The world of private equity has been in a shambles since the onset of the financial crisis, but some executives see that as an opportunity rather than a threat. Among them is David N. Roberts, senior managing director of Angelo, Gordon, who manages the firm’s private equity business. A 16-year veteran of the firm, Roberts also founded the firm’s opportunistic real estate area.
During a visit to campus recently, Roberts pointed out that while the government’s stimulus programs have not yet had a widespread impact, some opportunities are starting to open up that could ease the credit crunch. “The best government programs are the ones where the government is stepping into the financing markets, in a creative way, and trying to lower credit spreads,” he said. “For example, they have just started something called TALF, where they are making money available to make loans to help people like us buy triple-A rated securities. What that will do — it’s really just started — is to make other triple-A securities trade at lower interest rates. That will trickle through the economy to make credit more available.”
Roberts also noted that though opportunities do exist, they are rare. Each private equity firm has had to adjust to at least two trends in the market. “One trend is that most people have legacy portfolios, where they have companies they need to deal with and decide: Is this company worth nursing back to health? Is there a way of restructuring the balance sheet? How do I preserve value? Does it make sense to put capital in? A lot of private equity talent and energy is being devoted to that. The second trend is that the traditional leverage buyout is off the table, for now and for the foreseeable future. So when we’re looking at transactions, by and large, we’re looking at transactions that have no leverage, where you’re buying all equity. And therefore, you have to come up with prices and returns that make sense in that context. We’re finding some situations, but they’re few and far between.”
Knowledge at Wharton: To begin with, I wonder if you could tell us a little bit about the 16-year career that you have had in private equity and some of the opportunities that you see today because of the crisis in private equity as well as some of the government funding coming in through the bailouts?
Roberts: Private equity, like most alternative investment strategies, is cyclical. It is perhaps too simple to say — but I think it’s accurate — that it is a good time to buy when valuations and multiples are low, and there is not a lot of available debt. In hindsight, it wasn’t a very good time to buy when the opposite was the case, when lenders were throwing debt at everybody and when multiples were high. You now have a situation where it’s very hard to borrow. That is forcing acquisition multiples down. There aren’t a lot of sellers yet, but we believe there will be because of the necessity to de-leverage. So we think the next few years will be a very good time to be putting money to work in private equity and finding very good values.
Knowledge at Wharton: We read in the papers about the government’s stimulus packages and the bailout funds. Are you starting to see any effect at all of the government’s efforts to prop up the market?
Roberts: I don’t think there’s been any real effect yet from the stimulus that you can point to. The best government programs are the ones where the government is stepping into the financing markets, in a creative way, and trying to lower credit spreads. For example, they have just started something called TALF, where they are making money available to make loans to help people like us buy triple-A rated securities. What that will do — it’s really just started — is to make other triple-A securities trade at lower interest rates. That will trickle through the economy to make credit more available. I do think people have to be patient. These programs are not going to be ushered in overnight. They’re very complicated. There are a lot of issues to get through. But I have a lot of confidence that the people in government know what they’re doing, and that they will eventually get these programs going in size.
Knowledge at Wharton: Are you seeing any deals already? And if so, what kind are they?
Roberts: The first few deals that have come out are in this program called TALF. My firm has not yet participated, although we’re interested in participating and will look to participate as we see more and more transactions.
Knowledge at Wharton: What are some of the other trends that you are seeing, in a nascent form, in private equity these days?
Roberts: I think everyone is having to adjust to at least two major trends. One trend is that most people have legacy portfolios, where they have companies they need to deal with and decide: Is this company worth nursing back to health? Is there a way of restructuring the balance sheet? How do I preserve value? Does it make sense to put capital in? A lot of private equity talent and energy is being devoted to that. I think the second trend is that the traditional leverage buyout is off the table, for now and for the foreseeable future. So when we’re looking at transactions, by and large, we’re looking at transactions that have no leverage, where you’re buying all equity. And therefore, you have to come up with prices and returns that make sense in that context. We’re finding some situations, but they’re few and far between.
Knowledge at Wharton: You referred to TALF, which is one of the sources of funds for people. How are other deals these days being funded in this tight credit situation?
Roberts: Apart from the government, there’s not a lot of leverage being offered at prices that are reasonable. And that’s part of the issue. If you’re considering making a new loan, or making a new investment, you have to compare that to loans that are already outstanding in the secondary market, and where you could buy them. You can buy fairly high-quality loans, by any sort of historical measure, to yield in the 12% to 25% range, if you know what you’re doing and you have the research capability. So, for anyone thinking about making a new loan, it makes sense to try to compare that to what you can buy on the secondary market. Therefore, a lot of what the government is trying to do is to get those spreads to compress, to be lower, which, in turn, will incentivize banks and other financial institutions to make loans that are new. But until the existing spreads go lower, it’s very hard to justify new credit.
Knowledge at Wharton: Looking a few years out, considering the trauma that private equity and the financial industry overall is going through — how do you expect private equity to be transformed in the future?
Roberts: A lot of institutions will be disappointed with the returns that will have been earned in the monies that were raised in 2006, or put to work, I should say, in 2006-2007. So I think that the private equity business will shrink in terms of the number of firms and probably the amount of money that’s at work. But I think it is still an asset class that can provide good returns, and you’ll still see sophisticated investors and institutions wanting to participate in it. What you will probably see, though, after the cycle, is people recognizing the cyclical nature of it, like many other assets classes, where you want to be careful as to when you invest in it. The idea that you should always be investing the same amount in private equity every vintage year, as it’s called, may be challenged.
Knowledge at Wharton: Coming from the global look at private equity, as a whole, to your firm — you’ve been in the leadership role at Angelo, Gordon, for a while. How did your firm get impacted by the transformation of the market? And what strategies did you adopt to deal with this change?
Roberts: Using a baseball analogy — although as a Mets fan, I don’t like using that in Philadelphia — we have always been a firm that strives to hit singles and doubles. We have traditionally not used a lot of leverage. We’ve been conservative in terms of our funding. So while we generally have been long — and we’re generally not short-sellers — and seen some mark-to-market corrections, we have survived. Thankfully, we have money to deploy in this environment. And we have actually been growing, and hiring people, as well.
Knowledge at Wharton: Where do you see the opportunities for growth?
Roberts: We have a new unit that we brought on board last year that invests in residential mortgage-backed securities. We saw that as a big opportunity. That’s a huge market. We continue to think it’s a big opportunity. We have added to the area that I oversee, private equity, recently. We hired a senior person to add on to our staff because we see a lot of opportunities there.
Knowledge at Wharton: Do you plan to change your strategy at all in this environment? And if so, how?
Roberts: You need to take two things into account in private equity, when you’re pricing a deal. One is, you cannot count on leverage very much, if it all. And so you have to structure and price a deal with that in mind. Number two, you have to price in a continued downturn. It depends on the industry and the company, but you can’t count on this turning around very quickly and all of a sudden there being a great economic recovery in 2010, for example. That leads you to price very conservatively and to be patient. But we are out there very aggressively looking, because in order to find the right situations, you have to look at a lot until you find the right ones.
Knowledge at Wharton: What makes the situation the right one, from your perspective?
Roberts: In this environment, it’s typically going to be a seller that doesn’t have a choice about selling. If you owned a company and you were not in any hurry to sell, and you thought the companies’ prospects long-term were quite good, this would not be a very good time to sell. It is what I would call an exogenous factor. In this environment, that typically means that a company has too much debt. So they either need to change their capital structure and change their debt into equity, and they need an infusion of equity, which gives us an opportunity to take ownership — or it might be a company that needs liquidity, because it’s overleveraged and needs to sell part of itself quickly. I think what we’re going to be looking at are more forced sellers. We have certain industries that we like to look at, including financial services, including health care services. We’re doing a lot of looking in the consumer retail area, but that’s still a very scary area and one we haven’t done very much in lately.
Knowledge at Wharton: Would you give an example of a deal that you did, and how exactly it followed the principles that you just described?
Roberts: Sure. We do all sorts of what I would call unusual niche transactions. One of the businesses that we’re in is buying used semi-conductor manufacturing equipment. We’ve done a number of transactions over the last seven years or so. We had not found a portfolio to buy for the last two or three years, because the competition had grown quite fierce. We found a transaction recently where we used no leverage, and we felt that the pricing compensated us, so that we could assume a much longer time frame to sell and take into account the current recession or depression in the semi-conductor manufacturing area. But it’s a very inefficient, illiquid market. So, that’s an example of something we’ve done recently.
Knowledge at Wharton: You just spoke a little earlier about how you expect private equity, as an industry, to change in the future. As a firm, what kind of capabilities do you think you will need to succeed in the new environment? And also, as an individual, what are you doing to build those kinds of capabilities?
Roberts: There are still a lot of private equity capital that’s out there, so you’re always competing with another firm. I think that you have to present yourselves to somebody, whether it’s a management team or a seller, as being an attractive party, an attractive counter-party. The way Angelo, Gordon is built, we’re a multi-strategy investment firm. Under the same house, the same roof, we do a number of things, including real estate, distressed debt, commercial mortgage-backed securities, residential mortgage-backed securities, triple-net lease and so forth. And of course, private equity. So, we look for ways in which the other parts of the firm can help us get a bit smarter, or maybe add value to a company through our knowledge or through our network. You know, I would say the most important thing I’ve done recently is I made an opportunistic addition to my team — a very senior person from Goldman Sachs, who is looking to move from the investment banking side to the private equity buy side. There’s a lot of very talented people out there. Just like there’s a time where you can be opportunistic to make good investments, one of the most important things that you do at any business — particularly in a service business like we have — is to find the right people. This is a time not only to make great investments in companies, but also great investments in people.
Knowledge at Wharton: That’s a great point. Looking back on your career, what would you say is the single biggest leadership challenge you have faced? And how did you overcome it, and what did you learn from it?
Roberts: I think that a big challenge for me was when I transitioned. I started the real estate group at Angelo, Gordon in the early 1990s. I was a financial real estate person. I could analyze a property in terms of the financial characteristics. There was a lot for sale, and it was relatively easy to buy things at very big discounts and make a lot of money. I realized, three or four years into it, that this could be a terrific business for our firm, but that really to grow and to be there — to be able to compete effectively — I thought we needed somebody who had more what I’ll call “real real estate experience” than I had. Not just from the financial side. So I made the decision that I should go and effectively find someone who is better than I was, and replace myself and go off and start a private equity effort. Which I did. I think it’s always good to ask yourself, “Am I the best person at doing what I’m doing? Can I find somebody who’s better than I am?” It’s difficult and humbling to say to yourself, “Yes. There is somebody who can do the job better, and I should go out and find that person.” I go back to that a lot when I’m thinking about different tasks and who should do what. Am I the right person to do this, or is there somebody better? And I think that may be a more important overall general skill than any specific skill that one can have.
Knowledge at Wharton: That’s a fascinating answer. Thank you for that. One last question. How do you define success?
Roberts: First and foremost, I couldn’t define myself as being successful without the context of family — my wife of 23 ½ years who’s my best friend and the love of my life, and three children who make me laugh more than anyone else. I start with that as a premise. And then I think success has a number of parts to it. I look forward to what I do every day. I feel rewarded, both materially and intellectually. To me, both are important. And just kind of looking forward to the future is a very key part of success. And I do look forward to the future.
Knowledge at Wharton: David, thank you so much for speaking with us today.
Roberts: It was my pleasure. Thank you.