Odd Lots - How Oaktree's Head of Sourcing Finds the Next Great Deal

Episode Date: November 28, 2024

When it comes to credit investing (or really any investing), there's an analytic art in deciding the right price to pay for a security. But often that's only part of the challenge. First you need someone to want to sell it to you. In something like public-market equity, this usually isn't hard. Liquidity is deep, and the "ask" price is well known. In something like private credit, it's much trickier. Someone has to sell you the deal. Someone has to call you about it and tell you about it. So how do you get the call? And how do you know when to say yes? On this episode, we speak with Milwood Hobbs, the Managing Director and Head of Sourcing & Origination at Oaktree. Prior to this role, he was at Goldman Sachs, also in leveraged finance origination and sales. So he's been involved in numerous credit deals in his career. On this episode, he talks us through his role, what's involved in it, how he gets offered deals, and how he determines what opportunities are better or worse.Become a Bloomberg.com subscriber using our special intro offer at bloomberg.com/podcastoffer. You’ll get episodes of this podcast ad-free and exclusive access to our daily Odd Lots newsletter. Already a subscriber? Connect your account on the Bloomberg channel page in Apple Podcasts to listen ad-free.See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a very big. It's a very big. It's a lot. It's a firm. It's a few. It's, a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com

slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor. Bloomberg Audio Studios. Podcasts Radio News. Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Allaway. And I'm Joe Wisenthal. Joe, do you remember deal toys? Did you ever see those?

I never got a deal. I never, I do know what they exist. Well, you wouldn't get a deal toy unless you were working out. So I'm aware that they existed, but I don't, I never had one. I never saw one. I used to be slightly obsessed with them. So were they toys? Like, or were they like, like, or were they those sort of lucite, um,

Yeah, that's pretty much it. So if you are working in capital markets or in mergers and acquisitions and you completed a deal, you would mark the end of that transaction by, you know, getting some sort of swag, I guess. And it could be really boring. It could just be a loose site block or something like that. But some of them were really interesting and fun. And one of the ones I remember seeing was someone, it must have been working in like capital markets. It was a little toggle, like an actual talk, like think of like a railroad kind of toggle. And it was to celebrate the first ever pick toggle transaction. So can I say something? You know, we talked to, first of all, it's amazing. Second of all, you know, we talked to a lot of investors on the podcast. We talk to a lot of people

whose job in some way resembles our job, which is looking at screens all day or maybe looking at data. I think if I ever had gone into finance, I would have some job. that involved a lot of looking at screens and a lot of maybe looking at data, but mostly just looking at screens. We don't often talk to a lot of people who are in the world of actually talking to other people about making things happen. I never think I'd be good at that. No one wants to hang out with me, you know, stuff like that. And so I want to learn and talk to more people about how actually things in finance, whether we're talking about a deal, whether we're talking about a new issuance, et cetera, how that actually happens, how an instrument or security

actually comes into the world. Well, I am very pleased to say, Joe, that we do in fact have the perfect guest for this topic. We're going to be speaking to someone whose day-to-day business is talking to people, sourcing, and finding deals. Bringing things into the world. And someone who also knows exactly about that pick-toggle deal toy that I mentioned earlier. So I'm very excited. We're going to be talking, we're going to try to thread the needle between sourcing deals and also something else we've been interested in lately, which is private credit. That's right. All right. So without further ado, we're speaking with Millwood Hobbs. He leads oak trees sourcing and originations group. So really, again, the perfect person. Milwood, thank you so much for coming on all

thoughts. Thank you for having me. So I'm right, right, about the picktoggle toy. You've seen this toy. Yes, I've seen it. My favorite deal toys, there's two that stick out. When Ford spun out Hertz in 2005, I was part of that transaction. And so I have a set of car keys. And there's a track from Hertz. And it's, it's, it's, it's, it's, it's, it's, it's, it's, it's called loose sites. Yeah. And then the other one, which was pretty cool. I did the Mars Wrigley deal with Byron Trott.

And so I have two M&M. Amazing. Guys that sort of, they, they, they lay out the train. Do you have a room in your house that's sort of like I'm imagining high school athletes all their trophies, etc. Yeah. So, so, you know, I have, I, yeah, we moved during COVID in 2020 and we bought a house and I have like a real library. And then at library, there are two things from Investors.

some banking that I have. I have bank books from deals. We used to, we used to go to a printer, and we used to draft. Oh, like the pitch deck, kind of. Well, it's like a, it's like an actual, it's a glossy picture book of the deal of the transaction. It goes through transaction overview. It goes through company. It goes through business. And that was what folks used to actually underwrite deals back in early 2000. Yeah. And then I have Lusites. So I have a lot of Lusite. So the unit that you're leading at Oak Tree, that was created, I think, relatively recently in like 2020. 2020. What was the thinking behind that?

So the market, private credit in origination and financing of deals has evolved quite a bit. If you just go back to kind of pre-DodFrank, most private equity firms didn't have what we call capital markets professionals. And post-DodFrank in the migration and creation of a robust private credit mark, most of the private equity. firms have capital markets professionals who really spend time drafting, creating, structuring financings for the private equity buyouts. And what we figured out, Oak Tree, we were founded in 1995. We managed a couple hundred billion dollars. What we were figuring out when I first started in 2013, every strategy within Oak Tree kind of did its own thing. So if a deal came into one strategy and it didn't work, it just kind of died in that strategy. So what we decided as the market

evolve and move towards capital solution provider versus this fund does this and this fund does that. We created my group with the real purpose of a couple things. Number one is making sure we were focused on providing capital solutions versus trying to figure out what fit a particular strategy. Oh, I see. Yeah. And then the second reason we really did it is that, you know, capital is the commodity in our business.

Everyone has a lot of money. But how do you get the first call in the last call? And that's the relationship. So my team is meant to really spend time in developer relationships with the counterparties because, look, the reality of it is we shouldn't, we're not agreeing on, we have different investors. So the private equity firm has a different investor base than we have. And so the goal in my group is to, one, make sure the entire firm sees a transaction. And two, we're involved in the art of the deal, right? And so the goal is no one really should win.

Both parties should be just mildly annoyed. And how do you do that? Yeah. How do you do that? How do you do that? I love that. That's funny because we say that in journalism sometimes. Like, the goal is for everyone to be like slightly dissatisfied with the story.

Because if everyone's happy, then you basically put out a press release. Somebody's wrong. If one side is really happy, the other side's probably wrong. I know Tracy already more or less asked this question, but I'll just put it in a different way. Why do you just give us a sort of brief overview? If someone says, what do you do and how did you get here? Yeah. What did you do and how you get here?

Yeah, so you don't want my full background. Oh, I actually do because you've been in the market for a really long time. Yeah, yeah. Yeah, okay. Okay, okay. So, okay, I'll start from, I'll start from. So look, my dad was in public accounting. And originally, so I got a full academic scholarship to Rutgers to go to law school.

All right. I sat in political science and I would fall asleep and wake up and they were talking about the same thing. So I said, I don't think I can do four years of political science. So I switched to accounting because my generation, you did what the adult said to do. And so I switched to public into accounting. And my dad said, don't do public accounting, do banking. So I started out at a firm called Nations Bank, which is now, it's a predecessor to Bank of America.

And the most interesting job I had at Nations Bank, I was a controller for leverage finance. I was the controller and the youngest controller in the firm. And I said, I want to be a leverage finance banker, you know. And the reason why it sounds silly when you're at. my age, but they wore a nice tie, they wore a nice shoes. They were in big and finance. And at that time, Nation's Bank was a pretty big, uh, terminal B lender. And so they headed a group basically said, look, right now you're just an accountant. He said, go get a sales job and then go to business school. So again, I went to GE Capital and I financed, uh, commercial equipment. So rolling stock

assets, cars, trucks, forklifts, did that for one year to today and then went to Columbia business school. I summered at first Boston, and I summered in asset backs and leveraged finance, and then doing Georgia Bank in 2000 full time. And during that time period, I structured a lot of LBOs, Sun Guard, Neiman Marcus, U.S. Foods, Seridian first day. Neiman Marcus being the first ever picked toggle deal. Yes. And so you had that deal toy. I have it. I, you know, I'll be honest with you. I think I gave it to someone more senior. Oh. Should have given it to me. I would appreciate it. I know somebody who had. And then in 2007, I left Deutsche Bank. And really, and you sort of say, why would you leave Deutsche Bank?

And if you go back to 2007, the market was very concentrated. So versus today, there were eight underwriters who owned all the leverage finance risks. Right. So you could see the market, you know, when I got a call to say, hey, what leverage would you provide on a deal? I'd ask the private equity firm, well, what do you think the business worth? And they'd say, well, it's based on, you know, leverage. And so you could see that coming to a hedge. So in 2007, I went to Goldman Sachs. I did LBOs at Goldman Sachs and also did high-eal sales and joined Oak Tree in 2013. It's always interesting to hear someone's background. But I like how this dovetails with the actual development of the industry itself. Absolutely. And this idea that at one point there were just a handful of very

small or a handful of banks that ran leverage finance. And then of course we know about the proliferation of all that. So it's very useful to get that background. Well, why don't we dive into that a little bit more? So talk to us about how the credit market, the capital market, has evolved over the course of your career. Yeah. So look, when I first started, covenants were pretty standard. Amendments to deals were actually fairly standard. And as you moved forward by 2007, the majority of market was covalight. The one interesting thing about pre-Dodd-Frank was in the credit agreement, which is a document that sort of governs the loan, if you will. you had to hedge 50% of your floating rate risk. And so going into the cycle, two things that made sense then is, one, folks were hedged 50%.

And then the other thing is LIBOR, if you remember, back in 2007, was at 5%. So the spread to deals was 200250 to get to that 7.5% average LBO. Well, what happened at when Dodd-Frank, when the markets cried the world, the global financial crisis, rates went to zero, right? So companies actually generated cash flow in that cycle. The challenge or difference we have today is we've been in no rate environment. So no one really hedged, one. And then two, because there was zero percent base rates, the spread on deals was much higher. Instead of $200, $2502.50, $450, $600. So when $22, when rates started to move up, You actually had a situation where a lot of companies couldn't support the cash flows because no one predicted that race wouldn't move.

And most folks were not hedged like they were in 2007. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard. At Vanguard, institutional quality isn't a tagline.

It's a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing is subject to risk vanguard marketing corporation distributor.

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that this is going to restructure the financial industry, that there are going to be various activities, whether we're talking about trading, whether we're talking about lending, et cetera. These are not going to be part of the banks anymore. Talk to us a little bit about those sort of early post, you know, and we're talking 2009, 2010, those initial conversations that people were having about, oh, something, new opportunities are going to emerge from that.

Right. Well, if you go back to 2007, when a portfolio manager in a public side was selling risk in the market, the banks were the shock absorber to that risk. Right. So, you know, when I was sitting at Goldman Sachs, it wasn't unusual for us to buy $200 million of an issue. And it would be on your balance sheet. And it'd be on our balance sheet, right? Post what Dodd Frank did effectively is said, okay, if you go back to the leverage, and I hope I'm not being too technical, but banks were levered roughly 30 times pre-global financial crisis post their 15 times levered, right? So once you shrunk that liquidity or capital out of the banks, they can know. longer absorb the deals. And so what happens is, and this is why liquidity is really an important phenomenon, so when a PM calls the desk and says, hey, I have to move 5, 10, 15 million.

You're not really sure what their real size is because they know the market's not liquid. When I was in sales and trading, PIMCO or somebody would call and say, hey, I've got several million to move. And I'd say, well, this is your first call or last call. And they laugh. And they say why, I said, because I give you two different prices. And so what happens in a market that's less liquid is as they're trying to sell, they call different banks. And every time they make a call, a bank then assumes that there's more behind that to go. And so they re-wrack the pricing. And so in a public security, which is different than private, a public security can actually move pricing-wise without anything really trading. But on the anticipation,

that there's supply out there. And so that created, you know, and if you go back to 2009, private credit market was like $300 billion, right? Most of that was more mezz or off the run, not what we call our regular way direct lending, private credit, which we were active in, but we're doing it more on the distress or opportunistic credit side. And over time, because of the liquidity and capital requirements of banks, more of that has just migrated to the private credit market, supplemented by the fact that there are these

private equity professionals who are very efficient at looking at both markets and figuring out where they should play or where they should place their credit or their deals. I'm getting a lot of flashbacks to writing about corporate bond inventories at the dealers around 2012. So just on this note, is the pitch from private credit, is it basically execution. Like, you don't need to worry about us actually being able to do or complete this deal. Whereas at a bank, you know, they're taking into account leverage considerations, regulatory requirements and all of that. Right. Right. Right. So what a proper deal should be, right, if you're sitting in private equity, your job is to find the most efficient best price capital for your deal, right? The public market,

what they're very good at doing is saying, here is the indicative rate for a deal. And let's just say the indicative on a term loan is sulfur plus 400, right? Then the private equity firm comes to us and says, where will you actually own that risk? Right. So they get a level where we're owning, which won't be the indicative, because remember the banks are marketing, hey, we can get you the best rate and best execution. We're in the storage business. The banks are in the moving business. So they're trying to move the risk and we own the risk. And so we price the risk where we'll hold it. And if those two are not aligned, you would then and then what you add to that 400 is you add what we call flex. So if you take the indicative plus flex, that gives you an idea of what the

banks are willing to say that this debt will price. So let's say the flex is 150 basis points. So they know on the private equity side, they know worst case, the banks will own it at SOFAR 550. which the banks have gotten that sort of flex number based on their discussions with us to know where we would actually own that risk. Oh, I see. Yeah. So the process is how do you create an efficient auction to have the debt in the right market at the right pricing with the right structure? Okay, so here's my other question. When you are about to do a deal or when you find a deal, who are you actually talking to?

Is it the banks or is it like the companies that are borrowing in the market? So generally, in a... Who are most of your meetings with? Yeah. Oh, wow. Sorry, answer Tracy's question, but I'm just sort of like how I would have phrased the question. I'm talking to both, right? Okay, okay.

Everyone's my friend. And the goal is, the more conversations I have, the more informed I am of where the market is, right? You know, the interesting thing about public markets is that market reprises risk faster than private credit. Because there's a secondary market. private credit doesn't really have a secondary market. So what we're always trying to make sure we're understanding is, relative value between public and private. And so my conversation, let's say XYZ sponsor wants to buy a business, right?

And let's say it's a public company. The first call I'll get is Frenner's Barnes and say, hey, Millwood, we'd like you guys to look at a financing opportunity for a public company we're looking to buy. I'm like, great. I say, look, I'll put my compliance on the email and we'll do a conflict checks on that business because we don't know if we own the stock or there's existing debt outstanding. So it goes through a process where that company is actually vetted from a conflict's perspective.

Once it's vetted and that clears the process, then we get initial information on an LBO. And that information could be a selling memoranda. It could be an initial model. And so then we start the process. And what the sponsor wants to be able to do is from the preliminary information is get a sense for, do you like the asset or not? Do you want to finance it? Where do you want to finance it at? And what's your leverage and what you're pricing? So there's some high-level indication that they get from us to determine if we should move forward with a more robust diligence

process. So that's how it starts. And then at that point, we do a due diligence process on the asset, right? So we may have, we may call third-party consultants. We may do some background on it. We have a call with the sponsor. We understand. their investment thesis, like why are they making the investment? And then we talk internally and we have an investment committee and we discuss it. And then we'll iterate with the sponsor on diligence questions. And then at that point, it becomes, are you in, are you out? And so then once the sponsor kind of has a sense for who's in and who's out, now their goal is to get the right terms. And so there's a process around sending us their thoughts on the terms, right? And our job

is to figure out which of those we want to negotiate and which are we fine with. First of all, this is fantastic stuff. I want to talk more about, you know, what, or get to what it takes to be the first call because you said that's important. And I'm, like, curious, like, you know, Tracy and I are competitors. Why does one of us get the first call or not? But even before we get into that question, and it occurs to me that, you know, because you work for Oak Tree and there are multiple strategies within it, New York, I assume, with like different people on different committees and different funds, et cetera. Is there ever tension that arises between your recognition of the need to make the,

get that first call, versus what people on investment committees see as a fair price, right? Because if the investor is always trying to get every penny, right? Then at some point I'm going to stop calling Millwood. 100%. Talk to us about reconciling that. And I also have to imagine, just to sort of add on a point. part, reading this question, you know, it would be one thing if like it was a small shop

and one strategy, but you're looking at this holistically. Correct. Whereas the investor who's running a specific fund, there cares about their returns and doesn't care so much about the returns of the other fund or just the general. So talk to us about reconciling some of these tensions. Right. So the biggest tension is, like I said earlier, we don't necessarily agree on price, structure, leverage, right?

but what we're doing is I'm talking to that sponsor or that client or that company all the time. Hey, how's your family? I know where they get us. Go to school. I may do zooms with their kids. Hey, Millwood. So there's a part about being a nice guy to talk to. Hey, no, I want to go to Ocean Prime.

I know you know the manager. I'm bringing my family. Oh, so, yeah. Let me call. Yeah. So, yeah. So we are full service here. And again, like I said, the relationship is getting the first call.

last call. And by the way, out of 20 deals, I only care about the last two. So how do I pass 18 times? Yeah. So I can see the last two. So it really is a form of art, if you will. And what we're trying to do is demystify the negotiation. And we're institutionalizing relationships. So if XYZ sponsors in LA, they'll call me, say, hey, Millwood, who should I talk to? Okay, let me give you a list of folks. Because the more that that private equity firm or that sponsor or whatever client is feels like they understand our firm, the better the relationship. So we spend time making sure that they know who our CEO, Armin, is, or Bob O'Leary, that they know the PMs at the different strategies.

So it's not a scary monster. You know, when I, when I joined in the original oak tree, remember, we were more opportunistic, and as the market has evolved, and as we have evolved as a firm, we're sort of private credit and opportunity. And by the way, the client will say, no, it. I don't really care about one side of the house versus other. You're oak tree. Right, right, right.

So we have to sort of. And you're oak tree. I'm oak tree, right? And so I have to go to the market as one firm. Wait, talk to us a little bit more about what negotiations are actually like. Because I will say, we just had Sujit Indap on, who wrote a great book about the Caesar's Palace, LBO. Yeah, we're in that. Yeah, you're in that.

Yeah, I know it was not in it. Not you specifically, but Oak Tree certainly is. And there are some very dramatic negotiations that take place in that. Sure. Oh, yeah. I mean, look, sometimes you just, you get up, you throw your pencil in there, and you walk out of room sometimes. You know, so, you know, at the art of negotiation is what I say to my team is, it's not the negotiating point you're discussing at the moment. It's the points that are coming two points later, right?

You're always thinking ahead on the negotiation. You know, we did a deal for a business that wasn't really loved in the leverage finance market. And I knew that the type of business because I had done an LBO and the market really didn't understand it, but it was a great management team. Sometimes deals do well because the management team is very good and very articulate. And I knew this deal with struggle at a bank. And so when it was hung, which means the bank had the funded. They got stuck with it. They got stuck with it.

I called in and I said, hey, sorry. But I'll buy $50 million at $90. Okay. Right? Oh, gosh, I know what, 90. Wow, that's a deep discount. I said, well, you know, I think as you now realize that business is not, it's a little tricky business. And it was a public to a private.

So a private equity firm was taking a public company and making it private. And even though it was a declining margin business, there was a view that the public company expenses were high. So you could sort of map us. you can map a scenario where over 12 months they were going to cut some of the public company calls and create a more efficient, which would create more EBITDA. Yep. Right. So they sold it to us.

So now I'm a top five lender, right? With the right response, you have the right relationship, right? Well, sponsor, which, you know, they're meant to be opportunistic to. Cap structure. IbaDA grew. Cap structure looked good. So they wanted to do a dividend. Now, again, in a negotiation,

if you're doing a dividend, that means you're putting more debt on my capital structure. Yeah. Right. That's money that could go to you. That's money that could go to anybody with them, right? Yeah. And so, you know, the job of a sponsor at that moment is to call the top five lenders and say, hey, I'm doing a dividend deal and they take me from violently upset to mildly annoyed.

That's the job. Yeah. So this sponsor did not call us on that dividend deal. And so now I'm in a unique situation. They went to other lenders and got the 51%. to do the deal. And I felt some kind of way about that. Some kind of way. Some kind of way. And so I proceeded to try to figure out why folks would agree to this dividend deal. And so I called the market and a sponsor sort of said, you know, he calls me and he says, I know what? I hear you're

working against me on my dividend deal. I said, well, that's not actually true because you didn't call me when you launched it. So you said, but I thought we had a good relationship. I said, we do. I thought so, But you didn't call me, right? And so long story short, the dividend didn't go through, right? And so then we changed the structure of the dividend to allow, we shrunk the size of the dividend, we changed the original issue discount. And I told the sponsor, I said, look, unfortunately I'm going to sell the position when this closes. And the point of that story is sometimes it's life's too short.

And not all relationships are meant to go on forever. we still talk. I'm still a good friend. You still a good friend. But we haven't done a lot together since then because sometimes, you know, in a negotiation, if you don't see eye to eye, and that deal worked out, what happens if it doesn't work out? Yeah. Right? So sometimes you're managing relationships to keep, and sometimes you're managing relationships to not do on a business side.

But you always want to be friendly in this market because you're usually one person away from somebody that matters. Yeah. Actually, since we're on this point, that strikes me as very savvy and very wise and like probably a lesson many of us should learn in many realms that sometimes it's okay to take the L or let a proposal fall apart because life is long and other things happen at some point. We have listeners who are in college or young and they think about, you know, career trajectories, et cetera. I'm curious just from your perspective, this is probably a sort of attitude that you would hope. the people who work for you, cultivate, internalize, so to speak. How do you recognize who has that? And like when you think about like people that you want on your team, are you able to sort of like build intuitions about, you know, the people who can, who can think that way? Yeah. So good, good question. So I would say on my team, everyone is uniquely different and everyone

is exceptional at something and very good at everything else. And I think where you make a mistake in building teams, especially in our business, is you try to find someone who can be exceptional and more than one thing. So I'll tell you a good story. So when I was first starting out, I would fly to Dallas, Texas, and I would meet with folks in Texas. And I thought I was a pretty charming, knowledgeable person on the markets. And everyone in Texas was friendly. But what I figured out was by the time the deals made it to me in New York, everyone in Texas had already passed. So it's almost like wrong way risk. And so, They explained that.

Yeah, why was that happening? Well, because you're in Texas, right? It's a different culture, different market in New York. And in some markets, folks want to do business with folks they may see on the weekend or see in the gym or, you know, and so it's more of a, that person sits in New York. They don't really know me, right? Yeah, yeah. So, but if people in Texas didn't really like the deal, then you call the people in New York.

Oh. So I decided that I needed to put someone in Texas. So how do you hire people, right? So this is for your young audience. So I went to a conference, and he was kind of managing the room really nicely. So I gave him my business card. I said, hey, we'd love to spend some time with you. So I called him and we set up two days of meetings.

Well, he didn't realize I was actually interviewing him for two days. Because everyone says they have great relationships. Yeah. Everyone says, oh, yeah, I've got the best relationship, da, da, da, da. But how do you actually test that? So I spent two days with this person. And look, you know, high school football matters in Texas. I didn't play high school for.

I played high school baseball. This person plays high school football. And so you put someone in that territory that understands the local culture. And what we're trying to do is have a hub and spoke origination model where we have a global firm, but we try to talk on a more regional or local level. And that's what I think makes our sourcing origination, a little bit different. And again, people matter in this business.

And again, the goal is to get the first call and the last call. That person may spend a lot of time, you know, going to events, spending time with the families. Yeah. And ultimately, what you want folks to do is to show you deals because they trust you. And it's still a trustee business. Eating well shouldn't be complicated. But somehow it turns into recipes, prep, cleanup, and half your Sunday gone. Factors solves all that.

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What if you had the right design, the right lot and finishes, at the right price. Not someday, but right now. Register at Democrathomes.com and get everything you want right now. One thing I wanted to ask you, just going back to something you said about the management of a particular company being good. In credit, we've spoken about this on the podcast before, but we tend to think about it as avoiding losers, right? Whereas equities are more about finding the winners. How would love you said that. So I guess my question is like when you're looking at a particular deal, do you feel that you're making a bet on that business or is it just about looking at the numbers and making sure that, you know, you're not going to lose out? They're unlikely to screw it out.

Yeah. So, so interesting enough, what we're trying to do in a diligence process is figure out where there may be holes in that investment. We did one deal with a counterparty that we required them to switch to CFO. Just because the questions, it took too long to answer, like if I ask you, how many days does it take you to close your books? What percentage of that is manual versus automated? What are your management letters say in the auditor? You know, those types of questions, if you have to think about them or you say, I'll come back to you, as a CFO, that would be concerning. So, you know, our job is to protect our investors.

Yeah. That's our job. And what we're trying to do is make sure we understand the investment. And no one bats 1,000, right? If you look at the top 10 hiters in Major League Baseball, they strike out as much as they hit. So, you know, our job is to avoid losers, like you said, and we have to manage that through a process. Can you say actually a little more? I thought that was really interesting about some of the questions that you asked and the idea, like, why can't the CFO just quickly answer how long it takes to close their?

You would think that would be an easy? Yeah. I'm always surprised also just generally there's a bit of a tangent that even, you know, in 2024 with like all the computer and accounting systems. that like fraud still happens, that there are still ways, or, you know, companies like, we have a material weakness and we're going to have to, I'm always a little surprised that that can even still happen. I'm curious like how you're like this world of things just being wrong or ambiguous at companies.

I'd love to hear you talk more about that. When you're, when you buy a business as a platform and then you then buy successive businesses, more than likely they didn't have all the same financial system. Oh, yeah, yeah. And the integration process, depending on how quickly you want to grow it, drives how long you actually integrate. And so what happens sometimes is you don't fully integrate these businesses and systems. If you go back to failures of businesses in our market, SAP integration is a big sort of point of contention. And so businesses, you focus on risk

that you see time and time. So fraud, fraud, you know, there was a water business that was, you know, that was fraudulent that, you know, some banks lost a lot of money. You know, if you go back to like Collins and Akeman, which was an LBO long time ago, there was some fraud. And you could see what you're doing in a diligence process. You are looking for sort of what I call inherent weaknesses and the information you get back. In management letters, which the auditor is produced, is a good document that sort of highlights the risk of accounting systems, financial systems. And that's a pretty, systems tends to be a big driver of sort of integration issues. So this is a necessarily fraud, but you just reminded me of adbacks and deals and, you know, adjusted earnings

and things that can be inflated to make a transaction look a lot better than it actually is. The last time I remember writing about this was, I guess, gosh, five or six years ago, and the feeling back then was that there was more sketchy stuff happening on the valuation side of credit deals. Is that still the case, or has that been your observation over the years? Well, so the ad backs is an assumption and it's an ask to get credit for something that may happen in the future, right? Or it's saying something's happened previously that hasn't fully been flown through the financial statements and we want to get credit or we don't want it to affect our earnings. Every deal has adjustments. Okay.

So just start with the premise that adjusted EBAA will exist. And part of our job is to trust our partners that they're adjusting the right things. What happens is if you watch the financial statements over time, sometimes the adjustments never go away, right? And then you start to say, okay, this is recurring non-recurring. Right? We did a deal for a sponsor, and it was near year-end, and the sponsor is going through each line item of what they wanted to add back.

And you know what? I said, wow, we could go through this for three days, right, explaining why they add back. I said, you know what? You can add back $5 million. call it whatever you want. Right? So at the end of the day, what we're trying to do

is understand the rationale for the ad back. In a market like today, the problem is the rationale isn't fully explained all the time. And the amount of time you want to add it back

is kind of almost infinite. So you start to say, okay, and the sponsor's perspective would be I'm paying for that, right? Because I'm paying off that adjustee, but da, so you should leverage against that. The counter would be, I'm capped upside,

right? I'm capped at par. And if you go back to 07, a lot of the ad bags in some of the large LBOs never truly came to fruition. So if you take cap structures that were leveraged seven times, if you're adding back $100 million,

a $700 million more debt, that if the $100 million never comes through, at some level you could be over levered. So that's why you have to look at ad banks. And in the one notion, folks say documents are loose. Well, I would argue it's about asset selection, right? A document is not going to help you if you just underwrote the wrong asset. At the same time, a document, if you're doing well, and I'm not letting you lend more, what do you think I'm

going to do if you're doing well? I'm probably going to figure out a way to fix the document to allow you to lend more. So I think part of our, you know, business, you're right on ad bat, but, you know, cove light. The market is mostly cov light. And even when you think about structures with a covenant, a lot of times if you actually hit that covenant, it's unclear the business is a going concern at that point. If you need the document to save you, then you've already got a problem. Yeah, you're in. Well, since we're actually talking about documents and we have done a recent episode about so-called creditor on creditor violence and how that works, et cetera. One thing that came up with that and I'm also curious about it. It's like legal expenses and detail, like, you know,

every comma and all that stuff in these documents. I'm just curious, like, over the course of your career, how much have you seen, and to the, perhaps to the point that it extends, changes your expected return on investment, legal costs and the sort of rising lawyer fees, etc. to check those documents, regardless of how many covenants they have in them. And have you seen an evolution over time since you've just been in the business of how much of a deal resources end up going to the legal set? Yeah. How much do the lawyers bill you every year? Yeah. And what do you have you seen? So while I said, I'm going to now counter myself. Okay. While I said the document won't save you in a deal, it's very important you have a document

that sort of expressly documents what it is the intentions of the transaction. Yeah. And it's very good to have governance in the document, right? So if you just think about public versus private markets, in a public market situation, you're given two to three days to review a 300-paid legal document. Now, if the deal is going very, very well, arguably, there isn't a lot of opportunity for you to push back on the document, right? So you kind of take the document as is in the public market. And the issue with that, there's a lot of, and you said credit and correspondence, but there are a lot of opportunities for you to take assets out of a restricted group, create new co, and lending instead and take value away from existing lenders.

I think one thing that private credit is very good at and is focused on that part of the document, we've been very firm on making sure that the ability to take assets out and create new assets. or new financing or new capital, we've limited that quite a bit in private credit. But I will tell you, lawyers would argue inflation is real for them too, right? Yeah, sure, sure. So, you know, and a lot of that deal costs gets kind of, you know, born at the beginning. But yeah, lawyers, but you need lawyers, right? You need them. You know, there's two reasons why a deal usually gets hung up.

It's usually a legal or a tax reason. On the M&A side, on the financing side. And so lawyers are an important part of our process. And we spend a lot of time making sure we have the right counsel who can understand and be able to move with us. If this goes sideways, we want to make sure your bankruptcy and attorneys are really good. We want to make sure that you are put, you know, if you're thinking about biotech or something where IP is important, how do we make sure that IP you can't over license it? There's a lot of nuances in the document that we find lawyers are very valuable in our process. So I just have one more question, but, you know, you've had to.

had such a long history in this market and you've worked on so many interesting transactions. What deal are you most proud of? So when I was doing LBOs, it's almost like you're watching the company and the sponsor get married. And you sit in the middle of that marriage and you're kind of playing consultant. And all of my deals, I still talk to the CEOs of those deals because you get to know these people, your own planes with them for 10 days, you know, I know some of the quirks of some CEOs. You know, you just get to know people, you know, when I was doing the buyout, when Hughes spun out DirecTV, Roxanne Austin was a rock star, right? A female CEO running direct TV, a very profitable

business, and really get to know interesting people. So I would tell you there, there are, all the deals I'm pretty proud. There's probably one that was a bit of a disaster that, you know, we used to say, if you made one bond payment. Wait. Tell us about the deal. deal that you're least proud of. Yeah. So that was probably the deal. It's actually just a more interesting question, but nobody really wants to ask that first. Yeah. That's the more interesting question. That deal was hard. That deal was hard. It made one coupon payment and filed. Are you going to tell us what it is? No. Okay. I want to protect those involved. Okay.

Yeah. But good question. And I think, you know, so I've done a lot of deals and most of them I'm pretty happy about. All right. I think you mentioned, you take, all right, you want to be the first call. And to some extent being the first call is some combination of, you know, the ability to give decent pricing and also just being a likable guy that people want to talk to about their family, right? But I think you said you'd take 20 calls and maybe take, like, what's, so what you're saying, what I'm saying is out of 20 calls I get the last two are the most interesting. So how do you actually engage 18 times and it goes nowhere? Yeah. But like, is there a minimum? Like you have to say yes to, you can't say.

no forever, otherwise at some point you'll no longer be the first call, right? If I like, yeah, I might like talking to Tracy a lot, but if she never like in the end wants to consummate the deal, eventually she's no longer going to be my first call. What's how you say no? Okay. So talk to us about saying no, but still maintaining the first call. Sometimes, and we don't say no, we say, here's how we can get to a yes. Okay. Right. So sometimes you give a path to a yes. Right. Sometimes in a market like we're in today, you know, I'm not clear, it's not clear that someone takes might know offensively. There's a lot of capital. So it's easier to say no in this market than a market where there's not a lot of capital. And generally, we may say no, it may be a concentration

issue, maybe we feel like we have too much of that type of risk on our books. It could be an attachment issue, like leverage or attachment could be a problem. It could be that we had an issue with a similar business and maybe our LPs are fatigued in that type of space and we don't want to, you know, sort of bring it up again, there are host of reasons why we may say, no, we may not get there fast enough, right? That happens in this market. But generally, I think we're a pretty quick study, and what we are very good at is we do exactly what we say we're going to do.

So if we put something on paper, we're going to stand by that. And I think that goes a long ways. And I think if people say, well, why do they call, why do they call it a tree? I think we price risk, right? So in some markets, that's a real big competitive advantage. And I think we don't BS people. We say what we can do. We do what we say.

And that's it. And so sometimes our answer is, yeah, we like it, but we don't love it. But if the sponsor or somebody is able to say, well, Oak Tree's involved, right? That gets credibility to the deal. And we can help them get it done by saying we're involved, but we may not be the anchor. We may not lead it. You know, and when you're managing the size capital, we need to write three to four, $500 million checks on most situations. So we're always looking at the biggest deals with the

largest sponsors. Generally, those are safer plays than the lower middle market. So we think there's less competition when there's only seven of us that can write large checks versus in smaller deals, hundreds of folks can write small checks. I have one more question, actually. I just remembered. But you mentioned earlier that you want to be friendly with everyone, including the banks that you're ostensibly in competition with. One thing that's been happening recently, it seems, is that a lot of deals that were originally done in the private credit market are getting refinanced in the public market by banks. Yeah. So, first of all, why is that happening?

And then secondly, like, is that a concern for someone like Oak Tree? That is great. Like, if we can be on two or three year interim capital in most situations, that's good. The reason why they're going back to the public market is there's a spread between public. in private. So there's a cost reduction element. And then for the sponsor, there's more flexibility. Private credit is not meant to be the most flexible. It's the most efficient, but it's not necessarily most flexible. And if I can create an institutionalize and have a broader investor base, right, sometimes I can get more things done if a lot more people own it at very small sizes versus

five or six owning at a chunky sizes. So it's actually, you want a healthy market, public and private, right? And when most folks say, oh, you're losing deals to public, I'm like, well, we probably should have gone to public market anyway, right? It's rated. It's an existing issuer. It's been in the public markets. It's just staying in public markets. You know, if you think about the private credit market, we're $1.7, $1.8 trillion going to probably $3 trillion. There's ABF, asset-based finance, which is a new phenomenon, which isn't really new, right? GE Capital was a large ABF lender. But there's $3 trillion of dry powder at private equity. farms. There's enough for us all to do and be happy. All right, Millwood Hobbs, thank you so much for

coming on all thoughts. That was fantastic. That was so good. Thank you so much. I'm so glad we made this happen. Joe, that was so much fun. That was an unusually fun and good episodes, even though all of our guests are the perfect guest. You know, I'm, I really like, and I think we should do more about talking with the people whose job it is to be nice to people and hang out with people. Yeah, because Because that's like an element that still... Yeah, yeah, we could. We could. But that's like an element in finance that's still... You know, like I said, we talked to a lot of screen people and I'm a screen people.

I'm glad that there are still parts of the industry where there's a big role for likeable people who can maintain relationships and stuff like that. And play golf. But that's part of being human, right? Don't you have a whole song with the title, like, all my friends are online or something like that? Yeah, all my friends are on my phone. Yeah. Yeah. Like, I want to know more people who have... Friends who have friends, IRL.

Yeah. All right. There's a lot to pull out of that. I did think, like, Millwood's early point about banks being in the business of, like, pricing and moving risk very quickly. Mm-hmm. Was a good one because I think, like, that's kind of a fundamental difference with private credit. That was really interesting. I also, and it was really interesting hearing him talk about the tensions that emerge because you want to be the first call.

and you want to have a reputation for at least saying yes, 10% of the time or something like that. Yeah. With the demands of the actual PM who doesn't care about all the times, you have to say no. You know, I think this is probably a sort of asymmetry that comes up in a lot of sales-based businesses, right? Where you have some salesperson and their job is to hit a commission or something like that. And then you have like a product manager who's like, no, you can't price it at this. Or we can't move the product this fast. Yeah.

This is just sort of like an interesting dynamic that emerges in all businesses. And I really enjoyed hearing him describe how he negotiates that implicitly. The negotiations. Because a lot of these deals involve like so many different entities who are all coming at it from a different angle with a different incentive. Yeah. So much so much there. We'll have to talk to Melody. Yeah, we should.

All right. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Joe Wisenthall. You can follow me at the other.

the stalwart. Follow our producers, Carmen Rodriguez, at Carmen Armin, Dashel Bennett at Dashbot, and Kail Brooks at Kail Brooks. Thank you to our producer, Moses, on Dom. For more Oddlots content, go to Bloomberg.com slash oddlots. We have transcripts, a blog, and a daily newsletter. You can chat about all of these topics 24-7 in our Discord. Discord.g. slash oddlots. And if you enjoy Oddlots, if you like it when we talk about how to source deals in the private credit market, then please leave us a positive review on your favorite podcast. platform. And remember, if you are a Bloomberg subscriber in addition to getting our daily newsletter, you can also listen to all of our episodes absolutely add free. All you need to do is find the

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