they're coming down meaningfully. They have to. Purchase price multiples are exploding, and so the higher they go, the lower the returns are going to be. Things aren't going to go up forever, and so I think most of the big investors we talk to, they're of the mindset that let's invest with the best firms, but let's go in with eyes wide open and know that Returns are probably going to come down over time.

AI assessment note: “share with them Who we think has a real competitive advantage and maybe a few who got lucky”

Q So when you turn to this investment strategy predicated on protecting the downside, how do you go about filtering your investable universe to figure out where you want to make your bets on loans?

A The one thing I would say I was maniacally focused on is what's called our deal funnel. I thought the mistake a lot of direct lenders make is they don't put enough resources into their business, people. To create a very large deal funnel. So for example, if you only have four deals in house, and your best deal, maybe check six of the 10 boxes you want to track, you do that loan. So what I wanted to do was make sure we had a deal funnel that was as big as any of our competitors, but probably have a little less capital at the bottom of that funnel. So more deals per dollar of investable capital than any of our peers. That's what we set out to build. I can't prove it, but I can tell you I feel pretty confident that we've achieved that. We cover today over 700 private equity firms. We've worked with well over 500. We've done over thirty billion dollars of financings. I don't know the exact number, but probably 200 line items. I think the other thing we've done that most people aren't aware of is Early on, today, retail, high net worth is really in vogue. So a lot of firms, KKR, Blackstone, a lot of firms are active in that. But when we launched the firm, we decided we were going to be very active in that space. So we started that strategy six years ago. And what we did, which is different, and I don't know how they're running it today, but I looked at a lot of firms with REITs. And…

AI assessment note: “what I wanted to do was make sure we had a deal funnel that was as big”