Invest Like the Best with Patrick O'Shaughnessy - Ali Hamed – An Update on Private Credit - [Invest Like the Best, EP.172]

Episode Date: May 5, 2020

My guest today is popular past guest Ali Hamed, who joins us for an update on private credit. We discuss what has happened so far, what parts of the market are frozen, and where opportunities may lie. We also talk about how the world has shifted digitally since the beginning of the COVID pandemic. Please enjoy my conversation with my friend Ali Hamed. This episode is brought to by Koyfin. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Show Notes (1:41) – (First question) – World of private credit in the pandemic age (4:50) – Bag of uncertainty (6:27) – Important levers in private credit (9:15) – Scary scenarios and systemic risks in this world (13:21) – General trends in the credit data (15:30) – Are investors factoring government response properly (17:02) – Defining advanced rates (20:18) – Focus on quality vs rate of return now (22:26) – Pockets of opportunity as uncertainty declines (26:06) – Online ecommerce platforms, like the YouTube economy (29:40) – Non advertising driven ecommerce platforms (31:54) – How venture capital is responding (38:19) – How junior debt could be am opportunity (40:17) – Trends he’s thinking about; redefining small businesses (43:07) – Ali Hamed Podcast Episode   Learn More For more episodes go to InvestorFieldGuide.com/podcast.  Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on Twitter at @patrick_oshag

This episode is brought to you by Coifin. I've become very interested in the best software tools in investing. And when I asked Twitter for the best Bloomberg alternative, the overwhelming winner was an excellent new product called Coifin. It's a web-based platform that lets you analyze stocks, ETFs, mutual funds, and other asset classes in one place. I've been using it every day to track what's going on in the market, and I think if you try it, you will too.

Coifin has a ton of high-quality data, powerful functionality, and a clean interface. The best part is that it's free. You can sign up at www.coiffin.com. A-O-Y-F-I-N.com. Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money.

You can learn more and stay up to date at investorfieldguide.com. Patrick O'Shaughnessy is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. My guest today is popular past guest Ali Hamid, who joins us for an update on private credit. We discussed what has happened so far, what parts of the market are frozen, and where opportunities may

lie. We also talk about how the world has shifted digitally since the beginning of the COVID pandemic. Please enjoy my conversation with my friend Ali Hamid. So, Ali, I've been doing a lot of these updates on specific areas of the market in the COVID era. Haven't done private credit yet. I've been really excited to talk to you about not just private credit, but sort of all you see in the ecosystem that you operate in. Maybe you could begin by giving me a sort of state of the union. What are you focused on right now? What's been surprising or unsurprising about the world of private credit and how it's reacted to COVID thus far?

Sure. So I think the first reaction is everyone sort of froze for at least the first 30 days. I mean, the problem is no one underwrote to a pandemic and no model matters anymore. I was telling you, we were having a conversation in our investment committee meeting this morning. We were having like a genuine conversation of what if over 50% of people in New York City don't pay their rent. And then I look out my window and I'm looking at all these buildings and I'm like, oh my God, it's truly insane. And so I think that the number one, difficulty in transactions closing are that there's such a variance of outcome that people don't really know what safety is anymore. And so I think the first thing that started to happen is anything that was a short duration asset started to have to get worked out quickly. A lot of people say, well, the shorter duration of my asset, the less correlated to the market I am, because if I buy something that's five years long in duration, like I don't know what's going to happen in year three, but I buy something that's 60 days in duration, like a receivable or like certain merchant and cash advances. I can probably figure out what's going to happen 60 days from now. In this case,

the world changed so dramatically so fast that if you have an asset that's due in 60 days, you're dealing with it now because maturity is coming up. And if you had like a five-year loan out to somebody, you know, you can defer payment for a few months. And sure, three of the 60 payments may not come in. Over the life of an asset, you're going to be okay. If you have a 60, 14-day, 70-day asset, you are probably not picking up the phone for anything else. And also, for a lot of people, their funds weren't set up to do trades as quickly as they occurred. I think a lot of this stuff that happened in March, you really had to have a certain fund structure or a certain level of discretion to go make certain trades because the trades

went away so quickly. So there's a combination of people freezing if they didn't have to do anything. The shorter duration your assets, the faster you're trying to move. And then the other two things that we started to see first was basically people selling uncertainty. It wasn't really distressed. In distress, you kind of have a thing, and the thing didn't go as well as it was supposed to go. And so you can buy it cheap and for a high yield and exchange of all the work you're going to do, try to fix it. But in this case, basically people are just giving us a bag of stuff. And they were like, hey, here's a bag. And I don't really know what's in the bag. February, the bag seemed okay. I don't know how the bag is going to do in a pandemic. Do you want the bag? I'll sell it to you really cheap.

and find uncertainty didn't feel very good. I think a lot of people said is, let's just wait, let's sit in our hands, let's focus on the portfolio, and let's de-risk and not let's go find a million things to do. I think that's going to come. This could end up being selfishly. I look at this. I'm like, oh my God, this could end up being like a pinnacle moment in my career of the type of stuff that we're about to get to do. But there was a total shutdown of anything that didn't need to be focused on immediately. Can you give me an example of what a bag of uncertainty looks like? So let's imagine you were looking at a fund that was making small business loans. That is a big bag of uncertainty.

What will PPP do? I don't know. It seems like restaurants, it's not going to help restaurants a lot because restaurants don't need to pay their people anyway while they're shut down. Maybe they do have more resiliency. And then what is the default rate going to be? Is it going to be 10%, it's going to be 30%? Is it going to be 100%.

We're looking at stuff that is not really levered even senior pieces that not above 50% 50% advance that are trading at discounts. That's kind of crazy. And also, a lot of things haven't behaved like you might expect them to. So the subprime, I got on the call with a guy who was originating super, super deep subprime consumer loans. And his company is doing well, but they're not profitable. And his investors in him are trying to figure out, should he keep originating this environment? And my first thing that I got on the phone with him, I said, I bet you your book hasn't seen any issues yet. And it's like shock that I had already seen that. Because it was just weird. Subprime consumer really hasn't seen a huge tick up in defaults yet

because they, A, maybe just got laid off or B, maybe they're not going out of house, they're not spending a lot of money, or C, maybe they're not paying their rent, but they're paying their other loans because they're watching the news and seeing, hey, I don't have to pay my rent right now. So there's just so many, like, saying near prime is probably going to have more variance in subprime. Super prime, who knows. I mean, I think a lot of people are going through their loan tapes and looking at occupation of their borrowers.

super important to know what percent of your barbers are in hospitality right now, all kinds of stuff. Let's talk about what the important levers are for you in private credit. So private credit is sort of more of a niche asset class. Everyone's quite familiar with what's happened in the public credit markets with Fed intervention and investment grade and in high yield. So maybe some more awareness of what's happened there. But talk about sort of the important things that you're watching in the private credit markets, generally speaking, and where and how sort of what you guys do, deviate from, say, like, the beta of private credit, if such a thing were to exist? So I think one unique thing about private credit, or specialty lending in general, is the

diversity of the assets. And what that means is each asset is serviced or originated by a company with a bit more unique domain expertise than normal. So let's imagine you're looking at a traditional asset in public markets and some servicer of home loans. I think a lot of people are like looking at the servicers and wondering which of those are going to go bankrupt. I don't really trade in that space. I don't want to over imply that I am an expert. But I know in my world, the first thing people are looking at is the originators and servicers they work with that make sure that the assets that they feel like they're secured by are getting paid back. And when you're in a world that's as mainstream as resi or commercial real estate, there's a lot of servicers and a lot of originators.

And so if one originator goes bankrupt because we're now in a tough economic time and they're the bottom of stack or they can't operate, okay, you go find another backup servicer and they can go service your home loan. And if you're paying your home loan, you don't really care who you're paying back. In specialty lending, there's a lot more domain expertise in each of these, each of the lenders. One of the things that you and I have even talked about is when we look at financing assets, one of the things that's most important to us is that the assets aren't hard to actually service. We're looking for things where there's automatic repayment, where the repayment comes from someone other than the borrower. And it's because in times like this, if you're lending

money through an originator, and part of the originator's core competency is their ability to go get the loans as they come back. All of a sudden, you've actually taken implied corporate credit, and you have all these sort of tech-enabled startups and large originators that aren't operating a profit, still rely on venture capital to be funded, and if you're a lender lending through one of those, I think the first thing you're doing is working with your originator to see if they're going to stay in business or figuring out ways that you can help them stay in business. So as an example, Some of the things that these people are probably doing early on is, one, waiving the repayment penalties because they want just the money to come back.

Another thing they might be doing is lowering their advance rate. Hey, if you can raise more equity, I don't think people are trying to take in big swings right now. I think they're saying, if you can raise more equity, even at a really cheap price, I'll lower my advance rate in exchange for a lower rate of return. So I think people are basically doing a lot of blocking and tackling with the partners they work with on a day-to-day basis to service these assets as sort of a first order, because those are the things that are breaking first. What are the scary scenarios for you in the private credit world?

Is it basically just a wave of defaults? You've already mentioned those types of assets, and we've talked about before, the types of assets you're lending against are quite diverse. I think of produce pay, for example, people are still eating fruits and produce. So maybe that one's doing well. But is there a big systemic risk in the private credit world as much as there might be in the public credit world? We don't know yet. One of the arguments against that is, again,

and my point of the assets and private credit are a little bit more diverse, how many other people are financing perishable produce right now, not a lot. And I think a lot of it is just really unpredictable. And some people are going to get left holding a bag that maybe didn't desert you. Like, there's things that we did that were totally skillful in our opinion. And there's other things that we're lucky. So in terms of skill, like, yeah, like we underwrote to the fact that people are going to eat perishable produce. And we also underwrote to the fact that produce pays an incredible operator.

So even when I wake up and I look at the Wall Street Journal, And it says, oh, man, perishful produce is being thrown out and dumped. It turns out that produce pay is really good at helping farmers redirect their produce to non-hasp hospitality-type buyers and into retail and grocery. I get to sleep at night. And a lot of our operators have been able to adjust quickly. It turns out that a lot of what we finance is tech-enabled assets. And I could have never dreamed that the reason we're going to go through a recession

is because people are going to be at home using their technology assets. In many ways, there's people who, again, we're financing really high-quality, real estate assets or hospitality assets, that it's not that they were smart or dumb or taking more leverage than seemed appropriate. I certainly didn't have sales and revenues of hospitality going down 90% in any model I ever built. So I think you are going to see surprising people get blown up because it was just such an odd event. I don't think it's going to be systemic. And I do think there's going to be enough people ready. I know that I've pinged a bunch of my friends who have lending funds asking if they need capital. I know that a bunch of my friends who run lending

funds, I think me asking if I need capital. So there's definitely people see on the sidelines. And I also think the things that are going to get purchased first are going to be things that are perceived as less risky. And again, I think people are generally risked off right now. So the thing that I'm most afraid of is going out and bidding on something that looks really safe because I think there's going to be so much capital flooding to those things in the short term. Just like you saw that in public markets, kind of people try to fly to safety or fly to things that they thought were high quality. They weren't really like taking a swing at risk your assets. I think you're going to see the same thing happening in private credit first. It's just that everything happening in

private credit happens in slow motion because they're private transactions. And the other reason slow motion is occurring is defaults just take time. A lot of times default triggers are not, hey, if you have one monthly cohort that trips a performance covenant will default on you, instead of things like if you have two or three cohorts in a row, or if you have a quarterly cohort, or if you break a borrowing base and borrowing bases can be fixed because a servicer or an originator puts cash back into the SPV that you're letting against. So a lot of the things that require default just take 60 to 90 days

and we're still within that 45, 60 day window. And then a default happens and you've got to fight about it. Your lawyer sends like an angry email and their lawyer sends an angry email back and didn't do anything wrong. It's just kind of take it. time. And finally, one more for a nice thing about private credit is we sort of have thought clarity because we're not dealing with marked markets. We're not dealing with quitterty needs. We're not dealing with senior lenders. One of the things that I've always said about being a senior

lender, if you're a junior lender, you're juicing your returns. And sure, if losses occur, the losses that occur to you in an outsized way. But the more scary thing about being a junior lender is you have a senior who's really your boss. And they may make decisions because of other things happening in their portfolio. If you have a senior lender and your senior lender is some bank that has a bunch of other issues going on, you might be screwed, not because of anything you did, but because they're just trying to solve an issue and you had to pay them back. And so you can't work something out with your borrower in a way that makes sense for everybody. So there's all these sort of exchanges happening and they're just going to take a bunch of time.

Can you talk just to put some points of calibration out there for people? You sent me two really interesting data points, one from the Mannheim Oxen Index and one from Ally Financial. Maybe just share those kind of not the specific data points if you don't have them top of mind, but sort of the general trends that those data points point to. Yeah, I mean, I think when we sit there, you have to ask yourself, how bad is this going to be for you to even go post of what you're going to be willing to do? The things I sent over, Mannheim's posting, I think it's 11.8-ish percent down in terms of car prices, and that's despite the fact that people aren't really trying to sell use cars to put that

into perspective. In the last financial crisis, car prices were down at auction by about five and a half percent, most. This is quote unquote twice as bad. Allied financial, 75% of their poor plan financing are in deferment, 20-something percent of their consumer loans are on deferment. And all that means is you just don't know what's going on in there. And kind of back to the point I mentioned of your buying uncertainty, it doesn't mean that 25% in people have defaulted on ally loans. It just means that you have no idea what's going on. And if you go to the ally website, it's kind of easy. It says, hey, do you have an issue? Would you want to be put on deferment? They're

not making it hard, but it's definitely a black box. And then the other thing that we don't probably the easiest indicator of looking at what's going to happen in consumer credit is just unemployment. The numbers, everyone listening to this already knows what the numbers are. 26 million people unemployed were at levels that I've never seen before. And I don't think most people have seen. And the question is not really how high do they get, but more like how long do they stay that high. And again, that's all in the spirit of it's going to take a long time for transactions to start happening again. It's just going to take time for people to actually go back into their mom.

and drop a base case and drop a bear case. I think one of the things that people always used to do in lending is say, okay, let me like underwrite to a two times lost coverage ratio. And what that means is things have to get twice as bad as your base case for you to lose income. And often, let's call it four times as bad before people lose principal or whatever the numbers are. In this case, like you might genuinely have to underwrite this like a 10 times lost coverage. And no borrower who's taking capital who doesn't need to is going to take capital at the advance rates and the conservative levels that a lender would have to lend at right now.

to lend at right now. The 800-pound gorilla in all this is the government, and they're fairly swift fiscal monetary response to a lot of what's going on, and I would say very high apparent appetite for more of that sort of support. Do you think that investors are properly discounting that government participation in prices? Another way of asking the question is, you said there's just so much uncertainty, and especially in consumer, you know, unemployment's a key number. but if a lot of people are unemployed with fantastic unemployment benefits, does that change the picture? Does that mean maybe the stuff that's trading at crazy low discounts to par or crazy high yields might actually be attractive because there's this kind of backstop that we've never really seen before?

I haven't seen that yet because I don't think anyone is ready to underwrite to it until they actually see the results. I think what you're seeing instead is also instead of people looking to the way they're solving uncertainty is not by pricing their loans at higher yields. Instead, the way they're solving for it is just adjusting their advance rates. So if you were going to advance, lend money to somebody at 15% at 90% advance rate, instead now you're doing it at 15%, but at like a 60% advance rate, you're not saying, I'm going to take a view that the government's going to continue to support these people.

And so I'm going to keep it at 90% but just lend to you now at 22% because the world's changed. I think either people are not doing anything and are going to wait for the results to come in or they're just adjusting their advance rates to levels where even if they get it wildly wrong, it's hard to lose money. Can you define an advance rate for those that don't know what that means? Yeah. So let's imagine you have $100 of, let's imagine, Patrick, you're going to go out and make $100 of loans.

And you're asking me to give you debt, capital, finance those loans. If I give you $80 against $100 a loan, it's an $80 advance rate, which means you're fronting the first 20% of losses. And so it's basically just our way of talking about how much leverage there is. I would say the innovation, the quicker things that are happening to the market are less in my world, but more at the originators that we backworld. So I'll give you an example. There's a company called STEM that we work with. And STEM finances streaming revenues for musicians. A lot of them had their tours canceled. And so STEM is getting the opportunity to work with

artists that they may not have already worked with and finance them. And so they're reducing their risk by working with really high quality partners. And this could be like a huge moment for them. There's other businesses. There's certain ecosystems that are doing incredibly well. The Amazon ecosystem, the YouTube ecosystem, the Snapchat ecosystem. These are businesses that usage is up. And ad revenue really isn't as far down as you'd think, partly because for social and for a lot of these digital assets,

ads are being pulled from TV and instead are going on to Google. For example, because Google's a cheaper way to do it, easier to measure, hire ROI. And you're actually starting to see these businesses finance media assets at better than ever prices because traditional media companies need cash and are willing to sell those media assets. And so you're getting, again,

to work with large media companies that would have never taken a phone call for expensive capital before where the asset itself isn't performing badly because people are still at home watching and advertisers still need to reach people and they can't reach sports fans, for example, to ESPN right now, so they need to find other mediums to do it.

And for a media company, its bankers aren't going to give it any credit for a Snapchat account or for a YouTube account or for an Instagram account. There's no way they're looking at the balance sheet and saying, oh, wow, that YouTube library has value. And so these businesses, there's like a mismatch and understanding. And so it's really our originators that are seeing the biggest immediate impact.

And the other is they have a lot of questions to ask themselves. Do they pull back originations? One of the things that's going to happen and has already started to happen is origination demand has gone up because banks are going to be lending less. Traditional lenders are going to be lending less. And so these newcomers who do new types of, of financing where the world used to think that's complicated. I don't want to really figure it out. Now is kind of time people are trying to figure out how to get a new type of financing.

And so we're seeing their demand go way up. And the question is, do they pull back completely because who knows where the world's going, is the losses they would incur by pulling back completely and making no origination fees greater than the losses they would incur, they saw higher defaults. That's a model you have to run. What do I think the worst case scenario is? What losses would I incur in that default rate scenario and how does that compare to the loss of revenue I would incur if I do nothing? Some of them are saying, hey, is this a time that we take market share? One of the things that I think all lenders should be doing, if you are going to stay in the market, you should call every borrower that you've ever talked to who said no to your loan because of

price and ask them if they want a loan right now if you still believe they're high quality credit. So there's a lot of blocking and taxing decisions they're making at their level that are those bids are transacting faster compared to my world. Would you sum that up as saying a focus on quality or creditworthiness, not on rate of return is really the smart play here, meaning same rate of return but up your quality versus get your rates of return higher? That's absolutely one piece of it. And it's probably the biggest piece of it, which is our number one advice is don't pull back completely, be more conservative. If you have twice the level of demand, maybe don't make twice the amount of loans. Instead, keep making the same amount of loans, but just increase your pricing because if you charge higher prices, you can incur greater losses because the fees that you're charging, the rate you're charging will cover some of your losses and lend to people or finance people who are higher quality credits than you used to be able to get because your demand is higher.

So yeah, so we're basically just saying there will be a time to go toggle on risk again. But for now, if you can make the same amount of loans as you were making before, but at less risk, go for it. The other thing is we're looking for diversification in really tough times to lend. Maybe this is me. I cared less about diversification and I cared more about finding higher quality credits. And so in our credit books, for some of our portfolio companies, if they had the option to breach a concentration limit, but we felt like the answer was they were financing a higher quality credit,

we would say, yeah, you just go do that. Because we didn't really want beta exposure credit markets at the time because everything was overvalued. Now, you aren't willing to take that same concentration risk because, again, second order things are breaking in ways that we could have never imagined. And so there's all kinds of sort of de-risking things that you can do in the short term. The other thing, though, is we're trying to discourage our companies from chasing assets that are going to see low defaults in the next three to six months.

There is going to be certain things that appear that seem like, wow, they made it through the pandemic. Their default rates didn't tick up. And I bet you that's the first thing that all private credit investors is going to be chasing. And then you're going to have a bubble there of received higher quality assets. Whereas the stuff that used to be uncertain and did get hit, even if it ends up being a better place in the long term, is going to get completely ignored for a while. So step one is sort of defense and quality and everything you just describes or re-underwriting things. Maybe don't stop, but don't double focus on bring your average quality loan up.

Once that phase is done, what areas or pockets do you? think will then represent the biggest upside opportunity? And the answer may just be, we don't know yet, but what are the areas that you're at least thinking about or considering that as uncertainty declines might represent places to look? That actually doesn't seem too hard for us to figure out. There's a couple of initial actions. So last year and the year before, we used to underwrite assets that we thought were really great. And at the last minute, some JV investor who doesn't do a lot of private credit would come in and just take the deal from us at 300 basis points before where they ever should have. The first thing we're going is going back to all those lenders who probably now

have unstable capital bases because the lenders that were borrowing from weren't as stable as they thought they were. And so I think a lot of it's going back to what is the stuff that we always liked and just increasing the price that we're willing to offer them and go pick up coupons that we've always wished we had. And that'll be a really good opportunity. But more importantly, there is a new economy that was already getting created and this basically just hit the gas on it. So for example, e-commerce was obviously taking market share from physical retail, this forever made that go faster. And a lot of people who weren't shopping on Amazon and Shopify, which is crazy this is, many people still weren't. Now that's how they get

everything. And the Amazon economy is going to do incredibly, incredibly well. The third-party sales on Amazon are going to do well. And on top of that, e-commerce generally has so much more variable costs than physical retail. One of the interesting things is people used to look at these tech-enabled assets and say, oh, wow, they're newer, so they must be riskier. I think now they're going to say, wait, these tech-enabled assets have more variable costs, so they're more dynamic in changing market environments. They're actually less risky than physical retail, which is sort of like an interesting dynamic. It used to be to be an e-commerce company you were borrowing at a higher rate of return than a physical retail store. That'll never happen again. The Spotify ecosystem is going

to be really interesting. People are still at home watching Spotify. The Snapchat, TikTok, and Instagram ecosystems are going to be interesting. If you're a sports advertiser, for example, and I kind of alluded to this earlier and you need to reach sports fans. If you're Nike, you still got to sell shoes, but no one's watching ESPN or CBS or Fox Sports right now. And so how do you go reach those sports audiences? You've always been getting hit up by Instagram or by Snapchat and by the accounts on those platforms. And you may have been motivated, you might have allocated an experimental amount of your budget to those new platforms and to those new handles. Now that's how you reach people. And those businesses are going to forever be viewed as, just like Google is, a cheaper, higher

ROI way to reach audiences. And I don't think that's ever going to change. The YouTube economy, the YouTube economy was already quite large. It would have to become a permanent part of the American workforce. Gig workers, it used to be viewed that if you were a gig worker, you had less stable employment. You now have, quote, unquote, more flexible employment. You might not be unemployed, and if there's less work on Uber, you may have started working for Instacart.

And so I think that that fluidity of what your occupation can be might actually make you a better credit risk, not a worse credit risk. And so there's a lot of economies that we already started marching towards that suddenly became what the economy now is. And a lot of things that used to be perceived as, oh, that's tech enabled, that's new, new means risky, that must require a higher cost of capital, are now, wait, that's tech enabled, even during pandemics, which is going to be part of everyone's future investor conversation forever now, even during pandemic. pandemics, they're sustainable. Even when things are unpredictable, they can toggle up and down their costs. They're less risky. And I think that was an interesting shift. I'd love to hear more. You and me have talked so much about the YouTube economy. It's such a fascinating ecosystem, maybe starting there with YouTube, but also just the other online ecosystems that you think are most interesting and maybe surprisingly interesting as a result of this, everyone home online all day.

Start with YouTube. What have you seen so far, whether it's usage or advertising or other things going on inside that ecosystem that is compelling or interesting. Yeah, so just to explain it. So basically, when you see an ad play on a YouTube video, 50% of the revenue actually goes to the person who made the video, not to YouTube itself. So they split the revenues. It's 55 for the person they made it. And certain categories, you wouldn't really want to buy the assets.

YouTube's sort of an odd place. Viral videos, you have no idea how much money those will ever make. Videos with inappropriate content, advertisers try to avoid. And YouTube is having its own identity crisis of like, what is it really trying to be, how much governance doesn't want to have, et cetera. But it is the second biggest website in the world. It's not really a niche. Probably the future of cable.

Or if it's not the future of cable, it's a big part of what the future of cable is. And it's how people are doing their homework. It's how people are learning how to do things right now. And a lot of certain categories, you can actually price the assets and how much revenue, library videos, do. And YouTube, basically if you're looking at, and this isn't just YouTube. If you're looking at any Facebook, Instagram, Snapchat, if you're looking at any of these digital content assets,

there's a handful of toggles. The first is views. So right now, views across most of them are up as low as 20% as high as 100% up because people are at home watching. CPMs, which is the cost that advertisers are willing to pay for a view, might be down 50%, but that means advertising is flat. The views are up twice and CPMs are down half, and you end up kind of laying at the same place you were before.

And then on top of that, and there's still rate, which is one of the things that's sort of interesting, and I encourage people to do it at home. Kielan and I were watching Hulu last night. And when you look at the commercials, Hulu usually, depending on the subscription you have, and so maybe I'm showing how cheap I am, it has 90 seconds or whatever commercials. They weren't able to fill those ad spots. I was like, wow, that is like really sort of an interesting thing.

The other thing that was interesting about sort of these digital assets is a lot of them work on exchanges. And so the way the Google ad exchange works, your target, not that I know, have any relationship with Target, which is why I'm using them as my example, Target may decide that they want to spend $3 million a month on YouTube advertising. And so they do is they go to the Google Exchange and then type in, right now we're willing to spend $3 million a month on women between the age of 28 and 36 who live in X, Y, and Z states, and we're not willing to pay any more than X amount for 1,000 impressions. It's a real exchange. And so every time somebody

visits a Google page, their information is sent to the exchange. And then if Target was willing to bid on them, an ad pops up. The interesting thing about these exchanges, is they're similar to the stock market. You actually get real-time sentiment on how these retailers and how these advertisers are willing to spend. And so we've seen CPMs decrease and then come back up sort of even in the last week.

The first couple weeks of April, we're sort of gnarly. The last week has actually sort of bottomed out. And then we're actually starting to see an increase in revenues over the last week or so. And so there's actually been a great stabilization of these tech-enabled assets that don't rely on us reopening the economy. and don't rely on people walking to the store and people who knew about them,

but maybe had never taken a class on YouTube or had never really followed their favorite sports team on an Instagram account for the first time we're doing that and they're not going to stop. What about parts of the sort of digital world that aren't advertising based? So you mentioned maybe e-commerce is something that you've seen interesting trends in. Put some more meat around the non-media property, sort of advertising-driven part of what's interesting. digitally? Yeah, I think, and I'm being careful to only say some things I'm allowed to say, but there's definitely ecosystems in e-commerce that are going to do tremendously well. So one of the things that people don't appreciate is sort of diversity of how each industry is doing. So, for example, the luxury is going to struggle. Luxury brands, even if they're on e-commerce,

they can't lower their prices even if they wanted to because it would devalue the brand quality. Food is doing very well, but it depends on the category within food. If it's perishable, it's actually going to do more sustainably well. One of the reasons Curtis Pays is doing so well is because you can't hoard grapes, but you can hoard corn. So it's all these little nuances that matter. One of the things that we've sort of come to admire is a third-party ecosystem or third-party seller ecosystem on Amazon. So people don't really appreciate it, but two-thirds of e-commerce revenue on Amazon is done by sort of small businesses that sell through Amazon. I think the number is something like $150 billion of revenue per year right now is being done by those people. And it's an economy that

people really sort of ignore. And these are small businesses, like this is a huge part of the economy, and these are small businesses that are taking market share from physical retail. And there's going to be brand affinity and people are going to get used to those products. And they're probably going to become loyal shoppers of those products. The Shopify ecosystem is going to do tremendously well. These are people who are still selling their products online. When they used to advertise on Facebook, they used to compete against every other brand. But since advertising dollars have pulled back, it's actually a higher ROI for them than it's ever been to be advertising, and they're going to be able to take market share

from physical retail brands that shouldn't and can't be advertising right now. And again, people have brand affinity, and these are probably going to be a relationship that just don't come back immediately. So there are a lot of these permanent shift that's happening. And again, it goes back to it's almost wild to think that euth commerce was ever thought of as more risky than traditional small business when it turns out than this environment is doing, at least for now, tremendously better than anyone could have ever imagined. What have you seen so far in the early stage venture capital world, specifically around the types of deals that have continued to get done and at what prices? Venture capital has actually reacted way faster than private credit, which seems

counterintuitive. You might think, oh, in private credit, things are breaking, default rates must be high, how the heck our merchant cash advance doing, how are payday loans doing? Again, not that we do, sort of punitive MCA or payday. But how are all these sort of high-risk gas tests and they must be breaking like crazy? And for all the dynamics I mentioned earlier in the call, it really is sort of moving in slow motion right now. Venture capital, on the other hand, is moving really fast. And the reason is venture capital companies, by default, are always running out of money.

And when they raise capital, it's not because they're choosing market timing. It's because they raised money 18 months ago. They have six to 12 months of runway left. and there's no board member on the planet right now telling an entrepreneur, oh, yeah, things are definitely going to be better in a few months. If you can raise, you're going out and raising now. If you don't have to, you're going to lower your burn. We have seen across all a venture and across all startups,

there have been a lot of layoffs and a lot of people are trying to hunker down and see if they can push their fundraise off to the fall or winter or next year. But there's a good amount of companies that it's not that they're a bad company, it's just they had to raise. And so the valuations we're seeing right now are probably about 50 to 70% down of companies that are raising last month and this month. That'll start to come back probably even in the next 60 days, but they're going to stay down for a while.

And so much of the underwriting is there's a handful of dynamics that have with venture capital funds. The first is initially all these venture capitalists went on Twitter and told everyone, oh, we're open for business, screw the tourists. We don't really care about markets. The thing that's important to us is how you're going to do in the next. five to 10 years. If it's a good idea, it's a good idea, and we're still open. And I remember talking to a bunch of my friends in the space, and I was like, guys, the problem is not that the market's down.

The problem is that a lot of people got sick. Some people died. We all had to go home and we stopped doing anything. That's going to affect everybody. And then there was this huge influx of bridge rounds. And so VCs had a hard time doing new deals because they had a handful of their companies, their portfolio, that they were a hospitality company, a live events company. Their sales went down by about either 90 to 100%. And so you might have had a company that previously had 12 months of runway, their net burn just became their gross burn, or maybe the other way around it, their gross burn just became their net burn. They might have two months of runway.

And so all the attention went to solving those problems. And the attention went to, how do I help my portfolio companies mitigate their burn tremendously so we can push out fundraising for a while? And so that's the first order. The second order is then everyone went through their fund and said, how much drive pattern do I have left? And how much of my drive pattern will I need to use to lead insider rounds into my existing portfolio companies?

In venture capital, usually a series A firm will do series A deals, a series B firm will do series B deals, a growth firm will do growth deals, and there's some sort of validation of some third-party firm investing in one of your portfolio companies to create a new outside valuation. Many firms don't care about that, many firms do, but no matter what, funds were looking to themselves realizing that they were going to have to allocate much more of their fund than they ever thought they were going to need to, to lead insider deals, which means there it's going to be less opportunity to do new deals. And so just less names are going to get printed.

And so, again, in the short term, valuations, we were seeing things at two times, three times revenues on SaaS deals. We haven't, a company's growing really fast. I've never seen that before. For perspective, what would that multiple have been in December? Infinity. If you were a Series A company growing 100% year over a year as a SaaS business, 20 times revenue was not crazy, 30 times even, depending on the operator, depending on the fund, dependent on the growth.

I mean, growth was being valued at such an insane premium. One of these things I was saying to people is, if you were growing 100% year over a year, you could do any size round from any firm. If you were growing 80 to 100% year every year, you could figure out how to get around done, but it was to be hard.

Anything below 80% is just really hard. And now the question people are asking is, can you get to profitability with this round if you need to? and if not, can you get to a profitability with one more round? So again, I would say venture capital for the last 60 to 90 days was actually probably the best environment I'd ever seen. In terms of the attractiveness of the deals being done for prospective IRAs or something. Yeah, and a lot of the conversations, I mean, the conversation I was having with people,

so I think we did about four deals, which is a lot for us during that period. And I said, look, this is what I'm seeing in the market. And I would kind of list data points of, I wouldn't mean the companies, but I give them sort of characteristics of a company and evaluation. I'd say, this is what I've seen. This is what I'm willing to do. And there definitely was some feedback from entrepreneurs and operators that was, hey, like, there's no way we're going to close around about that valuation.

And I said, look, I hope you don't. And there's a good chance you're not going to. But opportunity costs right now is so high. And you can only underwrite so many deals at once that this is the bar I would need to dig in and potentially due diligence and close a transaction. And one of the mistakes a lot of operators made is pre-COVID, signaling was, I mean, signaling is always important, but signaling was maybe too important, where if you were offering a down round to investors, it meant something was wrong. And so what a lot of operators did during COVID is they said, oh, we're just going to reopen our last round. And the reality that just wasn't enough to get their round cleared.

And so then it became this awkward dynamic where they reopened their last round to, quote-unquote, be an investor-friendly. and then that didn't work. And so then they had to go back to people and say, oh, wow, we couldn't even close our last round. Now we're doing a down round. The operators who actually had the best time were the ones who said, we're not going to put a price on it. We have no idea where the world is.

We have no idea what the market is. They were completely humble about it. By the way, all the investors had no idea what valuations they should be giving either. I remember there was one deal that we were looking at where the VC and the operator were both really experienced and neither wanted to throw out a price first because no one knew what to do. and no one wanted to insult the other party. But they were humble about it.

They said, look, we're just going to talk to everybody, gather bids, and then we're going to see where the market is, and we're just going to raise it whatever the market is. But the whole reopening around or posturing or acting like, hey, this isn't going to affect me, I think that really damaged people. Outside of VC, what else do you think has been the wildest? You mentioned junior debt earlier as an area that's really interesting. I would love to hear about the price disparities, say, within a single company between junior and senior and senior. your debt and whether or not you think that's going to become a fertile area of opportunity on the long side? Yeah, probably in the next three months or so. So senior debt is a good position to be in because you're in control and you're not really a forced seller because as long as your

fund has liquidity, I mean, I think a lot of people, so far it seems like most people are doing a good job making sure they have liquidity, which I was, I guess, surprised in a positive way about. You don't really need to react to anyone else. Instead, you're reacting to the date of your portfolio. Of course, you want someone to make their interest payments. But what I mean by the data of the portfolios, you're actually looking at the data tape and looking at every single payment that's coming in and making sure things are going okay. And if they're not going okay, that's when all the negotiations, everything I told you about start to come into play, which is you're now going to spend the next 60 to 90 days trying to figure out a workout plan

with the originator or with the asset book to make sure that you don't get yourself into a knee-jerk reaction where you trip something, you try to transfer the servicing of the assets too quickly, anything like that. Basically, solution-oriented. But if you're the junior debt, you're not in control. You have a senior lender. The senior lender is the one calling the shots, because if there is a default in the loan book, they can call the default. You're the junior debt, and you now just have to basically act appropriately with whoever's on top of you. And so those are the places where we've now seen a couple of people trying to get out of positions, and we're starting to see those at 10, 20% discounts. It's not huge. And again,

and you're still buying uncertainty. And not only are you buying uncertainty on the loan book, you're also buying uncertainty on how the senior lender is going to act. And unless you know their senior lender really well and you know their position and you know what else is going on with their lives, it's hard to kind of buy their behavioral uncertainty. What other big trends are you thinking about, whether that's personally investing wise, areas that you're not involved in, that you'd like to be, which we joked before about how we both have felt this, not regret, but this funny feeling like, geez, I wish I'd done a little bit in real estate and now I'd be thankful that we haven't. What are some big seismic changes in your thinking personally or professionally

two months into this? The biggest one that I think that we're going to spend the next five to 10 years on is the new idea of what a small business is. And a small business is not a dry cleaner or a drugstore. And our portfolio company, Clearbank does an incredible job sort of unearthing what this small business economy looks like. Really, it's online. I have no idea what's going to go in the bottom of buildings. But unless the government does something that makes it feel a lot better to own commercial real estate or lease commercial real estate or be a physical retailer or have some minimum amount of cash, it's a mystery to me. So what we do feel convinced by is this Amazon third-party seller ecosystem is not going away. The YouTube ecosystem is not going away. The

Spotify ecosystem is not going away. So we do plan on financing small businesses, but our idea of what those small businesses is is completely different. And I don't think we're going to have to get too much more creative than that until I'm in a different stage of my life. There's so much wood to chop. And the market was crazy. The market just grew by like 100%. And we were almost one of the only lenders in that space to begin with.

And now we actually have our own proprietary data that we've been working off of for a few years. And all of a sudden, that's like the whole economy. it turns out that was less risky than whatever else was doing. So I don't really need to do a lot more. Does that then mean basically those listening? The two interesting strategies would be figure out how to build business online or enable others that do that? Or is that second category just already totally captured by Shopify and Amazon? The Shopify App Store I've always thought would continue to be like an interesting place to look for investment opportunities. So I do think servicing those companies will be interesting. I don't know whether it's staffing, whether it's warehouse management,

whether it's there's going to be stuff. I don't think we're going to figure that out for a few years because I don't think that we're really lean. We used to be known for being creative investors. The whole world just came to us. I don't have to be creative now for a long time. I can just keep doing what I was doing. The market just exploded in a good way. So I'm sure there's going to be people who are trying to invest in all that and the picks and shovels and my gosh, we're just going through the seismic shift of offline to online that we were already going through. But now clearly that's where the entire world's going to be. And so yes, there's always stuff that gets built around that. But I would say we're leaning away from creativity for at least next few years.

Well, a fascinating change from, I think literally our first podcast conversation was called creative investing. And it's funny to see the world have probably come to that, the categories you were interested in much faster maybe that even you anticipated. It used to be a novel idea that YouTube was going to take, continue to take market share from traditional cable. It used to be a novel idea that an Instagram account could be a commercial activity. And it used to be a novel thought that Shopify was going to end up creating an entire economy at top of that. And I think that became less and less controversial. And now it's just the norm.

Well, as always, I really appreciate your time, totally unique categories that we covered. again today, and we'll have to keep checking in as things progress. And good luck to you. Thank you so much for having me, Patrick. Hey, everyone. Patrick here again. To find more episodes of InvestorField Guide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com forward slash book club. After you sign up, you'll receive a full investor curriculum right away and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick underscore Oshag, OSHAG.

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