Steven Tananbaum: The Evolution of Credit Investing and AI Opportunities

0:05John Waldron:So when I think of AI on the credit markets, I think of it two ways. First is economically, because it's such a driver of our economy. It's hard to see how it's going to actually accelerate from here. So the issue is if it de-accelerates, what's going to be the impact? That's probably, to me, the biggest issue. And if it de-accelerates, will people be taking down their economic growth assumptions? And then there's the trying to line up where the best opportunities are between the different markets. And it could be the investment grade market, could be the better risk adjusted opportunity.

0:41Steven Tananbaum:Welcome to Goldman Sachs Exchanges, Great Investors. I'm John Waldron. I'm about to sit down with Steve Tenenbaum. Steve is the founder and CIO of Golden Tree Asset Management, a credit manager with over$70 billion in assets under management. He also happens to be one of the sharpest and most successful debt investors in the world. Today, I'll find out what's behind his success and where he sees opportunities ahead.

1:09Steven Tananbaum:Steve, welcome to Great Investors at Goldman Sachs. John, it's great to be here. So your first job was at Kidder Peabody, I believe? Yes. And then Makai Shields? Yes. Which is where you and I met? Yes. How would you describe your early career and lessons learned in those first couple jobs?

1:23John Waldron:So when I think of Kidron Peabody, a two-year investment banking training program focusing on M &A and high yield. And I went from an environment being a student where I had 25 to 30 hours of work each week to having 100 hours of work. So very overwhelming. I'm sure that you could relate from your experience at Bayer. And I was overwhelmed. So I had to have this strategy of, okay, what do I want to accomplish? How am I going to curate my day? and really be very deliberate about that. So that was probably the biggest memory of Kidder was how do I approach a day? What do I want to accomplish and be very deliberate, results-oriented.

2:04John Waldron:In Mackay, I get there and within two years, they give me the portfolio to run. So it's about a half a billion dollars. It's ranked 89 out of 91, which I didn't realize for anybody who's about to take over a portfolio, that is the best position that you can be. That was a gift. Yes. Yeah. There's only one place to go. And I was proud within three years, we took it to number one. But my approach was, okay, how are we going to do better? And I had a couple of moves. The first move was, if I think earnings are going to be better than what the market does, I bet the bonds are going to go up. So we had that earnings momentum.

2:45John Waldron:And the other was for some of these distressed names or stress names, which there were a lot in the early 90s, this was around the S &L crisis, that if there was intrinsic value, if companies were trading below intrinsic value, then there would be interesting creates. So for something like an RGR and Abisko, that would be the earnings momentum and that they could grow into their balance sheet. And it seemed like with Philip Morris at nine to 10 times EBITDA, and you can create RGR and Abisko closer to four times in the mid to high teens, that there was something to do there where they could equitize part of the balance sheet and that would be good.

3:23John Waldron:Or six flags where you could create the debt at 50 cents on the dollar at three times. Another thing, kind of an early lesson, so that was a strategy, but an early lesson was trying to think of how do other portfolio managers think. And that was something that I began to, being in a mutual fund where there's inflows and outflows, began to think how do they behave and why. Kind of a game theory approach? It wasn't so much a game theory as watching them behave. So in other words, a game theory is what's the logical way opposed to know what do they do and why do they do it? So for instance, when I got outflows, I try and sell the hardest stuff first because I noticed I couldn't sell it in a week or two, whereas they would sell the most liquid stuff first.

4:08John Waldron:And so moves like that. One of the moves that I ended up doing later was after the financial crisis, I couldn't sell any loans at 82 cents because you got dinged, was very prohibitive to buy a loan at 82 cents. But if I sold it at 86 cents, you got much higher credit in the CLOs. So I began to lift my offerings to 86 cents because I knew that they were looking for loans at 86 cents. There was liquidity there. Yeah.

4:34Steven Tananbaum:All right. So you're a credit investor, really, at the end of the day, although you do all kinds of things. How would you describe

4:40John Waldron:your natural state of being as an investor? So I never pigeonholed myself as a credit investor. I always thought of myself as an investor. And when I think of in high school, traded stocks and options, got my series seven and 63 in college. When I was at Mackay Shields, when I took over the portfolio, I asked to be managed in the equity division. And in fact, I ran a convertible equity portfolio, which did nicely. I was proud of those returns. So I always thought of myself as an investor. And in fact, whenever we look at an opportunity, any deal, I want to understand the capital structure and what I think is the best part of it, even if we can't invest, like on a LBO, well, would I buy the equity here?

5:21John Waldron:What do I think is the best part of the stack and why?

5:23Steven Tananbaum:So Makai Shields, long career, successful, you lifted the performance, then you decided to go out on your own. What drove that decision?

5:30John Waldron:I saw this huge entrepreneurial opportunity. So I'm going to finals and there's only four or five long lonely firms that I'm seeing in every final, in every large final. There's just a few of us that are up for contention. And many of them are being awarded two and three mandates. So in other words, there's five in and three are going to win, not bad odds. So coming from a multi-strategy firm, Makai Shields, I saw in like growth equity, there was a hundred managers who were top quartile who had decent records, which we were one of them at Makai Shields in high yield or below investment grade credit, much shorter list.

6:13John Waldron:So that would be on the long lonely side. The other side was the hedge fund side, that here's something where I thought it would be much tougher because the fees were higher and your mandate was broader. But actually I saw it was almost upside down that there was such a imbalance between people who could actually invest in credit and that people wanted to give them money that I saw this huge need. In fact, our original hedge fund investor who I brought in told me if I went off on my own, he would double the size of the money over 100 million and double the fees. So I saw this type of behavior and in both long only and in hedge funds, we had done really well.

6:56John Waldron:And the hedge fund had returns for the first three plus years, three and a half years in the 20s. So it felt like we were entering a good space. So you launched your firm in 2000.

7:07Steven Tananbaum:Yes. Let's talk about the environment. What did you see as you were launching your firm from an environment standpoint?

7:11John Waldron:So this was the period where the dot-com era, there was a lot of uncertainty. It was just starting to roll over. 99 was a very strong year. And in 2000 began a little bit of the hangover. And you saw that particularly in the summer, that's where things began to get a little dicey. And whenever you have this new technology, this innovation, there is the who's being impacted. And the instinct, and you're seeing this in AI now, is to be very broad. And that's what happened. There were so many different parts of TMT that were concerned about what the impact would be. And for instance, you take advertising.

7:50John Waldron:In advertising, newspapers clearly were impacted, but it took around four or five years to really get going until only 2005 or 2006. But you take something like TV programming or cable programmers more specifically, that was a terrific industry for another 15 years, but they were also impacted. So there were a lot of opportunities selling off, particularly in that summer. And then there were names like TMT, like Telesystem International. This was a hodgepodge of cellular companies, international and cellular stakes that ended up trading at 30 cents on the dollar because there was concern whether you could get financing.

8:29John Waldron:We cut a deal at 70 cents on the dollar. They ended up selling for significantly more than the debt the following year. So there was definitely things to do.

8:38Steven Tananbaum:So early days, your returns are pretty good, I suspect, because you were taking advantage of that dislocation, dispersion, however you want to frame it. Did you have any tougher moments? Was it, I mean, I assume, you know, you start your own firm, it's a little different than in the warm confines of one of these large organizations. So talk about any challenges you faced.

8:56John Waldron:So at Makai Shields, the returns were mostly very strong or average and more very strong than average. The first seven years at Golden Tree, pretty much the same, either very strong or average. 2008, really poor year. It was very humbling. It was really the first time we had just a bad year. And so that would be that moment where we had to make some corrections and we knew we could do better. We knew our risk management wasn't where it needed to be. I also had this view that we weren't the only ones. And if we made course corrections, if we could get through to 2010, we would be differentiated.

9:35John Waldron:So that was my mindset. So in 2009, we passed our high water mark in October. Very proud that we were able to do it in a finite period of time. And I remember thinking at the time, if I were to look back at my career, I probably was a seller too early. And I saw that the underwriting I felt in 2008 and 2009 was materially better than what it had been because of this concern, in that you were likely to be tighter than what people expect. So it was going to really swing as it usually does. And I felt even more so going from very wide to very tight. So we still were risk gone after October of 2009.

10:14So 2010, we ended up having a great year, 24%.

10:18John Waldron:And 2009 and 10 were two of the best years of my career. And that wouldn't have been possible without a very humbling and disappointing experience of 2008.

10:29Steven Tananbaum:That's a good lesson. Talk about your research process. I've always found you guys to be very granular, very focused on details, but there must be something about the process. And maybe it's part of what you just said in terms of changes you made in risk management. Just talk about how you construct that process.

10:43John Waldron:It's interesting because I think you might find it surprising that there's aspects that are granular, but very targeted granularly. So we start with providing a margin of safety, guardrails. So if we're investing in senior debt, it's two times asset coverage. It's a loan to value of 50%. If it's junior debt, we want to have one and a half times asset coverage. And that's basically gives us a margin of safety. From there, we're looking for what are the five or six issues that are going to drive the investment to be successful. And we want to understand kind of a, how did we get here and where are we going?

11:23John Waldron:And there are certain firms that want to have large investment memos that are very granular to be as complete as possible. That is not us. We have very senior experienced analysts. I think we have the best analysts on the street. We certainly, by reputation, have very experienced and accomplished analysts with 15 years experience plus. But they are fluent in the issues. But when they're talking about an investment, it's, hey, what are the five things or six things that make it work? And then what's the mosaic to execute. We want to have confirming explanations for why our thesis is going on. And by the way, if it's hard to keep track of or to confirm, we should discuss it.

12:05John Waldron:And then it becomes an allocation issue if we'd like the idea. Interesting. All right.

12:09Steven Tananbaum:So let me talk about stress, distress, where that's the catching falling knife question I want to ask you. Yes. So how do you avoid the value trap of this thing looks really cheap, but then realize it's gotten a lot cheaper because, you know, it should have gotten cheaper.

12:22John Waldron:I've been there. And it's such a great question. It really goes to your screening process on distressed investing. And part of this is what is starting out with a very tight premise. So I'll give you an example of the directory industry. Here's an industry that clearly was shrinking, disappearing, and had a lot of chapter 22s and 33s. We made$800 million on the directory business, very high competitive, high 20s returns. How do we do that? Our entry price. One of the things I'm going to stress, people talk about the prospects of the business and never talk about the entry price. I'm always surprised on that.

13:01John Waldron:We got in at one and a half times enterprise value. That was our average buy-in. Second was what's the strategy? We were involved with management teams that were returning capital and not trying to reinvent themselves. I remember having a conversation with management team up in Canada where they were saying, you don't understand the business is going away. And if we don't spend money to reinvent ourselves, we're going to have to liquidate. I go, exactly. Please don't do that. We want you to, the business is shrinking and you need to be in front of it, not necessarily try and reinvent yourself with a very uncertain success rate.

13:40John Waldron:And that's what was happening a lot in the industry. So aligning ourselves with managements that knew their own situation, were committed to returning capital and being involved in an attractive price. So those would be some of the variables that we pay attention to. Okay.

13:56Steven Tananbaum:There are a lot of good investments you've made over a long career, but are there particular situations that stand out to you? You've mentioned a few already, but just situations you look back and say, we really got that right. Sure. We really are proud of what we did there.

14:08John Waldron:So a lot of the investments start out with a thesis and when the thesis keeps working, we keep at it. So I'll give you an example in European banks. So we started an investment with Bawa and we were involved a little bit before the financial crisis, but added significantly after. And they needed to raise equity capital because their debt to equity was offsides as many, if not most of the banks were after the financial crisis. And when we invested, we thought that they could do around a high single digit return on equity and they could potentially get it to 12%. And if we got it to 12%, you could get out at book.

14:45John Waldron:And it was primarily a retail bank. So book seemed like a pretty safe assumption at the time. They did much better. They ended up very quickly going to the mid-teens, return on tangible equity. But how they did it, some of their token acquisitions, how they were valued, what the ECB's approach was, how the ECB actually was a much better advocate and partner than maybe what the news was reporting about the ECB and what their approach to banks were. So having that inside track, we're able to extrapolate and go broader in the industry. And by the late teens, we saw that many of the European banks were having return on tangible capital around 10%.

15:30John Waldron:They were trading at 60 % of tangible book. They also, and here's what people didn't believe, that they were marked correctly. And they didn't necessarily have a basis for why they didn't believe that, but that's what they believed. And right after COVID, they saw that they weren't taking write downs, so they must have been marked correctly. Oh, and by the way, the interest rates are going up and interest rates, if you have a stable economy, going higher actually is very good for banks. And their return on equity went from the around 9%, 10 % to 14%, 15%. And the books are now trade well over book.

16:06John Waldron:And so we on that theme earned about$3 billion. So very, very proud of that. And we just kept, when we saw it develop, kept going deeper into it. Another theme that we did well in was oil service during COVID. And in the spring of 2020, we saw, remember there was a day, I think it was April, where oil was negative. Remember it well. And we believed that because of the short-term dynamics caused by COVID, if you believe the economy and the world would get back to a semblance of normal, that oil and the suppliers to oil would do very well. And you were able to buy, whether it was onshore or offshore, oil service companies at a 70 % discount to what we felt the earnings, reasonable earnings capability should be.

16:55John Waldron:And on replacement value was like an 80 to 90%. And so we became one of the largest, if probably the largest owner, if you consolidated everything to offshore rigs, had significant onshore rigs as well. And that trade, we earned about a billion and a half dollars on that trade and it worked out very nicely. Those are two good examples.

17:14Steven Tananbaum:So GoldenTree to me now is quite multi-asset, multi-strat. You're covering a lot of different asset classes. How did that develop? What's the strategy been?

17:23John Waldron:And where do you think it goes from here? So we're always looking at what the best risk adjusted way to play a theme. Take for instance, cable is very much under siege. There's concerns about streaming, threatening their subscribers, broadband on threatening their subscribers. And we're looking what's the best way if we think this is a viable business to invest. We can do it through the larger distress cable name. We could do it through public company. So we're always thinking, what's the best way to do something? You're seeing an AI right now, whatever has the most demand for product is where they're financing.