[00:03:09] Clay Finck: So think of endowments and foundations, the forefront of different exposures to asset classes. And most of the activity was only buying private companies. That’s changed a lot, particularly say the last 15 years. And like a lot of things, institutional adoption of new assets takes time, and institutions saw performance, the financial crisis was a little bit of a catalyst because without a wave of default, private equity kind of held up through the financial crisis and for a long time has delivered returns that met and exceeded the needs of all these institutions for their spending.

[00:03:47] Clay Finck: So what happened kind of after the financial crisis is you had rates dropped to zero. So the whole fixed income side of asset allocation wasn’t really going to work in helping people get to where they needed to go. So they start thinking about different ways to effectively make more money and private equities delivered that for a long time.

[00:04:03] Clay Finck: So you started to see more and more capital flows into private equity strategies and it’s just grown and grown and grown. And so far they’ve continued to deliver and deliver and deliver. So that appetite’s just grown and grown. So you see like the early adopters, endowments and foundations, depending on how you define private equity, but their private assets might be half of their portfolios.

[00:04:26] Clay Finck: And some of the huge pools, like think public pensions or sovereign wealth, or even the massive wave of high net worth individuals, those numbers are often in the mid single digits. So you’ve seen that maybe that number has gotten to 10 percent or 15 percent and that’s huge dollars behind it. So you’ve seen this massive acceleration of growth.

[00:04:45] Clay Finck: And that’s what’s really happened over the last 30 years with that back half being significant acceleration in assets.

[00:04:52] Clay Finck: So in your interview with Mario Giannini, he had mentioned that the great financial crisis was the greatest thing that ever happened to private equity. Is it just the interest rate piece and just becoming more mainstream in the institutional world of being a part of a portfolio or is there something else to it?

[00:05:10] Ted Seides: It’s really those factors. I mean, if you think about why would it be the greatest thing, and he’s really referring to capital coming into the space. It’s a combination of where else can people put it? And on a relative basis, private equity looked a lot better and also private equity continued to deliver on its promise through the financial crisis.

[00:05:31] Ted Seides: So, stocks didn’t do well, obviously, in 08. Bonds did, but that wasn’t really the stalwart. Now you look forward and say rates are at zero. And hedge funds, which had been a kind of diversifying equity like return for many, many years until then, had gotten to a point where a lot of the late adopters may not have fully understood the underlying strategies.

[00:05:54] Ted Seides: So they may have thought that a hedge fund strategy was always going to deliver positive returns no matter what. And there were definitely some of the later adopters had that in their investment thesis. That part of the thesis clearly failed in 08, so people were less confident in hedge fund strategies.

[00:06:09] Ted Seides: So again, where else do you go? Private equity didn’t necessarily mark to market, but you had this drop in 08 and this pop back in the public markets in 09. And if you held the business through that, you generally did fine. So private equity before, during, after, looked like it was continuing to deliver these, these Sort of a risk premium above what equities were delivering over time.

[00:06:32] Ted Seides: And that drove a lot more interest into the space. So it was kind of a combination of what happened in private equity and what happened in the other asset classes.

[00:06:39] Clay Finck: David Swensen, who I believe you worked with in the past, he referred to private equity as a superior form of capitalism to which you agreed.

[00:06:48] Clay Finck: How about you explain what you think he meant by this?

[00:06:52] Ted Seides: Well, if you think of capitalism as sort of driving profits, a private equity firm that buys a business has control. So they have control over who’s running the company, right? They can change management. They have control over operations. And making improvements in the operations, they have control to some extent and how they grow into new markets.

[00:07:12] Ted Seides: And they certainly have control over how to finance company. So there’s no better way to think about how you would drive the profits of a business than being a control owner. And so public equity investing, you’re not a control owner. You’re at the behest of other shareholders and the management team.

[00:07:30] Ted Seides: But in private equity, you really can control outcomes. You shouldn’t say you can control that, but you can control the inputs. into what deliver the outcomes. And that’s true kind of more than any other form of investing. And so that’s what he meant by driving that. And part and parcel with that, if you think about what happens when all this capital comes into the space.

[00:07:50] Ted Seides: As we described over the last 15 years, it’s a high fee business. The private equity firms now have significant revenues that they can invest into delivering returns. So you’ve seen more and more resources deployed to say, improve the operations of companies. Then a private equity firm would have been able to 20 years ago because they can pay for talent.

[00:08:11] Ted Seides: And that comes both on their team and say, there’s a whole world of operating partners or someone that may have been a senior executive at a company that partners up with a private equity firm to go parachute into one of their portfolio companies and help that management team do better because they have pattern recognition, even understanding of how to drive, say the economics of a particular business.

[00:08:31] Ted Seides: So that combination of the ability to control outcomes and then the power of having resources behind you to be able to spend to increase profits really makes private equity like a remarkable activity in terms of the ability to drive profits.

[00:08:47] Clay Finck: I know this is a hot topic in question, but the returns. You mentioned private equity delivering strong returns, oftentimes higher than the public markets.

[00:08:57] Clay Finck: When someone asks you what type of returns private equity delivers, what sort of numbers are you seeing?

[00:09:03] Ted Seides: Yeah, well, there’s two types of ways of answering that. One’s about the past and one’s about the future. I’m much better at describing the past, so I’ll do that, and then, you know, we can talk about what you might think in the future.

[00:09:13] Ted Seides: No matter how you measure it and how you look back, even the average private equity fund has delivered a couple of hundred basis points over the S&P. So think four or 500 basis points, four or 5 percent per year over. And there are measurement challenges and there’s IRRs and multiples and all these things.

[00:09:30] Ted Seides: But when you have that significant of a net of fee premium, no matter how you slice and dice comparables, it’s been significant value added to the investors in private equity funds for a long time. with pretty high degree of consistency as well over different measurement periods. So you can’t measure it week to week or month to month as you would or day to day in the public markets because businesses don’t revalue that quickly and private equity firms don’t revalue their businesses that quickly.

[00:10:00] Ted Seides: But if you look at starting point to ending point of buying a business, selling a business and that for a fund and use public market comparables for those periods of time. By and large for a long period of time, you’ve seen outperformance of public markets, even in just the average private equity fund.

[00:10:17] Ted Seides: Then there is a wide dispersion of returns across private equity firms. So you have the opportunity to say, if you’re a limited partner of picking better firms and doing even better than that.

[00:10:27] Clay Finck: I pulled a one data point you had in your book from Hamilton Lane data via Cobalt of silver 20 year time period, the year ending December 31st, 2022.

[00:10:38] Clay Finck: They saw a compounded time weighted returns of 14.6 percent versus 9.8 percent for the S&P 500. So that’s net of all fees and expenses. And it’s somewhat surprising and counterintuitive because when you look at a lot of public equity managers, you see underperformance across the vast majority of them.

[00:10:56] Clay Finck: But it’s interesting how in private equity, which you think would be pretty difficult to go in and understand this company after all this due diligence process and have everything go to plan delivering worthwhile returns to investors.

[00:11:08] Ted Seides: Well, there’s a couple of different levers to that, and particularly some real tailwinds in that period, right?

[00:11:14] Ted Seides: So one is generally speaking, there’s probably more leverage on buyouts, and many of them are leveraged buyouts for a name than you find in the public markets. And the cost of debt was really cheap. So understanding that part of financial engineering is one lever that a private equity can pull. And they did in that 20 year period.

[00:11:34] Ted Seides: So your cost of capital is much less than the private markets and the public markets if you knew how to use debt and were willing to do it. So that’s certainly one. Another is that generally speaking, private equity firms buy cheaper than the public markets and that can change over time. It can be cyclical, like prices have gone up, but over these last 20 years, as capitals flowed in, you’ve seen somewhat similar to the public markets, a multiple expansion.

[00:11:59] Ted Seides: But if it starts at a lower level. You’re going to get, you know, a higher return from that change in multiple. And then you have that lever of improving operations and you put those together. And yeah, you’ve had really extraordinary outcomes for a long time.

[00:12:12] Clay Finck: Warren Buffett shared in one of his recent Berkshire annual meetings that he’s seen cases where returns for private equity aren’t calculated in a way that he would describe as honest.

[00:12:24] Clay Finck: And he said, if he were running a pension fund, then he would be very careful investing in alternative investments, such as private equity. What are your thoughts on some of these statements from Buffett?

[00:12:34] Ted Seides: I think it’s absolutely correct, right? You can’t willy nilly go into these strategies. You have to be very rigorous with your diligence and really understand what it is you’re buying.

[00:12:44] Ted Seides: It’s not trivial how to measure a return stream in private markets, because, you know, it’s, there are IRRs, there are different multiples that people calculate. It takes a long time before you exit. So a thoughtful investor has to be able to pull all that apart and understand really where the value creation occurred and if they think it’s likely to happen in the future.

[00:13:06] Ted Seides: Most of Warren’s views on anything other than the S&P 500 are tied to fees, which I know as well as anyone. And he’s right, right? The fees on these activities are high. Now there’s another side of that, which is the incentive alignment is much, much better than it is with say public market management team may have stock options that may or may not be tied to shareholder performance in the private markets.

[00:13:32] Ted Seides: You have an incentive fee. And the private equity firms get paid if they deliver profits. In fact, in the private markets, the incentive fees are almost always over a compounded hurdle rate of about 8%. So it’s not just delivering profits, but there’s a real significant cost of capital. They have to achieve that hurdle before they get paid significant fees.

[00:13:52] Ted Seides: And so Warren’s a smart guy. He’s not wrong with the generic statements he makes. And that’s a good example of it. But I think once you get past what’s he really saying, he’s talking to the mom and pop investor who see a headline and say private equity generated 15 percent and the S&P was 10.

[00:14:09] Ted Seides: Therefore I should buy it. And you know, that’s not the case at all. There’s a lot more that goes into it. In understanding where you’re going to put your dollars than just a return stream.

[00:14:19] Clay Finck: So if I think about some of the factors that are driving strong returns for private equity, obviously you have the leverage piece and many of these deals that are being done obviously need sharp investors, allocating the capital.

[00:14:32] Clay Finck: And then I think part of it is also just like money being locked up for, say, five or 10 years that capital is committed over a certain time period. So they’re able to go in and make a smart purchase and know, hey, this is likely going to work out pretty well over a five or seven year time period. Would you agree with that?

[00:14:51] Ted Seides: Yeah, there’s a behavioral piece that happens when you lock up your capital for a long time. And we know this from the public markets, right? You look at the returns of say, a mutual fund time weighted returns and the experience of investors in those funds. And there’s this huge gap in this, the time weighted and the dollar weighted return.

[00:15:08] Ted Seides: Well, those normalize in the private markets because you don’t have an option to get out. And when you get into the institutional markets, there are layers and layers of that. Right? So you start with the private equity manager, they buy a business that’s illiquid. They can’t change their mind and get out.

[00:15:24] Ted Seides: You know, if something goes wrong the next week, they have to try to get in there and fix it. The limited partner that commits to the fund, if the fund isn’t going well for a period of time, even a couple of years, they can’t exit. They have to wait. And then that limited partner typically has a board who would, might respond to a weak period of performance of a public market manager, but they can’t do anything about it in the private markets.

[00:15:42] Ted Seides: So all of our behavioral hardwiring that costs us to chase performance and make suboptimal decisions when we’re in a period of fear all gets thrown out. And I do think that contributes to the long term experience, the positive experience of investors in private equity funds compared to some of the public markets, just because of all of the behavioral issues that we all have as investors get taken out of the equation.

[00:16:08] Clay Finck: So are these LPs, are they getting quarterly and annual updates generally, but these assets aren’t marked to market, so they don’t know the exact value of their overall performance. What type of updates do you think they typically are getting?

[00:16:22] Ted Seides: Quarterly or more frequently if they have communications with the GP, if there’s a reason to, but there are quarterly reports that come out.

[00:16:28] Ted Seides: Those reports regularly indicate updates on the performance of the companies. That may or may not include a new mark or a new significant mark. It does matter for different layers of compensation, but ultimately, as an investor, you’re allocating capital, private equity firms buying a business and selling a business.

[00:16:50] Ted Seides: They’re not taking an incentive fee along the way, the way, say, a hedge fund would. They only get their carry after they sell their businesses. So there are some things that happen in marks that do matter along the way because these pools of capital have to spend every year. But for the most part, it’s an interesting question of like, what’s a better way to mark assets.

[00:17:09] Ted Seides: There’s two different ways, the public markets is priced on what somebody else is willing to pay every second. And in the private markets, it’s based on what does someone think the intrinsic value is worth? Those are two different methodologies. You could do one, you could do intrinsic value in the public markets and every different investor would have a different valuation for Coca Cola every day.

[00:17:26] Ted Seides: But that’s not how it works in the private markets. So you can get very frequent updates of the performance of the companies. And then for the most part, the marks are slow. They’re slow moving on the upside. If public markets are doing well, they’re slow moving on the downside. If public markets sell off.

[00:17:42] Ted Seides: And over time, the data would show you that generally speaking, private marks of private equity firms are held at a discount to public market comps. And that’s almost always the case. So they might buy at a discount and then hold it where they have purchased it. And then when they sell it, they might sell it at a discount or if it goes on IPO, it becomes the public market valuation.

[00:18:03] Clay Finck: I mentioned at the top that some people. Of course, I’ve painted private equity in a bad light. There’s been a number of books written that I’ve seen that have been published over the years. And some of these private equity firms kind of get a reputation of buying these businesses, gutting them, letting go of a bunch of employees to of course, optimize for profits, at least in the near term.

[00:18:24] Clay Finck: What’s your take on the bad reputation that private equity has received in recent years?

[00:18:30] Ted Seides: I would even say recent years, the private equity reputation has been horrible for a long, long time. And so we should say a private equity can encompass a lot of things, but the case studies I’m writing about in this book, it’s not the venture capital end of things.

[00:18:41] Ted Seides: So you’re really talking about the established businesses, buyouts, leverage buyouts, and turnarounds. You know, it’s hard to know exactly why the reputation for private equity has been so bad for so long. I lived through it on the hedge fund side. And some of it has to do with regulation, where you really couldn’t talk about what you’re doing publicly up until recently.

[00:19:00] Ted Seides: Some of it is that the firms had a good thing going and they didn’t really want to share what they were doing, particularly broadly. And so there wasn’t really a reason for a lot of the managers to pound their chest. So instead, what you read about in the news tend to be outliers. It’s always the case.

[00:19:16] Ted Seides: It’s news. It has to be new. And that might be something that goes really, really well or something that goes quite poorly. And private equity today encompasses 10,000 businesses across every industry. Guaranteed, all these stories are correct. Like, there are bad actors, for sure. There are businesses where a private equity firm bought it, took out a big dividend, and then for whatever reason, the business went bad and went under and people lost their jobs.

[00:19:40] Ted Seides: Absolutely. There are businesses where a private equity firm goes in and thinks it’s run incredibly inefficiently and slashed costs and people lose their jobs. A hundred percent. Those things happen. It also happens in the public markets. It also happens in privately owned family businesses that nobody reads about.

[00:19:56] Ted Seides: And it’s probably a tiny percentage of the 10,000 businesses that are owned. So it is a story, but it is far from the story. And in fact, if you put data on it, in aggregate, private equity has been a huge job creator. Much of the returns have been driven more by growth than by cost cuts. And so, it’s not that these stories are wrong.

[00:20:21] Ted Seides: In fact, I had Brendan Ballou on my podcast, who wrote Plunderers, one of the books about it, last year. And you would not have thought when you talk to him about his thesis for his book that he thinks private equity is a bad thing. He just makes the case that these GPs should be more legally accountable than they are for the outcomes of the companies.

[00:20:38] Ted Seides: So then you say to him, okay. Is that any different from a public company CEO or a privately held company? He says, no, no, it’s not any different. So why are you poking fun of private equity? I don’t know. So he wasn’t as nearly as negative as the title of his book seemed to indicate. And I think for the most part, that’s why I put this book together because most of the people that aren’t in that inner circle, that if you’re not an institutional investor, allocating capital to private markets.

[00:21:02] Ted Seides: If you’re not a private equity manager, you don’t really know for the most part what happens in these deals. You just hear about a story here and there that tends to be a truthful, sensationalized version of like what really happens in the core of the business.

[00:21:16] Clay Finck: A lot of people aren’t going to be diving into a lot of these details of 10,000 different businesses.

[00:21:21] Clay Finck: They want a story and they want a narrative. And sometimes people just want an actor that they can point fingers at. And that’s where private equity comes into play there. Let’s talk about the geographical sort of breakdown. Is private equity more prevalent in the U. S. than other developed countries? And if so, why is that the case?

[00:21:40] Ted Seides: It’s certainly a global business, but it’s far more activity in the U. S. than internationally. And there’s a bunch of reasons for that. One is the historical nature of just the banking systems and the capital that you’ve had in the U. S. far more than say in Asia and more than Europe, just access to credit, access to creative financing markets.

[00:22:02] Ted Seides: And then you’ve had the capital on the equity side be more dominated by U. S. institutions. So both the equity and debt availability, you know, that’s one. There’s also an attitude, a cultural attitude towards debt and risk taking that is much more comfortable in the U. S. certainly than in Europe and to some extent in Asia.

[00:22:22] Ted Seides: There’s regulatory issues, right? It’s just much easier to do mergers in the U. S. historically than Europe. You have labor issues, particularly say in much of Europe and many different countries where it’s just hard to make changes if you feel like it’s the right thing to do. So it’s just easier to conduct capitalist activities in the U. S. And then there’s some minor things like for a leverage buyout in the U. S. Historically, it’s changed somewhat, but interest was tax deductible and that wasn’t the case in other countries. So you have sort of an efficiency in cashflow. That you get in the U. S. That you wouldn’t elsewhere. So there’s a whole bunch of reasons why the U. S. has been a much better playground for leverage buyouts in particular than, than Europe and Asia.

[00:23:06] Clay Finck: Man, that’s interesting. Interest is tax deductible in the U. S. So another aspect that I find that’s quite interesting is that private equity has an impact on public markets. For example, say you have a small cap in the public market that’s just getting hammered and it starts trading down. And it starts to get to a level where maybe private equity would start to get interested just because the valuation is so attractive, then public equity investors might step in and start pushing the price up.

[00:23:35] Clay Finck: So in a sense, it can make public markets more efficient. Curious to get your thoughts on that.

[00:23:41] Ted Seides: I think that’s absolutely right. I mean, maybe the best comparable is to look at U. S. small cap land versus Japan over the last 30 years. Maybe that’s changing in Japan. It feels like it is. But for a long time, you had all these value traps in Japan because there was no way to unlock the value.

[00:23:59] Ted Seides: And so you can have cheap companies in the U. S., but for sure, there’s the potential that something could happen. Doesn’t mean it will. Doesn’t mean things don’t trade cheap from time to time. But by and large, if you looked across the universe of companies in Japan, you have all these companies that traded at discount to book value with tons of cash on their balance sheet.

[00:24:19] Ted Seides: But it’s been really, really hard. To do a public to private buyout in Japan, you don’t have that same kind of issue in the US. So yeah, I think that the presence of private equity certainly brings some rationality to public market prices for sure.

[00:24:34] Clay Finck: And one of the interesting things I also read in your book is how important pricing is in a private equity deal.

[00:24:42] Clay Finck: I would think that price is one of the most important things, if not the most important thing to a lot of these sellers. But you think about people who build their own company. They tend to value it much more than anyone else because, you know, they’ve poured their heart and soul into this. Based on your research, where does pricing land in the list of priorities for sellers and what tends to sit above price, if anything, in terms of importance?

[00:25:08] Ted Seides: Well, there’s a bunch of different perspectives. Mario Giannini has this great line where he says of the top 10 criteria, what drives private equity returns price is number 11. And the reason for that is if you hold the business long enough, your returns will be generated by the economics of the business.

[00:25:22] Ted Seides: It’s the weighing machine and not the voting machine. So yeah, price does matter for sure. And as a driver of returns, but it’s not the most important driver on the margin you can get to extremes. And that’s when price really does matter for a seller. It really depends on their motivation. You have some sellers that absolutely want out and just care about the highest price.

[00:25:43] Ted Seides: You have others say of a family owned business that really care about the legacy of the business and they care very deeply about who the buyer and the steward of that business is going forward. And it also depends on size, right? So the, if it’s a public company selling a division, they almost have a fiduciary duty to run a process and try to drive the highest price.

[00:26:00] Ted Seides: Even if they have a favored person to sell it to, and they’d rather sell it at a discount, they have to go to a board and make a case why that’s the best bid. So it really depends on the situation for the seller. Price is a very important component of the transaction for sure.

[00:26:17] Clay Finck: If I was in a private equity seat, I would say one of the most important things that’s happened over the past couple of years is interest rates have ticked up over a long stretch of.

[00:26:26] Clay Finck: Very low interest rates. How has this impacted the market just based on what you’ve seen?

[00:26:32] Ted Seides: Well, it’s been very quiet the last two years for a whole host of reasons, but a big one is people need to see what the increase in rates does for where clearing prices end up for some of these assets, right? Rates actually aren’t that high.

[00:26:48] Ted Seides: They are relative to where they’ve been. But you know, when I started my career, short term rates were 6, 7%, and nobody thought of that as high. That was normal. So many of the businesses, depending on the degree of leverage, can operate just fine in a higher interest rate environment. But if you run a DCF and your cost of capital is higher, right, the valuation comes down.

[00:27:08] Ted Seides: So one of the things that’s happened is there hasn’t been as much deal activity the last two years. As people try to figure out, like, what is the clearing price for an asset? Certainly a buyer wants to see that rates are up. Therefore, we can buy something on the cheap, but the seller might say, well, we’re just going to ride this out a couple of like, we have a price we want to get to, and we’re going to ride it out for a couple of years and let the company grow into that price.

[00:27:29] Ted Seides: So you’ve had a much quieter deal environment as a result of that.

[00:27:33] Clay Finck: You mentioning that a number of times throughout this conversation, I’m just reminded of the real estate market. All these real estate companies, they can go in and buy a property and do whatever they want to it and add value that way.

[00:27:44] Clay Finck: And then you just mentioned the seller piece, so many residential homes, for example, they’re just sitting on it because they have a two or three percent mortgage and they’re not going to do anything because their cost of owning a home goes up significantly if they go and move somewhere else.

[00:27:57] Ted Seides: Yeah, I don’t think it’s not as significant of a factor in most businesses than it is, say a single family home where they’re not renting it.

[00:28:05] Ted Seides: There’s no rental income. There are no other levers to drive value. There isn’t growth in the, you know, they’re not renting it out and renting it at higher prices. So it’s just price, which is directly influenced by rates, but it is a factor.

[00:28:17] Clay Finck: It’s definitely a factor. I did like in your book, how you tied in many of the podcast interviews you’ve done where you interviewed a number of people working in private equity, KKR being one of them, uh, I believe your chapter was titled the perfect private equity deal.

[00:28:31] Clay Finck: So let’s chat a bit about that one. KKR has been a leader in the private equity industry since its founding in 1976. And today they oversee 500 billion in asset center management. In 2015, KKR put together that perfect buyout that you outlined in your book. So talk us through some of the details in this private equity deal.

[00:28:52] Ted Seides: So when I thought of the perfect buyout, right, the concept is, You’re buying the kind of business that everyone would want to own on leverage. So think about a business, you know, the Buffett would say had a wide moat, right? It’s got recession resistance, growing revenue, has great margins, free cashflow generation, all the things that you would want of a business.

[00:29:15] Ted Seides: Maybe it has a great management team. Maybe there’s a management team, a private equity firm can easily install. Maybe the operations are really efficient, or maybe there’s some low hanging fruit. And so you could think about lots of different businesses that anyone would want to own because they’re just incredible businesses.

[00:29:30] Ted Seides: And it turns out that niche garage door manufacturing is one of those. So KKR bought this company called CHI overhead doors, and they make custom garage doors for homes. If you think about your garage door, most garage door transactions happen when someone buys a new home. And that’s somewhat economically sensitive.

[00:29:50] Ted Seides: More of them happen when a garage door breaks. And if your garage door breaks, you’re pretty much replacing it the next day. It doesn’t really matter if the economy is soft. Like you kind of got to get in and out of your house. So it’s been a business that has grown steadily for a long, like probably decades.

[00:30:06] Ted Seides: And this particular company had a niche in making custom doors, very efficient operations. And so it’s the kind of business that you would just want to own, like at high margins, steady growth, recession resistant, generates lots of cash. You’d want to own that forever. Most private equity firms can’t because they have fun lives that are short.

[00:30:27] Ted Seides: And so in a business like this, one of the exits is, well, just another private equity firm will buy it from you. And when you’re selling it, it’s a bigger business and you might get a little multiple expansion. And so I think when KKR bought it, they were the fourth private equity owner. They’re a large firm, so it took the business a while to grow.

[00:30:45] Ted Seides: To be big enough that it fit into their sweet spot or even size, like is one of the smaller deals they’ve done. What was interesting about it is that nothing about that would tell you that it’d be one of the best deals that KKR ever did. Like you’re buying great business, it’s probably going to be a great business when you sell it.

[00:31:01] Ted Seides: But they really specialize in trying to improve the operations of companies. And had a model for their manufacturing business they call Ownership Works. Which, to simplify it, most of the time you buy a business, you incent the management team with equity. And KKR had a model that said they’re going to incent everyone in the manufacturing operation, all the way down to the line worker, and the truck driver, and everybody.

[00:31:24] Ted Seides: And then it’s not just saying we’re going to give you equity, it’s teaching them what it means, it’s treating them as owners, it’s letting them be involved in some of the capital allocation decisions of the business. And in this case, it really worked. And margins improved, the business continued to do better.

[00:31:39] Ted Seides: They weathered through COVID and when it came time to sell the business, KKR had put 250 million into the business. They distributed about 350 million to the employees. More than they even put into the business, they gave to the employees when they sold it and they made a huge multiple of their capital on the exit.

[00:31:59] Ted Seides: So, super successful deal. They ended up selling it to a strategic, but they didn’t sell it to another private equity firm. But you do see these businesses that are so good that anyone would want to own them. And they do from time to time go from private equity firm to private equity firm to private equity firm for just that reason.

[00:32:19] Clay Finck: Yeah, so essentially they were incentivizing employees to deliver the end result that they were wanting within the operations. I made a note here that KKR, they told everyone they’re going to be getting a bonus of at least 15,000. And after it was all said and done, the average ended up being 175,000. So it was a win win for everyone in this situation, certainly.

[00:32:41] Clay Finck: And I have here that they paid out dividends over time. It wasn’t just this thing where they had a promise, like, hey, five years down the line, be getting this big payout. So they showed the employees that they were serious and what they meant. And, you know, they pay out that first dividend and creates this flywheel of incentives.

[00:32:57] Ted Seides: It was a pretty emotional thing to 60 minutes, just did a piece on that deal with Pete Stavros. And you could see him in this piece making the announcement of what they’re giving out to the employees and then in conversations with the employees afterwards. It’s pretty amazing. The impact you get a positive impact you can have, right?

[00:33:17] Ted Seides: Very, very different from what you’re going to read in the headlines about how terrible private equity is. I think all the employees of this company might have a slightly different view of that.

[00:33:25] Clay Finck: So the reason I’m even familiar with KKR is a big name investor, Chuck Akre actually owns in his fund, KKR is a publicly traded company.

[00:33:34] Clay Finck: And I took a look at their share price performance and it’s been a big winner. And what I also noticed is that during the bull markets, it tends to outperform and during the bear markets, it tends to underperform the overall market. And it makes me think, is this just a leveraged equity play? I’m curious to get your thoughts on that.

[00:33:51] Ted Seides: So KKR’s business is a combination of private equity, big credit business, some other businesses. I don’t think it’s necessarily a levered equity play. Like if you think about the economics of how they get paid, there’s a management fee and an incentive fee. Management fee, it’s steady, right? It doesn’t matter.

[00:34:09] Ted Seides: And the incentive fee, I suppose, could come up and down, but by and large, the public markets have never given as much value to the incentive fees as the management fees. So my suspicion is that that’s just how public markets value asset managers. They view it as a levered play on the market. And it’s no different for an alternative asset manager than a traditional incentive fee.

[00:34:27] Clay Finck: Let’s turn to one of the other case studies from your book. Most private equity companies are likely looking for what you just described, a great company with great financials and recession resistant. And it was my surprise to learn that one of Apollo’s best private equity deals was the purchase of Yahoo.

[00:34:46] Clay Finck: They made the purchase in September of 2021. So there’s still some time to see exactly how it plays out for them. Talk more about this deal for our audience.

[00:34:56] Ted Seides: I named that chapter ‘You Bought What?’ For just that reason, Yahoo. So Yahoo historically is just fascinated in the heyday of the. com boom, the Yahoo that Apollo bought is a combination of Yahoo and AOL.

[00:35:11] Ted Seides: And AOL back then bought Time Warner, which was this marquee peak of the bubble merger where this upstart.com bought a traditional media company for something like 180 billion. It didn’t go well, but the combined AOL and Yahoo at the peak were worth 350 billion like 25 years ago. Roll forward and those businesses, you know, com bubble pops, things get valued differently.

[00:35:37] Ted Seides: Verizon bought it in 2017 for 9 billion with the idea of blending the traditional telecom with a much more significant internet presence. They branded it in a business called Oath, and it just didn’t really work for them. And so, you know, they went to spin it out. And a lot of times what happens when the public company is sort of done with a division that isn’t really doing well, they just want to get rid of it.

[00:36:04] Ted Seides: And so, carve outs can be difficult and messy and have nasty processes, but like who would want to buy Yahoo? Like this is not the leader, right? It’s not one of the mag seven and Apollo. There are a lot of different levers. We talked about the private equity firms can drive value and Apollo is kind of known for being value investors.

[00:36:24] Ted Seides: So they will absolutely try to make all the improvements that they can on a business, but they really try to create a lot of value for the purchase. And they ended up buying Yahoo for 5 billion, and they financed it with 2 billion of equity and 3 billion of debt. And this was cheap debt, so this was pre rates going up.

[00:36:43] Ted Seides: And at the time Yahoo was a bunch of things. It was the Yahoo. So think about all the internet pages, that homepage, mail, sports, finance, like 900 million monthly active users. So still a very popular website. Didn’t make a whole lot of money, but very popular website. AOL is no longer the you’ve got mail from the old AOL dial up service, but there’s an ISP service in AOL.

[00:37:05] Ted Seides: They owned Yahoo Japan and they own this massively growing. ad tech business that was really like, people weren’t sure what to do with it. It was growing and very popular, losing money. And what Apollo did was in the first 18 months, they had spun out Yahoo Japan, and they sold this ad tech business that had been losing money for a pretty significant amount of money.

[00:37:29] Ted Seides: And they returned the 2 billion they paid within 18 months. So what they’re left with is a profitable. I think making about the high hundreds of millions of dollars of the Yahoo internet portals and this legacy AOL business. And it was, let’s say it was making a billion dollars, which they paid nothing for, and then they had a plan, which they’re executing, which is okay.

[00:37:53] Ted Seides: How can you take 900 million monthly active users and turn that into a profitable business? And he said, okay, what if you really focused on sports? Could you bring gambling into Yahoo Sports? Could you bring, you know, I’m just making up all these things in finance. Could you put stock trading into the finance?

[00:38:08] Ted Seides: All these different things that hadn’t been done, thinking about each of those very popular portals as a business. And we’ll see what happens with that. The interesting part of it is nobody else wanted to touch this asset. And if you had said to somebody, oh, all you have to do is sell these businesses and you get all your equity back in 18 months and you’ll own this thing for free, anyone would have done it.

[00:38:28] Ted Seides: But nobody had the foresight to do it. And they executed incredibly well because even they got more value for the assets that they sold than they had anticipated. So like you said, most of the deals in the book are still active deals. There are one or two that are full cycle and this is one of them. So, you know, we’ll see what happens over the next couple of years, but it certainly looks poised to be one of Apollo’s very best deals ever.

[00:38:52] Clay Finck: Yeah, I mean, in Yahoo, in the year 2000, it was the most visited site on the internet. And then for ever since then, it’s just been a business that’s been in a decline. And when it gets plugged into one of these conglomerates like Verizon, not a surprise that it sort of gets neglected. So that’s where the superior form of capitalism can come in private equity and give it the proper attention and allocate capital more efficiently and make the most of some of these assets that Yahoo had under their umbrella.

[00:39:21] Ted Seides: Yeah, I mean, you know, there’s another part of it that Apollo is being very involved in, which is you have these assets that are remaining that have value, but you also have a business that’s been dying for 20 years. So you have to really think about like, how do you get, who wants to go work at Yahoo?

[00:39:38] Ted Seides: Yahoo hasn’t been named as one of the leading AI companies, right? How are you going to attract talent? And that really comes from being able to recruit top motivating management team with a new game plan and they’ve done that that’s not something you can just do say, oh, we’re just going to take this asset and strip it of other things and we’ll see what happens like you really have to get the right leaders in place to drive value because it all starts with the people so far.

[00:40:02] Ted Seides: They’ve done a great job of that.

[00:40:04] Clay Finck: Yeah I recently had an interview with as what to motor and he had a book come out titled The Corporate Life Cycle and he claimed one of the biggest mistakes for a declining company is trying to look young again. So BlackBerry for example, they threw billions of dollars in shareholder value down the drain not to be realized because they were chasing investments with no returns And you do make a great point that Yahoo’s competing with Alphabet.

[00:40:27] Clay Finck: Like, they’re gonna have trouble attracting talent relative to that. So it’s certainly a challenge. One question I also had come to mind for this deal is, Apollo ended up paying five times EBITDA to Verizon for Yahoo. And it almost sounds like a poor deal for Verizon shareholders. Do you think this was actually value destructive for Verizon, you know, to the benefit of Apollo just due to that purchase price?

[00:40:52] Clay Finck: Or is that sort of run of the mill type deal?

[00:40:56] Ted Seides: I mean, yes and no. I think it’s important to know that Verizon rolled into the deal with Apollo. So whatever changes in economics Apollo is driving, Verizon is getting piece of that. And so I think you’d have to ask the question, what was their alternative and could they have done that on their own?

[00:41:09] Ted Seides: The business is a thorn in their side, a rounding error. They were not going to dedicate the resources to it. They didn’t have the financial creativity to figure out what to keep and what to sell and how to drive a new business. So my hunch is that net net, it was probably a very positive outcome for Verizon because even if they sold the assets that look cheap in retrospect, it’s not at all clear that they could have delivered that value on their own.

[00:41:32] Ted Seides: In fact, it’s highly likely they couldn’t have.

[00:41:34] Clay Finck: Yeah, totally makes sense. I wanted to cover one more deal from your book. That was the chapter titled The Tiger Woods Pinata. So that’s tailor made golf brand. It’s purchased by KPS Partners. I’ll throw it over to you to touch on this one.

[00:41:50] Ted Seides: It was an interesting combination, right?

[00:41:52] Ted Seides: So CHI is this great business. Yahoo is probably like a, not a great business, but certainly an orphan business. TaylorMade is a great brand, right? For those who play golf, it’s like one of the top, say, four golf brands, had a really interesting history. It’s been around for well over 50 years, prior 20 years it was owned by Adidas.

[00:42:11] Ted Seides: And it had a real heyday when Tiger Woods was popular, golf really exploded. After that, so say starting about 10 years ago, that demand started softening. And what happens with the division inside a corporation is they bulk up, they project linearly that growth is going to continue. They have all these manufacturing facilities, they have all these people, and they start losing money.

[00:42:34] Ted Seides: And so the entire industry was soft, you come to around 2015, there are two golf retailers, golf Smith and sports authority, which was a lot of sports, but had significant golf. They both went bankrupt. Nike announced they were exiting the golf equipment business and Adidas decided they were going to get rid of this, you know, thorn in their side at that time.

[00:42:55] Ted Seides: So you had a business that had done a billion dollars of revenue. It was down to 600 million and had been making a good bit of money. It was now losing 200 million a year. So losing 200 million a year, and then they put it on the blocks to sell it. So they give it to bankers and bankers don’t know what they’re selling.

[00:43:12] Ted Seides: Like, oh, this is a great golf brand, or, oh, this is a distressed turnaround, or this is an equipment manufacturer and everybody loves golf. So we’re going to sell it to a Japan buyer, a Korean buyer. They literally sell it to everybody who they show that steel to anyone who will take a look and people look at it and they don’t know what to make of it.

[00:43:29] Ted Seides: Like it’s this money losing business. That’s not what most private equity firms do. So the auction goes nowhere. KPS is a really a turnaround shop that focuses only on manufacturing businesses. And so they saw it. Dave Shapiro, who’s the S in KPS, like he’s a golfer and he’s like, yeah, I’ll learn about golf.

[00:43:47] Ted Seides: He said some deals are more fun than others to look at. And they looked at it and they went, you know, okay. And what they saw was this is, this had a number of problems. But one is this is a manufacturing business. So they manufacture golf clubs. And there were some real problems in the way they were doing their manufacturing.

[00:44:03] Ted Seides: And there were some real problems in their supply chain. And there were some real problems in how they marketed this thing. So these guys hung around the hoop. And this process just lingered on and on and on. And KPS bought it in 2017. There was nobody left. Nobody else cared. They were the last buyer.

[00:44:21] Ted Seides: They ended up buying it roughly for the working capital of the business. And when you carve out a company, so corporate carve out is super complicated. So think about this. Adidas has 500 contracts with athletes that are somehow tied into tailor made. Every single one of those has to be changed to the new owner.

[00:44:41] Ted Seides: You have to work through every single one of those contracts. If you’re manufacturing something, who owns the facility? Who owns the distribution? Right. There are hundreds of these agreements that have to be worked out. And so what happens is when a buyer comes in to carve out a business, they have what’s called transition services agreement, and it’s not like say Apollo buys Yahoo and the day they buy it, yeah, Verizon is going to roll over part of it, but Apollo owns it and that’s it.

[00:45:05] Ted Seides: When you carve out a business, you have to live with the seller for a while because you have to work through these. You can’t just do all 500 different agreements on the same day. So KPS buys this. You can’t get financing from money losing business. So forget about leverage buyouts. You can’t get leverage.

[00:45:20] Ted Seides: No one’s going to lend to a business that loses money. So they got a seller note for a hundred million dollars. They gave Adidas an earn out and they paid 175 million. Now, one of the things that happened was Adidas had brought in, they brought back someone to run the division who had been inside the company during those two years, and he had started to make improvements.

[00:45:39] Ted Seides: So by the time KPS closed, it was only losing 50 million bucks. We’re still losing money and sales were down. And then they ran their playbook. So their playbook is manufacturing excellence. They looked at the supply chain and they saw that there were significant inefficiencies. Yes. And how they were manufacturing the products and how really it was integrated with the sales team.

[00:46:00] Ted Seides: So sales team or the product development team would come up with a club and then they’d send it over to get manufactured and they’d manufacture and they said, well, before you do that, why don’t you figure out, talk to the manufacturing team, see how much they think it’s going to cost. Like some really common sense things, like let’s be a team together.

[00:46:15] Ted Seides: So they fixed that. One of the other cool things about the business that’s fun to talk about is every year, TaylorMade would come out with a new driver, let’s say, new golf club. And as their revenues were softening, they said, well, we’ll just going to make up for this with volume. So every year they would give you a new driver for 20 years, they’d give you a new driver and say, it’s going to drive seven yards further.

[00:46:36] Ted Seides: You start doing the math on this and we all should be able to drive the ball like a mile. It just doesn’t work. So people realize it doesn’t work. They also know, hey, when a new driver’s coming, they’re going to discount that last one 50%. I’m not going to buy the new one. I’m just going to wait until the other one goes on discount.

[00:46:52] Ted Seides: So they had a real pricing problem because they were accelerating the new club over and over and over again. And they conditioned the customer to just wait and get it at a discount. So there were certain things they could fix. They also looked at the marketing spend. So, for a long time, TaylorMade had said, we just want to be everywhere.

[00:47:08] Ted Seides: And they had contracts with 500 golfers. There was no rhyme or reason to the value they were getting from it. And Capia said, we don’t have to be with the best golfer. Let’s just look at who has big social media followings. Those are the people pay attention to, let’s do the contracts with those guys. And that’s what they did.

[00:47:25] Ted Seides: So they completely turned around the business. They only owned it for four years. And it went from losing say 200 million before to making 200 million. And then they sold it to another private equity firm in Korea at a huge multiple. They made eight and a half times their money. One of the fun little stories and why we call it the Tiger Woods Pinata is when Dave and the team at KPS looked at their marketing budget, right?

[00:47:48] Ted Seides: They’re used to manufacturing products. You don’t have huge marketing spends, but in a consumer facing product like this, you have a big marketing spend. So every time they looked at it, they were like, we have to be able to cut this. We have to be able to, and the CEO said, man, every time we talk about marketing, it’s like, you’re whacking me with a pinata.

[00:48:04] Ted Seides: And when they closed the deal, they gave them a, like a tailor made mascot pinata filled with golf tees that Dave has in his office. So really cool story about a product we know, right? Golf clubs. And just really interesting to see how a corporate owner completely screwed it up and a private equity firm was able to fix it.

[00:48:23] Clay Finck: I mean, it’s just a reminder that so much of investing can just be common sense as cheesy as it might sound. And sometimes you just need a new team or a new leader who’s an outsider to just come in and start making actual changes rather than just falling under this bureaucracy of doing what we’ve always done.

[00:48:40] Clay Finck: So for example, the golf ball business, Taylor made this great brand. The golf balls, they were like 3 percent of the market, but Titleist with their Pro V1 have like 50 percent of the market. What can we do on our marketing side? What are we doing wrong? Not selling golf balls, you know, just seems like these simple things that just takes a new leader to make these adjustments.

[00:49:00] Ted Seides: There are a lot of examples in private equity of just that. Common sense isn’t common practice. And whether it’s carving out a division of a big corporate conglomerate that no one’s paying attention to it and really focusing on it, or buying a family owned business that’s been run by a family that may not really understand best practices.

[00:49:18] Ted Seides: There are so many ways that good private equity firms are able to add value and create value for these companies.

[00:49:24] Clay Finck: Shifting gears here once more, I think many people in the audience are probably wondering if they should be allocated to private equity for their own portfolio. What types of investors do you think should seriously consider an allocation to private equity?

[00:49:40] Ted Seides: Yeah, it’s a really interesting question because One of the waves of capital inflows to these strategies is becoming what’s called the mass affluent right now. And you have a lot of the bigger shops, particularly the public companies, say Blackstone, trying to find ways to create a product that works for an individual as opposed to an institution.

[00:50:00] Ted Seides: Certainly by design, they’re less liquid strategies. And so even though you’re seeing things like interval funds and ways of participating, to really get the bang for your buck, you have to have some tolerance for long term illiquidity. And unless people have that, it doesn’t make a whole lot of sense to pay attention.

[00:50:18] Ted Seides: So you’ve seen much more of the activity in the institutional market because there’s plenty of excess assets that don’t need to be liquid. I think we’ll see what happens. It’s hard for an individual to parse through the many, many funds, even let alone deals in the private equity space to have a really good sense of where they’d want to allocate to.

[00:50:38] Ted Seides: And so sometimes you see that capital just going to brands, which is okay. Blackstone’s done a remarkably good job. KKR has done really, really well. So the larger firms are where you’ve seen more of the individual dollars flowing. And you know, those generally have been very strong, safe hands.

[00:50:56] Ted Seides: They’re not easy to access for individuals. And that’s where you’re seeing some of this product innovation come. And I don’t think there’s a structure yet that’s kind of settled in beyond the original LPGP private partnership structure that’s been widely adopted. But there are a lot of people with a vested interest in making that happen.

[00:51:15] Ted Seides: So we’ll see over the next couple of years how that plays out.

[00:51:18] Clay Finck: Only answer this if you see fit, but I’m sure many in the audience are wondering if a private equity strategy fits into your portfolio.

[00:51:25] Ted Seides: Well, it does. I mean, I’m a big believer and unfortunately I have some assets that I don’t necessarily need liquidity on.

[00:51:31] Ted Seides: So I probably have half my assets in private strategies. Most of that are in funds because that’s my sweet spot or co invests alongside managers that I’m invested in. And yeah, a reasonable amount of that is in private equity.

[00:51:45] Clay Finck: You’ve had just an amazing career. And with the podcast, you’ve been connected with so many different types of individuals within the investment space.

[00:51:54] Clay Finck: If you were to restart your career today at age 22, what career path within the investment industry would you pursue? And why?

[00:52:03] Ted Seides: I mean, I think that you have to be paying attention to technology. And so I don’t know what that translates to in terms of like, what strategy should you pursue? Because to me, that is more personal.

[00:52:15] Ted Seides: In the sense that the activities that someone does, if you’re doing research on a public stock, is reading, talking to people, it tend to be truthfully like an introvert’s dream. And private equity is deals. It’s almost like you’re a general contractor. You know, you’re working with people all the time, different personality type, right?

[00:52:35] Ted Seides: So you don’t see a lot of deep, deep introverts gravitating to private equity. as a simple lens, but there’s a lot of different lenses that would match who you are to what type of investing you might want to do. So those are the two ways I would look at it. One is like, who are you and what fits that day to day function of what you’re doing?

[00:52:54] Ted Seides: Where does that fit best? If you look at it from the outside view, private equity will not in the same way, and hedge funds, I would say, will not have, say, the compensation over the next 20 years that it did the last 20, right? It’s just a very different industry structure. It’s much more mature than it was.

[00:53:11] Ted Seides: And so if people really want to look at how can they extract value, you know, hopefully they’re creating a lot and they’re extracting a small portion of that. What we’re seeing in AI is the very beginning of something that’s going to revolutionize everything. And if I were starting over, like, that’s what I would want to be paying attention to.

[00:53:28] Ted Seides: Now, how you participate in that can really tie into who you are, but that’s kind of clearly the area of change that’s going to be incredibly important for the next generation.

[00:53:38] Clay Finck: You mentioned that the benefits to these private equity managers is going to be less in the coming years. Is that just a result of lower fees or what are some of the other factors there that makes you say that?

[00:53:50] Ted Seides: It’s a couple of things. So I think private equity will continue to grow, but the structure of the industry is effectively formed, right? You have a small number of kind of mega funds and they are raising more and more of that incremental capital because it’s coming from say individuals who are looking for the brand.

[00:54:07] Ted Seides: And it’s the same thing in hedge funds, right? You’ve seen a high concentration, increasingly high concentration of the assets going into the largest funds. It just means it’s harder to crack in, right? It’s a mature industry. If you were trying to create, you know, a soda beverage company, like it can happen.

[00:54:22] Ted Seides: But generally speaking, you’re going to have a hard time becoming Coke or Pepsi. And so when people think about like, I want to become the next Blackstone, it’s like, I’m not sure there’s going to be a next Blackstone. Like I think Blackstone is going to be the next Blackstone. So it’s not that somebody can’t have a really lucrative career.

[00:54:34] Ted Seides: It’s just when I started in the business, it wasn’t even a thing. Like I went to business school in 1999, almost nobody had even heard of private equity or hedge funds. And so it’s not at the forefront of what will happen. If people ask Howard Marks, like what career advice would they give, you know, if they wanted to have a career like his, and his first piece of advice is start 40 years ago.

[00:54:54] Ted Seides: So the question is like, what will be that driver for the next 30 or 40 years? And it may well be people can have great success within these industries, but I don’t think you’re going to see the next great wave of businesses created, like the next wave of great new private equity funds or wave of new hedge funds created over the next say decade or two.

[00:55:14] Clay Finck: That makes sense. Well, Ted, I’d like to give you the final handoff here. Thanks so much for joining me. I really enjoyed your book and walking through some of these super interesting case studies of private equity deals that, you know, it’s definitely something new to me. Please let the audience know how they could get in touch with you, learn more about you, and any other resources you’d like to share here.

[00:55:35] Ted Seides: Well, thanks, Clay, and thanks again for having me on. It’s so fun to be in front of the incredible audience you guys have created. Everything’s housed under our website, which is just capitalallocators. com. We post all our stuff to Twitter and LinkedIn. I think those are both under my Ted Seides on Twitter and Ted Seides on LinkedIn or X now, I guess it is. And that’s probably the best way to get in touch. You know, there’s content and some events that we do a whole bunch of different stuff.

[00:55:58] Clay Finck: Well, thanks again, Ted. I really appreciate it and hope we can do it again someday.

[00:56:04] Ted Seides: Thanks Clay.

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