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Hello and welcome to another episode of The Odd Lots podcast.
I'm Joe Wisenthal and I'm Tracy Alloway.
Tracy, there are just so many credit related things to talk about right now, all things credit.
I love it.
I love it.
Credit is interesting again.
This might be one of the.
Only credit episodes that we've ever done where like I found the guest because I feel like when I think about like a credit all the credit episodes, it's usually like someone you know. Randomly. I found someone who knows a little bit something about credit. She's like, oh, let me do it.
Let me The stakes are high.
I know I was thinking about there because you're like, how, Joe, you like pick someone who doesn't know anything. No, I don't think that. I think we have a very knowledgeable credit guest. But I'm a little stressed about this aspect.
I believe in you, Joe, you do. I trust your judgment. But to your point, there's a lot going on. So obviously there are concerns around private credit. We've had some idiosyncratic defaults and frauds in the market, and each one is special in their own way. But I think the worrying aspect is that they keep coming to light. Yeah, right, And so you've seen people like Jamie Diamond using the
cockroach analogy, which is now famous. And at the same time you have the connection with AI, right, which we have spoken about a little bit on the podcast with Paul Kadrowski. All these complex circular financing structures that are driving a lot of the credit boom, or have been driving a lot of the credit boom, and then at the same time you also have the impact of AI on credit itself.
Yeah, that's right because in theory right, like we've talked about this. We did that episode with Joel Werthheimer that was in a slightly different context, but we've done these episodes about you know, just the incredible length of deal text,
et cetera. And perhaps if there's one area where maybe we could say with some high degree of confidence that large language models could be useful, it is can we break down this multi hundred page agreement so that we don't have to have you know, junior associates or junior lawyers or junior bankers up till four in the morning making sure that every comma is in the right place, et cetera. In theory, this could be an area in which AI could be productively applied.
You know, there was an actual case argued over a comma. I can't remember exactly what it was, but like, you're absolutely right, the grammar, the specific words clearly matter in legal language. I would just add one of the things that's been driving arguably driving private credit is the booming creditor on credit or violence in public deals. So it was this idea that you could avoid that by having you know, this private close relationship with your borrower where you are higher up.
In the waterfall of payment. So this is important.
It would be really nice if you could upload a credit agreement to chat GPT and just say, make sure there's nothing in that would get me in trouble. Make sure there's nothing in here that five years later I will regret the placement of a.
Certain Make sure I don't lose money, make sure.
I don't lose money in some technical way anyway. So there's just a lot going on. I feel like there's plenty of episodes to do on this, but we really do have the perfect guest, someone who literally sort of sits in the intersection of I think we identified three distinct trends. Here we are going to be speaking with Dan Wortman. He is the co founder of a company called Nohica AI, and it does exactly this. It sort
of attempts to use AI to understand credits. There's a lot of understanding about deals and the text in them. He also just has a lot of understanding about AI, etcetera. So we can talk about all of these things. Dan, thank you so much for coming on the podcast.
Thanks so much for having me. I'm a fan of the show. Love to hear it you guys. It kind of like celebrities for me. So it's kind of fitting that I'm here because at least with folks of Bloomberg, because many people think about us and Oedica like the Bloomberg for deal terms.
Okay, well let's see. Let's see if you actually live up to that.
No.
But so since I said I'm stressed that, oh this time, we're doing a credit episode and I've found the guest give us the quick version of like your career and what no Edica is.
Yeah, so let's start with Oedica. What we build at no Edica is a power software for benchmarking real time data on what's market in credit m and a capital markets deal terms. Okay, so said another way, we help folks like transactional attorneys, credit managers, bankers. We help them figure out whether the terms of their transactional agreements like think financing agreements, murder agreements, perspectuses, and really all other corporate transactions are on or off market by benchmarking them
to market comps. So as far as the genesis of oedica, it was kind of born out of my own experience in my career. So I started my career at Blackrock.
I was on a team responsible for coming up with new financial products and fixing and markets, and we were developing these new interesting innovative structure and I just learned a ton about the capital markets ecosystem, and in particular just this is a fifty trillion dollar global market and it runs on phone calls and relationships and it's unbelievably antiquated. Then fast forward, I went back to get my GD I joined WALKT toall Lipton, where I did corporate transactions.
This was twenty seventeen to twenty twenty two. So if if you guys remember that time, it was heyday of merger activity. So I worked on you know, T Mobiles, Bioto Sprint, the biggest thirty billion dollar commitment at the time, Algon ave to see raytheon and I distinctly remember sitting down at my desk. I was looking at a transactional grip and a multi billion dollar merger, and I was looking at a term, and I was trying to figure out whether I should help my client accept term A
or term B in this context. And I was stuck. So I called the seenor partner on the deal. I said, hey, where's the database of information where I could see exactly how this term should come out and quantify it for my client? And you know, the answer was that doesn't exist. Now that was two and a half plus years ago. Now I left walked out to start no edico with a fairly simple idea, which is AI enables us to finally quantify what market agreement terms should look like in
these markets. You know, now we work with almost all the top twenty law firms on the street, but helping them advise their clients on these deals. And this here on track to do about a trillion dollars or of transactions through the platform.
And you get one percent of that.
So that's great, Well, talk to us about what these financing agreements actually look like and how traditionally they're sort of judged by both the investors and the lawyers who are looking at them.
Yeah, I mean so when I say deal terms, what I mean is deal terms are really the underpinning of the entire transactional system, the rules of the road. You could think about them like speed limits, double yellow lines, street lights. They're kind of the plumbing that goes into the transactions, putting in a way that people can understand. Imagine, I go sign of lease. Most people are very familiar with certain things, right, like the rent price, the how long the lease.
Is, subletting policy exactly.
But if deep in that twenty page lease the least says if the weather gets under thirty degrees at any time, you forfeit your right to the apartment, Well, that's a deal term, and that affects whether you want to accept that lease or not. And so it's the same in capital market terms. To give you a more tangible example, Yeah, are you guys fast food people? Yes? Yes, Okay, So I'm like a McDonald's guy. Yea, And whenever I go to McDonald's, I always ordered the tempiece chicken McNugget. I've
ordered the ten piece hundreds of times. There's exactly three things that happened to you order a tenpiece, you open the box, you have nine pieces. You open the box you have exactly ten pieces. Or you open the box and you have eleven pieces. Now, if you have nine pieces, you go to the counter, you say, hey, I'm missing a piece. They give you a piece. You get the benefit of your morgan. If you get ten, you enjoy your McNuggets. If you get eleven, what do you do?
You stay quiet?
Exactly so you had the jaguar right now. There's this kind of unwritten rule in American consumerism, which is that if a company that's bigger than you gives you something by accident, then you get the benefit of that as a consumer. Well, in twenty twenty, the exact kind of thing happened in the credit markets, but it ended very differently. City Bank sent nine hundred million dollars to lenders in full prepayment of a loan for Revlon, and they did
so accidentally. Now, they were supposed to just send an interest payment. At the time, the terms of the credit agreement were silent. The governing documentation, especially with this loan, didn't say what happens in that scenario. Long story short, many funds did not give back that hundreds of millions of dollars and litigation ensued. But a deal term in credit deals called erroneous payment. Deal terms started popping up in the market. No Whatadka's data last clocked that deal
as a last quarter ninety percent of deals. So if you don't have that term now in your deal, you're way off market in terms of the way the market actually operates. This is why deal terms are important. These are hundreds of millions of dollars at stake. In the context of all these deals.
There's something very loyally but like I have to say, I've never counted the McNuggets. I really get it, so just I would this example would have never occurred to me because I'm not the type of person that opens a box of McNuggets and start.
Clearly, you don't value McNuggets.
Not evidently not. What are some other deal terms? So that's a great example that. Okay, now, after that incident, which is infamous, language about this start popping up. What are some other sort of classic and I'm sure they get much much more esoteric than that. But what are some other like interesting deal terms that trend over time.
Yeah, so it's really interesting. So there's a whole host of what it would call structural protections in a lot of these deals. These come in a lot of different vivors. Many people talk about them as things like anti pet smart terms, things like j crue blockers, things like sert of protections. Let's talk about some of the Yeah, let's talk about some of these, so anti pet smart terms. These are protections that prevent guarantor releases when subsidiaries of
the credit group become non wholly owned. In other words, it prevents value from being transferred away from the loan into some other structure which doesn't provide credits for it. Let me put this in a way that most people don't understand. If you were getting a mortgage on your house, pretty simple framework. You take out the debt, you pay your mortgage payments, you pay a packfal loan. Bank can foreclose in your house if you stop paying a mortgage.
But in the mortgage if it said something like well, if you sell any part of your home front door, a window, a shingle, the bank loses the ability to foreclose in the house fully. Well, then what would you do. You'd sell a single shingle, you would stop paying your mortgage and you get to keep your house and you get the benefit of that. That's what anti pest smart terms actually prevent. They prevent the ability for credit groups to actually sell a single equity and actually lose the
credit support from that particular equity. So it's kind of interesting what we're seeing in the market right now. We have this really unique vantage point from the point of view of our software where we quantify trends in deal terms over time, and so we can actually very precisely tell you the percentages of deals that are actually getting a lot of these structural protections and actually gives us this really unique window into the anxieties and the optimisms
that are currently happening in the market. Some people think about this as kind of an early signal of something likely to come. So what are we seeing, Well, we're calling it a flight to fortification, and it's really happening on both issuers and barbers. And I'll explain what I mean. We're seeing massive increases in lenders getting structural protections in these deals. Basically, these are protections that help make sure they're collateral is locked, things like the anti pet smart terms.
In return, borrowers are getting the same fortification. In fact, they're getting more economic flexibility. You could think about it as a way for them to weather the storm. This is how we're seeing it. So things like add backs to eve, you know, more ability to send money to shareholders, more ability to make long term events bins. Let's talk about the actual specifics of what we're seeing. Antipasmart terms, the one I just talked about, we clocked out at
twenty eight percent of deals in Q three. That was at four percent in twenty twenty three, and Q two is at twenty five percent, is the highest we've ever recorded. That term J crew blockers, which prevent issuers from moving material ip out ofside the credit group. That's at forty five percent of deals now the baseline from twenty twenty three to fifteen percent, and last quarter it was thirty
eight percent. Anti SERTI protections, which are leansbordination protections. They actually helped secure your place in line if and when some sort of distress activity happens. That's at eighty four percent of deals. That's the highest jump we've ever seen. Quarter quarter it went up from sixty one percent to twenty three point jump, and the baseline is thirty nine percent twenty twenty three. That's pretty significant for a quarterly jump,
and it really signals something about the market. On the quantitative side, we track a lot of stuff too, including the ratios under which borrowers need to maintain specific types of leverage. We saw that at three point nine times EBITDA in Q two and it went down to three and a half times, But again that's signaling some sort of anxiety among the lender group that we wouldn't normally see. Now you may ask what a borrower is getting for this, Again,
they're getting more fortification. One of the ways this is coming up is in EBITDA adbacks, so EBADA add backs. Basically, there's a very long and complicated calculation of cash flow and a lot of these deals and the adbacks to EBADA basically allow bars and issuers to add back certain things to count them as cash flows.
To flatter their balance sheet basically correct correct.
One of the more interesting adbacks that we track is what's called a cost saving satback. So imagine a borrower knows it's gonna optimize some cost in the future. If it can reasonably predict that cost, it can add that back to today's cash flow. That cost savings atback, whether materializes or not, is added back to today's cashflow. Sixty four percent of deals now have cost savings atbacks in them.
That's the highest we've ever recorded for deals, with those adbacks being above twenty percent of EBITDA that came in fifty one percent, which is also the highest we've ever tracked on the platform. They're also getting things like excluding lenders that are short in their debt. So, for instance, folks may be familiar with what happened with the Windstream
case a few years ago. What happened in that case is certain hedge funds were actually short the debt the loan that was in default, and that makes them not exactly aligned with the company that has the debt outstand. Terms started popping up in the market which we've tracked, which are called net short lender terms, which allow bars to exclude those lenders from voting. That is now in thirteen percent of deals, which is the highest we've ever tracked.
So you could see the fortification actually on both sides of the market, and it really signals, I think, to us that there's a risk allocation happening with a lot of these anxieties.
Joe, First of all, you know, my husband was a corporate.
Lawyer at one point.
Yeah, okay.
So one of the things he's most proud of is he came up with some language in a deal shortly after the two thousand and eight financial crisis, and it was he sent it to me just now a significant dislocation in financial markets. That was him, and that became like standard language in risk factors, at least in a bunch of that's a contribution.
I'm the inventor of this deal, so and so the inventor. Some people invent great medicine, some people invent some new technology, and someone invents a new deal term that gets propagated across that's right documents for years thereon after.
That's how it works.
But Dan, I wanted to ask you something. Okay, So you say there's more fortification in a lot of deal terms, more protections perhaps for both investors and lenders.
I guess one of the things we.
Heard prior to twenty twenty in them for some years after it was we had this explosion in CoV light deals, right, fewer protections for investors because everyone was so desperate supposedly for yield for that particular paper, So the balance of power shifted to the borrowers they were able to dictate
the terms. How are investors getting better protections now? With you know, credit spreads still at basically multi decade lows, which suggests that there's still a lot of demand and that they don't hold all the power in the market.
Yeah, I think about it, and what the data supports that we see on the platform is. I think about it less so as what they're getting, but more about what the terms actually reflect in terms of the macro environment that they're operating in. So, for instance, right now, we're seeing this flight to fortification in part largely due to probably a few things. Number one being some of these headline risks that folks have been talking about, and well, I'm sure we'll get into some of what's going on
in the private credit market today. So people flooding into more structural protections because they're worried about their place in line if there is distress. I think number two is just mac or wise if you think about it. In the credit markets, there was a ton of debt taken out in twenty twenty, twenty twenty one, twenty twenty, early part of twenty twenty two. This leads to a lot of maturity walls upcoming, especially in twenty twenty seven twenty.
We don't say upcoming on the show, we say looming.
Yeah, exactly. There are a lot of looming maturity walls in twenty twenty eight, twenty twenty nine vintage. And you can think about it as well. That's a macro factor that people are thinking about when they underwrite alone, because many of these deals actually have five year tenor you know, seven year ten or eight year tenor in some cases thirty year tenor, and so they're thinking about all these
protections in the context of that market. I also think it's really interesting, aside from the credit context, right now, we're seeing a lot of structuring in terms happening in M and A markets, So things like regulatory uncertainty, things like tariffs, things like libildy management, as we talked about, things like tax uncertainty. I'm happy to go into these, but we're seeing a lot of things in this area.
One kind of small example of this in situations where a buyer and a seller have regulatory uncertainty, which you know a lot of folks think about the administration and they're not sure exactly how things are going to play out. You actually see regulatory review in deals get hyper focused on and it actually precipitated a new deal term this year which we tracked in the market. We had an almost term detection of the platform. We sent out a note to all of our clients and it's called a
new outside date structure term. Basically, what it does is it allows buyers of acquirees. It allows them to lock in their financing for longer and actually stand their financing in the case scenario regulatory review les. And that's just an example of the kind of innovation that's happening in the merger markets. In terms of tariffs, we picked up
the first tariff event of default in a credit deal. Ever, it happened in a Superior industries deal over the summer, which probably isn't surprising to use an auto manufacturer deal. I've made a lot of parts in Mexico. That's not five percent of MNA deals for tariff based m and A carve outs and railie respect clauses.
Can we talk a little bit about you know, you're scanning these documents. Google's ingram has existed for a long time. Tracking the prevalence of a term is not novel technology that control EF right control f Yeah, this is sort of like very barely even councils technology at that point. What is it that you you know, when you're talking about the changing prevalence of these terms, what is the actual novelty here that isn't just sort of yeah, document search over time.
Yeah. So, Tracy, your husband's a former corporate lawyer. You know, he would tell covering corporate lawyer or covering corporate layer exactly. I am myself as well. One of the things he would tell you is that there's constant innovation in these markets.
These agreements are highly complicated, there very long. They have a lot of what's called long range dependencies, which is that you may be used to seeing something in a particular area of the document said one way, but in reality it turns out it's punted to three different causes deep down, and you actually have to go find that information.
This is why it's also jiu jitsu between the borrowers and the lenders, right, because like the borrowers are often trying to hide something that's favorable to them, or the lenders are trying to hide something favorable to them. So the structure and the way it's worded changes a lot to your.
Point exactly, And these are sophisticated parties paying millions, sometimes hundreds and millions of dollars in advisory fees to make sure that these terms look the way they do. Now that leads to kind of the technological innovation that I think has enabled a lot of this AI for the first time, can attribute in particular, new language models, can attribute more semantic meaning to phrases and language that was
impossible with things like n grams. And so what America does is it used as a series of language models, including a multi layered information extraction system to make sure that it's encoding all this semantic meaning inside all these terms, so that when you look at a J. Krublacker in the first way, it may be phrased a thousand different ways,
but we can track that term over time. That has enabled the ability to actually quantify for the first time what a market agreement term looks like in these markets. And I think that's why it's so interesting to folks on the platform.
So I know you're not doing litigation, but I guess I'm curious how you deal with or if AI is helpful with in litigation what would be called precedent. But I'm assuming you're building up a big database of all these different deal documents.
Is it useful?
Is AI useful to go back and look at previous documents in order to shape new ones?
Yeah? Exactly, So in New Edica, we are ultimately an a power software company, but we actually have the largest knowledge graph of deal terms in ex systems. So Tracy, exactly what you said. It's a database ultimately of precedent comparable deal terms, and that database is going to be mind bowing as over billion terms in it, So its issue to a large as in existence, we map that
back to deal characteristics. It's the same in litigation, right, So in transactional markets, folks are innovative, but they also want to rely on something that has happened before, or at least in part, they want to rely on something that has happened before, and so folks are constantly looking for ways to tie things back to comparable deal terms.
It's the same in litigation. So obviously not expertise, but the same concept, which is, you know, when you write a brief, you were constantly citing cases that the judge has you know, relied on in the past. And you know, for lawyers and you know outset of lawyers, even just deal professionals generally bankers, credit managers, people are highly reliant on present What.
Is your text acre did you what do you build and how much is it? Like, oh, you're using chat, epts, API, et cetera. Like, okay, yes, large language models are good at identifying deal terms or novelty, et cetera. There's semantic meaning of these terms, but what did you actually build and what do you actually employ in your technology?
So we were starting in twenty twenty two, so we're what you would call AI native. We were started in a system that already and language models existed in. However, we because of the nature of the sensitive documents in terms that we deal with, especially for you know, major law firms, financialist yea, this is like.
A big issue with the right that they don't want to just be uploading their stuff to chat GPT right exactly.
And so we actually utilize you know, adapted language models, open source language models that we adapt on our armed proprietary data sets and then deploy and secure environments and single tendon architectures, you know, for individual instances of institutions that deploy our product. And so you could think about it as based on the language models that are ultimately
underpinning a lot of the gpds and the clouds. However, it's fine tuned to this particular data set, which makes it obviously much better at handling this exact problem, which is a big problem in the market. Now. We also
layer on top of that information extraction model. So for instance, you may know that a term exists in what deal, but you may want to know what terms should exist for a JP Morgan deal, or for a B of a deal, or for you know, a particular type of counterparty, and so in those context we actually want to map those deal terms back to deal characteristics, and we actually utilize a lot of models to extract information and marry that with their party data sets. So that's a little
bit about how the technology works. I think I always think about it from the user standpoint, What does the user really want? These really wants to know how they're going to invite their client on a particular merger on a particular credit deal. How often does this come up? You always call your attorney and you're trying to figure out, well, is this market is it off market? And that's what our data provides.
Okay, so structural fortifications in deal terms. What are you seeing right now?
Because as we started this conversation, we were talking a lot about the recent blow ups in the private credit market, and if you look at some spreads on certain firms, certain bonds, it does seem like nervousness is creeping back into the market. I see spreads on you know, it's not private credit, but spreads on triple C rated debt have been creeping up recently. How scared or concerned are people right now?
Well, I recently wrote about this in the Wall Street Journal a little bit, and then folks contacted me and I kind of said, you know, you're causing a stir. And then I saw Howard Marx came out with his letter, which I think was called Cockroaches in the coal Mine, and they had a lot of the same themes. I think folks who have been around credit market for a very long time can kind of see what's a little bit of what's going on.
To us.
Let me just talk about what the data supports to us. What we see is creditors maybe preparing this their system for distress, and I'll talk about what we're seeing in the data that kind of supports that. But you can think about it like the evolution of your house security, right, So you know, first you lock the doors. Then you know, you get a bolt lock, which gives you better protection. You know. Then you you know, you add a security system on top of that alarm system. And at the end,
what do you do. You kind of up all your valuables and you ensure them if people are going to get into the house. And you know, for the past few years, we've seen lenders really focused on keeping people out. This is the locks and the dead bolts, and this is what we were talking about with j crub blockers.
This is making sure you can't structure around me. From a liability management perspective, But over the last quarter something kind of changed, which is we started seeing people and lenders obsessed with lean subordination terms, which is the term that governs who gets paid first when everything falls apart. So this isn't really about preventing liability management exercises that much. It's actually about controlling the recovery when a bankruptcy does happen.
And so we clocked that term at eighty four percent of deals in Q three, biggest quarterly jump we've ever seen from the prior quarter. It's also the highest we've ever clocked that term. So this bes the question of why Wire Credit is so focused on making sure.
Their place on line is in recovery.
In recovery is the same. Perhaps it's a reaction to the Lieboldy management transactions we talked about, so perhaps folks are thinking that that will precipitate. Perhaps it's a reaction to some of the maturity walls that folks understand, or perhaps it's some of what I was saying in the appad, which is folks are seeing that there may be distress events on the horizon and they want to make sure that if there is, they have the most negotiaing leverage its possible.
So I know it's broad statements, but you know, when we look at these sort of environment under which companies like First Brands or Tree Color or some of these other ones that have gone into distress very rapidly, when we look back at when these were birthed.
Et cetera.
Can we say like these were sloppy times, These were loose, sloppy times that people were not thinking much about either just quality due diligence or diligent terms.
Yeah. So I think with First Brands is a great example. Right. So First Brands is an automotive replacement company, right, so they make things like breaks and wipers and filtration systems. Beginning in twenty nineteen, that company effectively rapidly expanded through
debt fueled acquisitions and it dramatically increased its scale. But I think what First Brands illustrates is something that you know, we might get into with the private credit markets, which is that they primarily funded these acquisitions with large debt facilities. Then tariffs hit in April twenty twenty five, which obviously changed their business because they actually do a lot of manufacturing, and that kind of magnified problems. So you can think
about out. One of the main problems with First Brands, which is also kind of some of what folks are worried about in the private credit markets today, is what's called off balance sheet financing. What First Brands used is a lot of you know, receivables financing facilities that weren't properly disclosed to a lot of folks that were lending
to the company. In fact, I think in that sense, just to give you a sense of quantum, this is over eleven billion dollars of total obligations that they had when they actually started disclosing it in terms of off balance youe. Financing and you know, they were disclosing things like five to six billion dollars of actual debt obligations. And so this led one of the creditors lawyers to say that
two point three billion dollars just disappeared. And so that structure, the ability for first brands to get that debt was made possible by the private credit markets and how deep
the private credit markets have become. Because if you're a big credit manager in private credit markets, you could fund you know, that type of receivable facility to a first brand, and first brands could use that facility to then, you know, make sure they are constantly continuing to acquire new businesses and keep rolling over the cash.
I have a theory that receivables, financing and factoring is to the private credit market. What French quants who went to that one elite school are.
To trading blow ups.
I like that theory.
Yeah, thanks.
So the other thing we wanted to ask you about, and again we reference this in the intro, is we are seeing these really complicated deals that I admittedly cannot keep track of in the AI market, where you know, one company is going to buy chips from this other company, and then that company is going to borrow from whoever and use the chips funding to pay them back, and then that money somehow goes into the company that is buying the stuff in the first place. It is all
very circular, all very incestuous in many ways. In my mind, are you examining those types of deals or just putting on your credit expertise hat if you see something like that, what are you thinking?
Yeah, well, it's probably helpful to kind of talk about some of the structure of these deals, which I think again is made possible by how deep the private credit markets have become. And usually when I do that, I try to think about, let's try to make this a little bit more fun. So imagine for a minute, Joe, you just love pizza. He does love pizza yesterday twice.
There you go, You're a pizza fanatic. You love it so much that you decide to eat pizza every single meal of every single day for the rest of your life, like you are committed to subsisting pizza, committed to the carbs exactly. So, Joe, you made that decision. You come to me and you say, Hey, Dan, I'm going to eat pizza for every meal of my entire life. How about you open a pizza restaurant for me to eat it. It'll be really lucrative.
We're going with this, but this is actually a very good to note do, right, Like you would have have a lot of confidence in me to commit to my word. If you're going to open a restaurant.
Yeah. Now, now you come to me and say, it's going to be super lubritive. Here's how we're going to fund it. Ten percent equity. The bank is going to give you ninety percent of the funding in leverage. And it's Dan's restaurant. Joe, you don't on the restaurant, but you're going to eat at it. I'm the full beneficiary, full beneficiary of the restaurant, but it's ninety percent. Okay,
So I opened the restaurant. You eat there every single day. Now, Tracy, Joe comes to you for a personal loan to fund his lifestyle, his pizza eating.
Tracy, trust me, she would lend it to me.
Well, here's the question, right, should you, Tracy? Consider the ninety pizza restaurant that Joe is eating at for all his meals. Now, on the one hand, it's not Cho's loan, right, so he's not on the hook if the pizza restaurant goes under. On the other hand, it's Joe's only source of food.
Which Joe will die without the restaurant.
Which is his He's committed to the restaurant, and it kind of makes the restaurant intertwined with Joe's ability to pay your personal loan back. So, I guess that's a good question. No, there's great.
So now let's take it out of pizza. Who is so that's whatever? Like okay, now who is the chips buy or whatever?
This is essentially what's happening with off balance youe. Financing and data center deals. So, and it includes Metas. I'm sure you saw the Hyperion deal. It's his Metas infrastructure deal with Blue Owl. Except I think it's even more intriguing than some of the pizza stuff. So Meta and Blue Ol basically created a joint venture in a special
purpose vehicle not that different than the restaurant. And the deal is the joint venture would be owned twenty percent by Meta, eighty percent by Blue Owl, so Blue Owl controls it, and it would effectively be funded with ninety percent leverage. So call it thirty billion dollars of total enterprise value, three billion dollars of equity, twenty seven billion dollars give or take of debt. In other words, Blue
Oul is effectively owning the restaurant. Meta is effetively eating at the restaurant, and the bank's funded with ninety percent leverage. So what this does is it keeps the debt off of Meta's books right while also giving investors credit managers the ability to put money against a data center asset. So Meta in this deal will make rent payments associated with the data center based on its cost of power. That's the cash flow that's going to the SBV, and
that effectively funds the interest expense. Let's just talk about the debt for a second. In a normal LBO context, ninety percent leverage is pretty exceptionally high. Most people would consider fifty to eighty percent leverage to be relatively normal for a stable cash flow business. So the debt itself
is actually quite high on some of these structures. The only reason it was possible was because it was given an investment great credit rating, and in part because Meta agreed to a four year operating lease with what's called a residual value guarantee, which means that Meta is guaranteeing
a capped amount of some of that cashflow. However, that guarantee is capped and is only partial, which is why they don't have to take it onto their book and why would be a footnote as a contingent debt obligation in their balance sheet. Now let's talk about the asset that's being underwritten. This isn't pizza. Pizza actually has a stable price, right. We have thousands of UTI history on pizza, right,
and you can track that price over time. Data center is optimized for GPU performance on training fundamental AI models. Not so much of a mature asset, actually, I think most folks would think about it as a burgeoning asset. Now I'm in this world. I mean, folks, there's a high amount of demand for a lot of this compute, and I definitely think the demand is there, but at the end of the day, it's an immature asset with
a price that isn't so well defined. So just a recap, you've got off balance sheet financing which isn't reflected with whoever is lending money to metal or even buying its equity with ninety percent leverage on an immature asset, And I think that's why these deals are so interesting. So from our point of view, I mean to make sure you get the terms right, and you know, we will look at these data center. A lot of these types
of financings run through our platform all the time. To make sure you get the terms right on what this structural protections look like in these deals is critical for the fortification of something that is in the structure.
So I know we've seen these idiosyncratic blow ups in the private credit market so far, but just looking at the AI market in particular and the financing there, it feels like right now people are still willing to lend money. And we've talked about this on the show before, but a lot of the AI competition is couched in this existential language of you either win it AI or die basically,
and so the spending keeps going. What is your guess on like the thing that kind of knocks that cycle or that flywheel.
And tears it apart.
So I'm obviously in the AI industry. We're in the credit industry, so we see both sides of this phenomenon. I fundamentally believe AI is a paradigm shift. I would not have left, you know, the deal markets if I didn't think that. And I think what we're witnessing is very similar to the Internet in the nineteen nineties, or the iPhone in two thousands, or social media in the twenty tens. And I think this paradigm shift is going to ultimately change a ton of industries, including capital markets
and finance and law and all these amazing industries. And so that I think is very true. But I also think two things can be true. I think AI can be a generation defining category and a technology that's upending a lot of industries. But I also think that categories will have winners and losers. And when folks are racing to define a category, as you know, you often see with a lot of these transformational types of technology, there
may be more losers in the headlines. Then you're used to seeing in a lot of these markets, but the winners will be bigger than anyone's ever all.
Right, So if I don't need the pizza, someone else is going to pick up the pizza and they're gonna they're gonna eat it.
Look what we focus on in Oadica is in a market moving this fast. Yeah, we all need to pay attention to the terms that actually underpinning a lot of these markets to make sure if there is any bleeding, that bleeding gets stopped as quickly as possible. Just to give you one last example from a recent market deal, you can look at the Frank jpm deal as like a really interesting one. This is, you know, this was a deal where JPMorgan paid one hundred and seventy five
million dollars to acquire a company. There's a very small deal, but to acquire a company called Frank, which is a streamline fasta kind of support service.
I remember this.
It turned out there was a lot of synthetically made up types of data in that.
Business, and the founder is going to prison right.
Allegedly there's a lot of there's a lot of made up stuff in the business. And I think seven days.
Executive who worked at Frank sends to sixty eight months.
Yeah, yeah, yeah, and so. But I think the most interesting part about this particular transaction to me is JPM ended up signing a merger agreement that said that the indemnification for the founder's litigation, for any founder's litigation, would be paid for by JPM.
Right, they paid her lawyer.
They paid one hundred and fifteen million dollars in legal expenses for her lawyer on her fraud. And so when you're moving really fast, yeah, right, you can kind of ignore some of the nuts and bolts. But I think it's actually even more critical and fast moving markets.
Dan Workman, co founder of no Edica, thank you so much for coming on outlook.
Thank you thanks for having me us.
Tracy. I wasn't really sure where he was going with that pizza analogy, but it actually does make a lot of sense, and it's something I think is a phenomenon and just a lot of financial transactions, which is how much like in certain environments, the lender and the creditor are like both each others, like they're both leaning on each other. They're both the creditor and lenders, they're relying on each Yeah, at the same time.
Much in the way you rely on pizza.
You would lend to me to buy it to eat pizza.
Right, I would thank you if it was a matter of survival, that was.
A matter of survival, thank you.
I think it's just.
Because you want to eat really expensive pizza then no.
You know.
The other thing too, is just like from talking to you over these years, you know how many times I've heard something there's a lot of cuve light stuff going. It is interesting to think that, like, you don't often hear that quantified what that means, right, things are like cove light these days, et cetera. And the idea that like, maybe we could get better numbers on some of these things seems like potentially labor saving for lawyers. Stuff like that.
The specific numbers on specific deal terms were really interesting to me. And the idea that even today lawyers and bankers still have trouble anticipating every single thing that could happen to particular deal, and so they're having to react to it and come up with the new terms, the new deal language, and insert them into the documentation.
I find that interesting.
The tariff example, you know, the problem is is that AI is good and this is I'm certain if we talked about this more, AI will be used to come up with new deal terms and the cat and mouse game will continue forever. So I suspect that we are not going to have lawyers will always find new work to do, and they'll just get work. They'll just get more creative about outsmarting the systems that are designed to detect these phenomena.
We will end up with thousands and thousands of pages of term sheets that, like humans are just physically incapable of reading, it has to be read by AI.
I probably literally, that is what's going to happen.
Yeah, all right, shall we leave it there.
Let's leave it there, all right.
This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
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