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Our next guest says that highly leveraged software default rates could hit fifteen percent in private credit. Joining us now is Bruce Richards. He's the chairman and CEO of Marathon Asset Management. And you've just put out a link LinkedIn post this morning. Danny and I were reading it before the program, likening what happened in energy in twenty sixteen, twenty seventeen, twenty eighteen to what we're looking at it
in software now. Is it fair to compare those two industries, because I think Scott was saying, hey, there's a different ball of wax here.
It is a bit different ball of wax.
And Scott's right to say there's no comparison between the industries.
Well, let me explain why I come to that parallel.
So back in twenty fourteen, a new technological change happened for oil and guts is called horizontal drilling or fracking. And that technological chan change to the couple of things. Number one, it changed the pricing structure for how oil and gas and oil gas services would work. And number two, based upon all the capital that was raised, now, all of a sudden capital dried off because the pricing structure collapsed, and so what we have in software is very similar.
We have a technological change which is forever going to change how software is going to be priced, and that we should think about that industry and based upon that technological change, and how much leverage is in the broadlys medicated low market and then more importantly in the direct lending market leveraging up these software companies, the capitals now drying off. And so what did we see as a
result of that technological change in oil and gas? We saw a fifteen percent of fault rate in the subsequent
years twenty sixteen and twenty seventeen. So for me to say that software, which is the biggest sector within the direct lending business, couldn't get to a fifteen percent default rate, I think is actually missing the mark because I think that's exactly what's going to happen in years twenty seven, and it has the chance of happening in twenty seven and twenty eight to have back to back years.
SOLI industries are very different.
There's a lot of similarities because of technology, technology changing how pricing structure works at a time when too much capital has been flooding into the sector.
Just think about this for a second, Matt.
Only one percent of companies in the US to software companies, and only seven percent of all publicly listed companies or software. Yet twenty three percent of the direct lending business is software.
How did we get there?
It was a goal rush to financie software companies in these buyouts.
And the public companies are sitting in good shape because their debt.
When we look at NASDAK SMP Russell two thousand, the debt that these software companies have with really good margins, the debt that they have is only zero point five one turn of leverage, and the quality syndicated loan market, you have five turns of leverage, ten times leverage. Right in the direct lending business, you could have twenty times leverage.
So you don't have the companies that can.
Generate the free cash flow to reposition for AI.
They're in a very tough position.
So Bruce, what is the effect of that. I think a lot of investors are reading your research and starting to wake up to the fact that this could become a reality, and as a result, we're seeing redemptions. You know, people are trying to get out of these ill liquid private credit funds. And what we see some of these companies doing blue Out for example, is Okay, we're gonna sell a ton of these assets.
We're gonna sell these loans.
And they want to be able to say we got, you know, ninety nine percent, we got ninety eight percent.
Of the par value for that.
So they can't be selling those twenty times even to software loans, right, They must be selling their best assets.
So it's I can't speak SEP Well or others of course, not liquidity crisis or requity issue right now in their funds.
It's you know, something I'm not focused on when.
I am focused on is the availability of capital on the back end of this to extend these loans. And I believe that it won't be availability of capital. So I think the next round in the year's twenty seven to twenty eight, when a lot of these loans come due, is in the direct lending business to extend and amend or extend and pretend to pick those loans because it won't have the cash.
Flow payment in kind financing and so, and.
You will be getting you won't get paid back in interest. And because you've extended loans, you also won't be getting paid fast.
So what does that do to an entire industry that is both private credit and private equity that has loved software, that has gotten into twenty three percent. If all of a sudden they can't go to capital markets and they can't get those loans but financing ceases to exist, what does that do to the industry.
I think the industry's fine, because I think direct lending is a big industry, and I think that there are other sectors of the economy. Again, software is only a few percent of the overall economy.
But it sounds like you're saying software lending is over it's done after this episode.
I think when you lend in software, you have to lend it very conservative multiples of business itself is an uncertain business, and so four times that ebadops, not ten times, is probably the right number. And getting paid a little bit more for that risk and extra one hundred base
points on your loans. Now to the extent that financial conditions tightened a little bit on this in the direct lending space because of what's going on, we can get paid more for loans that we're making in the marketplace with tighter covenants, So I think for lenders that aren't in a bad position, that actually can extend credit, it's
actually a good place to be. And so I wouldn't let software just like oil and gas when you had that problem with those companies back in and sixteen, twenty seventeen, twenty eighteen, didn't tank the economy.
The economies is fine.
I think Commune will just be fine without having to deal with the default rates they are coming, the problems they are coming because the economy is so much bigger and diverse than this, and so it's not going to do anything to cause any kind of destruction to the broad up private credit markets or the brought or the
broadup credit markets, or the economy. I don't believe that it all is the case, but what it will cause is religion to come back in and discipline to come back in, because it's quite simply, you know, Danny and Matt, twenty three percent in software is just too much exposure to one industry group when it only represents a very
small part of the overall you know, equity markets. It's only one percent of all companies in the use of US or software companies, and only seven percent of all publicly listed companies in the US are software companies, so there's too much exposure for them to have had.
Everyone regrets it now.
We're thankful that we have one percent exposure and not that type of exposure. It's going to represent some really good opportunities for us as lenders in the years to come down.
But I'm wondering, you know where those opportunities are going to be, and specifically in software, because religion has already set in with some of these names. Are there some you think that are over sold or there's some that you think, you know, the debt is cheap enough to go in and pick it up, because that's historically where you've made a lot of money.
Brews.
First of all, I think in the public public equity markets, they're going to be in a really good position.
They'll buy a lot of.
This at pennies on the dollar because they're the ones that are going to have the capital, the cash flow, the margins to be.
Able to do so. Smart.
Private equity will also come in and recapitalize and buy new companies, but they'll pay a lot less. The whole ratings of where you know what multiples you pay for the company has come down substantially, and private equity tradiacy doesn't pay more than twelve times for a company traditionally, and so getting the whole sectory priced based upon this existential risk that you have, look private equity have is important and that's where we're moving towards. And the second
thing is private equity has all the upside. Imagine a company for creative destruction that they can reposition. Instead of making two or three times their money, they make five or six times their money, so they can afford a few zeros right and still come out okay. Private credit can't afford the zeros. They only get paid back. Part they don't have the upside. So what you need, Matt
is certainty when you lend. It's an uncertain business right now, and that's why capital will not come be become a veilop.
Are you not buying anything then not right now?
In software, what we're focused on are businesses where halo is the effect.
Part assets low obsolescence. I'm talking about in lending.
Our last private credit blending deal in DL was a concrete.
Deal was Rebard.
The deal before that was side side for commercial, so that you lay there on the lawns, right and so these are real asset lending opportunities and our last asset.
Deals in our abl.
Business hard assets, low apse lescens our aircraft, maritime assets, turbines, cranes and engines.
Because you're bullish the economy, because we love.
The economy and we want to be able to lend. Say had a three hundred million dollar asset, pull two hundred million on an LTV basis the sixty six percent LTV. That nice margin of safety with that hard asset where we have a perfected interest in that heart asset. It's not software where the recovery value will be close to zero if there's a default. We get full recoveries in the events of a default on most of those assets.
And so and we very rarely have.
A default because they're missing critical assets for these companies.
And so it's a very different dynamic when you talk about HALO.
And with HALO, that's why you see industrials and you know, MAI brails up twenty five percent of the year, with a lot of the software companies are down twenty five to forty percent of the year. Where you talk about the mid market software companies, and so we're in a very good position at Marathon as a lender with capital available to land and with how our position is currently positioned