How does a private equity firm grow to be one of the industry’s powerhouses?
Like any other enterprise, it’s likely to start small – but also to find a new way of doing things, said Joshua Harris, co-founder and chief investment officer of Apollo Global Management and a keynote speaker at the recent Wharton Private Equity & Venture Capital Conference 2014.
“We pioneered the distressed-to-control business,” he said, recalling the firm’s origins in 1990. “We started really small — 10 individuals doing deals.”
Previously, investment firms typically bought companies the way a couple would buy a house, with a relatively straightforward exchange of cash for equity, he explained. But Apollo’s early deals involved purchasing a troubled company’s bonds on the secondary market and then, through a bankruptcy or other reorganization, converting this stake into equity with majority control. Early ventures involved firms like Vail Resorts, Culligan and Samsonite. “It was pretty novel back then. Nobody was doing it.”
Today, the publicly traded firm employs about 700 people to manage about $160 billion in assets. The stock (ticker APO) returned just over 50% in 2012 and more than 104% in 2013.
At the firm’s founding in 1990, conditions were especially ripe, an opportunity that comes up only once every 20 years. “It was a unique-set situation,” he said, recalling that the landscape was changing as the government clamped down on the junk-bond industry that had boomed in the 1980s. Just out of Harvard Business School, Harris felt that risks were unusually low and opportunities high. He and other Apollo founders, such as Leon Black, were veterans of Drexel Burnham Lambert, the junk bond specialty firm that went bankrupt in 1990.
Over the years, he said, Apollo has flourished by staying flexible, acquiring either equity or debt as opportunities were unearthed, but always with a value orientation that emphasized getting a good price at the start.
As time passed, that flexibility paid off as market conditions evolved. A key trend of recent years has been government pressure on American and European banks to reduce risks, he said. That is expanding opportunities for the PE industry, which has plenty of room to grow: It manages only about $1 trillion of the world’s $80 trillion to $100 trillion in assets.
“Banks are getting smaller,” and PE firms are moving in to run risky businesses that banks once financed, he said.
At the same time, there are plenty of investors — such as sovereign-wealth and pension funds with long-term perspectives — that are looking for the kind of market-beating returns sought by PE firms, he noted. Pension funds are especially hungry, because returns in their traditional investments such as bonds are not keeping up with the rise in health care costs. “In every case, there’s this search for yield.”
All that bodes well for the PE industry, he added. “We find ourselves in the situation, for the first time ever, where we have more money than we can spend. Our growth is limited only by our ability to find good assets.”
Historically, Apollo has returned $2.50 for every $1 invested. Going forward, investors may settle for less, Harris said, but Apollo will continue to strive to deliver “best-in-class returns.”
In today’s climate, investors are choosier about their PE investments. That means money will gravitate toward the large firms with solid track records, and those niche firms that offer a unique approach, in Harris’ view. Firms in the middle could get squeezed. Starting a PE firm will take bigger commitments from investors than in the past, with $500 million no longer being enough.
“If you don’t know what your strategy is, if you don’t know why you exist and what your points of differentiation are over the 300 other firms, then you are going to be in trouble.”
Outside of Apollo, Harris is known for his lead role among partners who purchased the Philadelphia 76ers basketball team in 2011 and the New Jersey Devils hockey team in 2013. Though these ventures are separate from Apollo, a private equity background was key to his decision to get involved in professional sports, Harris said.
As a Wharton undergraduate with family ties to Philadelphia, Harris was a longtime Sixers fan, he said. And his PE experience had often involved carve-outs, or “buying little jewels” buried inside big corporations. The Sixers, at the time owned by Comcast Spectacor, looked like they could benefit from the kind of hands-on guidance PE firms give their acquisitions. Over the past three years, Harris and his co-owners have given the team a new coach, general manager and chief executive. “I feel very good about it…. It takes time.”
“Try to be clinical and unemotional. What’s the upside and what is the downside?”
And although there is a big emotional reward to owning pro sports teams, they can be good business investments as well, he said. As with the Sixers purchase, Harris feels he and his partners paid a good price for the Devils – consistent with his long-time value-investing PE strategy.
In the long run, professional teams can benefit from a global fan base, he added, noting there are millions of pro-basketball fans in China. In addition, some teams are evolving beyond performance-based entertainment to become media companies. And by owning two teams, Harris and his co-owners can create some synergies with strategies like overlapping management and sponsorships. While human judgment will always be part of sports management decisions like selecting players, there also is room for more sophisticated analytics, he noted.
What’s his advice for business students considering PE careers?
Harris suggested working for a blue-chip financial firm for three to five years, to get experience and put some money in the bank. Then, before starting a new venture, he said, “try to be clinical and unemotional. What’s the upside and what is the downside? If there is a downside, what’s the other scenario?”
He also urged students not to overlook practical matters. “How will you survive and feed your family” if the going is tougher than expected? If, on balance, such questions have good answers, “then go for it.”
Students should acquire solid financial skills, he said, recalling that he had done a two-year program for analysts and then earned an MBA from Harvard. “I enjoyed finance…. If you fake it and you don’t really like it, it’s not going to work out.”
Private equity, he observed, can offer a fast path toward running a business. And it can be very lucrative. “That’s not the only reason to do it, but it’s a positive – better than the reverse.”