Saddlebags Redux
The Blind Squirrel's Monday Morning Notes. Year 3; Week 8.
Eye-watering vet bills and ‘iPad guy’ tradesmen trigger a refocus on the opaque world of private assets.
Saddlebags Redux
It’s time to check back in on ‘Team Saddlebags’, the 🐿️’s nickname (riffing on Tom Wolfe’s ‘Man in Full’, Charlie Croker) for the private asset industrial complex (private equity, credit, real estate and infrastructure).
It has been a crazy busy week for the 🐿️s. We have just moved house, and I commence this week’s note after 3 days of lugging boxes and deciphering the assembly instructions of flat pack furniture (pour out a large 🥃 for the 🐿️!).
Tough enough on its own but complicated by several mercy missions to the vet with ‘Gnu’ our elderly Schnoodle.
The old boy has been in the wars over the past couple of years. Thankfully, this week he fell ill during regular office hours, and I was able to take him to our wonderful local vet where these days he definitely has double platinum ‘frequent flier’ status. I would like to take this opportunity to thank the handful of members whose annual subscriptions covered the week’s insanely expensive treatment!
In Melbourne, if your four-legged friends get sick at the weekend you are faced with dealing with the private equity owned mafia chains of 24-hour emergency vet clinics. 2 years ago, when Gnu first came down with the pancreatitis, the root cause of his current ailments, he was struck down late on a Saturday afternoon. By Sunday evening, his ‘bar tab’ was running well into ‘5 digits’ (without surgery!).
I feel bad for the impeccably trained animal-loving vets and veterinary nurses. These days, it is clear from the looks in their eyes that they feel sick about charging those exorbitant fees, but alas they are now in the ‘billing targets’ business. They are in the same game as the ‘iPad guys’ from PE roll-ups in the trades (plumbers, HVAC engineers and electricians).
Earlier in the week, Google AdWords directed Mrs. 🐿️ to an electrician for a quote to replace some light fixtures in the new house. She rightly showed the iPad guy the door with a flea in his ear after his tablet spat out an absurd estimate for a 60-minute job.
We got precisely the same job done for 25% of iPad Guy’s crazy estimate with the 🐿️’s favorite local ‘sparkie’. These business models count on ‘the idiot that blindly (no relation!) accepts the quote’ (just like the car owner that under-uses his car wash membership). It is, however, very different when ‘man’s best friend’ is bleeding out.
Sadly, private equity is responsible for the ‘ensh*tification’ of so many things in our daily lives and the 🐿️ reckons that it is about to become a noisier problem for the industry. Consumers and politicians are finally joining the dots.
Politics are becoming a problem for PE
The 🐿️ has had his eye on ‘Big Privates’ for a while now. During 2023, we played the theme with a short position in financial intermediaries (principally Goldman Sachs) that would suffer in a world of reduced deal activity by the financial sponsor community. That trade worked exceptionally well, and we took it off as we prepared to focus on a larger prey.
The rodent’s plan to ‘Take on Omar’ (🐿️ code for Black-‘if you come at the King’-stone) in late 2023 was put on hold by the Fed’s Halloween pivot before we could put it on and we have spectated (with a slack jaw) as BX 0.00%↑ casually tacked on $90bn of market cap in the intervening period between then and now.
Yields don’t matter. It’s all about scale.
The chart above raises some questions. You would have thought that the shares of one of the largest users of the credit market would be much more sensitive to changes in long term interest rates. Yet, the shares of Blackstone (as well as its ‘Big Privates’ peers like Apollo, KKR and Carlyle) have largely ignored the bond market in the past 2 years.
Not content with conventional fundraising targets, the giant asset gatherers are targeting assets from the insurance market and now even retail (via ETFs). Fortunately, not all the RIAs / wealth managers are buying it.
‘Big Privates’ are doing such a good job at raising money that they are basically having to morph into unregulated banks in order to deploy their groaning assets under management. They are already taking massive market share in investment grade direct lending and are now even muscling in on syndicated loan fees.
The ‘golden age’ of distressed?
‘So, what 🐿️?’, I hear you ask. The problem is that all this frantic deal making - away from the scrutiny and daylight of public markets - is obscuring a noticeable deterioration in asset quality. It feels as though private markets are doing deals that (more heavily scrutinized) public markets may well have turned down.
And when these deals don’t work, they are being aggressively ‘photoshopped’. Euphemistically sounding LMEs (liability management exercises) sound a lot more palatable than the old school parlance of ‘extend and pretend’.
These LMEs are also incorporating nasty new features for (existing lenders) like the ‘dropdowns’ (that’s a posh word for collateral theft!) that the 🐿️ looked into last June when we lifted the hood on Vista Equity's disastrous LBO of PluralSight.
Meanwhile, Howard Marks, one of the market’s the most celebrated distressed debt investors, quietly sets a record for the largest ever fund raise of that ilk.
Presumably it was a similar set of investors to those chasing ‘Fund No. 17’ from Big PE and the ‘Golden Age of Private Credit’ that provided Mr. Marks with his latest war chest. Do these LPs really not suppose that those funds will largely be deployed in buying assets from private deals they already have exposure to for ‘pennies in the dollar’ or is that only what happens to the ‘other guys’ deals? 😉
Therein lies the rub. At some stage the endowment CIOs, pension advisers and allocators are going to realize that this is a real headache. Private credit cannot - at that scale - pivot to distressed investing in the way that they pivoted in the past from LBOs to larger asset pools like investment grade and infrastructure credits.
By definition, the market for investing in credit assets at those pennies in the dollar is a LOT smaller. Without a ‘limitless’ addressable market, the fundraising machine inevitably grinds to a halt.
Ever since becoming public companies, PE shops have struggled to persuade the market to assign a multiple to their performance fees. The multiple assigned to the base management fees has expanded over time, but the name of the game has 100% been about the business of asset gathering.
‘Big Private Asset’ already dominates the largest asset pools. Attempts to grow AUM by further encroaching on the territory of commercial banks may be challenging in an environment in which banks look to face less regulatory scrutiny.
PE is NOT Popular
The new US administration has populist tendencies and came to power with a mandate to tame inflation rather than stoke culture wars. As discussed above, the antics of much private equity activity is both inflationary and decidedly UNpopular.
Even the compensation model is under attack! News the other day that the American Investment Council (Big Private’s elite lobbying unit) looks set for a very ‘busy’ 2025 is yet another signal that the tide may be turning for the industry.
In Section Two this week, we look at how the 🐿️ might position himself to capitalize on a potentially sweaty time for ‘Team Saddlebags’. An extract from Tom Wolfe’s ‘A Man in Full’ for those not familiar with the reference:
“The sweat patches under his arms had converged and were now running down his sides, forming a pair of saddlebags on his shirtfront. They were the size of two dinner plates, and they were darkening the fabric of his white shirt”…”The bankers stared at the saddlebags of sweat on Charlie Croker’s shirtfront. One of them whispered to another, ‘Is he melting?’ The other replied, ‘No, it’s worse. He’s evaporating.”
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