Business Breakdowns
· Matt Reustle, Hunter Hopcroft
[00:00:00] S0: Yeah, it's really interesting to think through. It might just have to do with market dynamics. But is there any reason why they wouldn't just be in-house? You might be able to explain where the fee structure and that type of relationship is more beneficial than just housing it on the balance sheet. But is there anything that immediately stands out as to why the relationship is better in that form than being in-house? [00:00:00] S1: Right, so let's say it was all in-house. You would have your 90% of investment grade, and you'd have your 10% that dropped down. So basically, for every hundred dollars of insurance assets you bought, you would get $10 of equity to do your alternative manager strategies, to do LBOs or private credit—whatever you were doing. But what Rowan has decided is he's going to take that $10 and have these platforms use it; he's going to use $5 to put into an origination platform and raise another $5 of outside capital. And now that $5 is receiving GP economics—or a sort of private equity structure—on the returns and carry from that originator. And whereas something housed entirely on the balance sheet, you buy $100 of insurance assets, you get $10 of equity. Rowan has figured out a way to buy $100 of insurance assets and turn it into more like $30 of equity by running it through this private equity structure. They get fees and carry on the origination platforms that he's seeding. [00:00:00] S0: Yes, I think we have arrived again at the theme of complexity and finding creative ways to generate returns.
· Matt Reustle, Hunter Hopcroft
[00:00:00] S0: Yes, I think we have arrived again at the theme of complexity and finding creative ways to generate returns. [00:00:00] S1: That's really the tip of the iceberg, because there's a whole other level of financial engineering that's going into these balance sheets too. If we think of the traditional private equity structure, LP Capital is really a form of leverage. In some sense, it's equity, but it's leverage for the GP in that they're participating disproportionately in the upside over certain hurdles. And through very complicated structures, Rowan is taking this $10 of equity that's dropping out of insurance assets he's buying and using it as their GP stake on all of these other origination platforms that can generate private equity–like returns. [00:00:00] S0: Yep, that makes sense. And I guess just on that point you mentioned, it is essentially a form of leverage in many ways. It's a form of liability in the sense that when a fund is retired, when it reaches the end, that capital theoretically goes back to the investors. And Apollo keeps some percentage based on the return profile and the fees that they earned.
· Matt Reustle, Hunter Hopcroft
[00:00:00] S0: Yep, that makes sense. And I guess just on that point you mentioned, it is essentially a form of leverage in many ways. It's a form of liability in the sense that when a fund is retired, when it reaches the end, that capital theoretically goes back to the investors. And Apollo keeps some percentage based on the return profile and the fees that they earned. [00:00:00] S1: I've likened this—and people will certainly push back on it—but private equity is a way of bootstrapping a call option. Let's say that you're getting 20% of the returns above 8%. That is effectively a call option that's 8% out of the money. So LP Capital is a very special form of leverage where the GP benefits if it works out, but it has very little risk if it doesn't, and by Rowan layering on an insurance balance sheet on top of this, which has really long-duration, low-cost capital, you start to see the wisdom of what he's building here.
· Hunter Hopcroft, Matt Reustle
[00:00:00] S1: I've likened this—and people will certainly push back on it—but private equity is a way of bootstrapping a call option. Let's say that you're getting 20% of the returns above 8%. That is effectively a call option that's 8% out of the money. So LP Capital is a very special form of leverage where the GP benefits if it works out, but it has very little risk if it doesn't, and by Rowan layering on an insurance balance sheet on top of this, which has really long-duration, low-cost capital, you start to see the wisdom of what he's building here. [00:00:00] S0: How much does the duration play into this? I think it's something that is certainly a theme in the markets right now, whether it's in venture or in private equity. You have funds that reach the 10-year mark, 12-year mark—you get all of your extensions in, and they have these prized assets that might be sitting there, but the market multiple, the IPO, is not that attractive. They end up selling at some discount to some public peer that trades at a significantly higher multiple. And it feels like it's leaving crumbs on the table in terms of the return profile. This is getting brought up a lot where you'll need to see things trade hands. Do you think that plays much of a role just in terms of that theme today, or is this a much bigger evolution for the business beyond that?
· Hunter Hopcroft
[00:00:00] S1: Well, I think as you see Marc Rowan's public profile increase, especially in his recent interviews and the way he speaks at conferences, he's really proselytizing this idea of private and public markets converging. He really focuses on liquidity. And again, it goes back to that original quote about the early days at Drexel of understanding the trade-off between risk, liquidity, and credit. Rowan's argument is basically, if you're a retiree or a future retiree who is 20 to 30 years from retiring, if you are a pension or an endowment that doesn't need money until long in the future, why are you so concerned about having daily liquidity? And Rowan's vision is really to see these public and private assets converge and that wall between the two come down. That's getting very literal here—in the past two weeks or so, Apollo and State Street have launched a private credit ETF which holds some listed credit and some private credit. So Rowan is at least walking the walk in terms of trying to make a case for this private and public divide coming down to decondition investors from expecting daily liquidity. And the way he set up Apollo today really speaks to that.
· Matt Reustle
[00:00:00] S0: Yeah, he's a great spokesperson for the private markets. I heard him in an interview mention that 80% of companies generating over 100 million in revenue are private. And I don't know that you can really take that 80% and apply it to the size of the market because there's a certain scale factor of the biggest companies in the world. But he brings up some strong points just in terms of the evolution of where these businesses can operate and be a hybrid of the two. But you also see them making announcements like having a private credit trading desk, which implies liquidity is something on their mind, I would imagine.