E387: Where Alpha Hides in Private Equity | Josh Adams

0:00Complexity to us comes in the form of these complex, unloved businesses, orphan assets, that ultimately have led to the businesses being really challenged. We think about ourselves as not financial engineers, but operational engineers. How do you create value? It has to be an alpha generating kind of returns. And that to us has always come in the form of what's in your control, operational improvements.

0:32Josh, you're a partner at OpenGate Capital, a billion-dollar firm based in New York and Paris. Before we started recording, you mentioned that you guys are shifting more towards the European market. Why is that? Yeah, well, we've been investing since 2005 and originally founded back in Los Angeles, which is part of the DNA of myself and Andrew Niku, the founder of the firm, who came from Platinum Equity, which also is based there in Los Angeles. There's a little bit of history with Europe. Europe has a tremendous amount of complexity, one of which that we've navigated since 2007. We opened an office in Paris, which was a little bit of a unique place to do it.

1:11Being a Brit, it wasn't something I was that comfortable with at the time. But joined in 2012, we quickly saw the amount of opportunity in the European market. Later, we've now seen many firms move to Europe saying, oh, this is a great opportunity to be there. With all due respect, you've seen a lot of American suitcasing back and forth there. But you need to have a local presence with locals on the ground and in Europe more so than anywhere. So for me, it's been a great opportunity of what we invest in, complexity. So operationally focused firm investing in industrial corporate carve outs has been one of our biggest things over the last 20 years.

1:45In Europe, they're plentiful and the complexity is plentiful. So it really has become a bigger opportunity for us. So still investing in North America, but also shifting, I would say, to 70, 80 % of our time now in Europe. And I've now actually relocated from the North American market back to Europe as well. Why do you lean into complexity? Because it's a differentiator at the end of the day. I mean, if you want to step back and think holistically about how capital allocators and investors think, over time, they are now looking more and more for people who can differentiate themselves. We as a firm have done a great job of doing that now, having, you know, kind of learned some lessons along the way of, you know, what are we really good at and how do we get there?

2:29We had 10 years investing our own capital, which is a pretty unique story. And then in the 10 years of institutional capital that we put to work, that in itself has allowed us to say, who are we and what are we very good at? And ultimately, the response of that has been we play into this level of complexity where others shy away from it. So complexity to us comes in the form of these complex, multi-jurisdictional corporate carve-outs, embedded businesses within large corporations, unloved businesses, orphan assets, whatever you want to call them, that ultimately have led to the businesses being really challenged in a market because they haven't had the ability to grow, to have the capital to be put behind them, or they've gone through some market environmental shift.

3:12we've been able to come in really push on those situations pull on those opportunities and create standalone entities for a strategic buyer down the line so we see more of that in europe and i think it's also fair to say that the north american market which i'm so grateful that i've had 13 14 years of living here and breathing this is such an efficient market that the inefficiency of europe is where opportunity lies and that's created a great opportunity for open gate i had this three hour dinner with one of the chairman of the largest banks in the U S multi-billionaire, epic investor. And the way he looks at alpha is he looks for things that are boring and hard and ideally both.

3:52If you take a step back and if you think about where is alpha in the private markets or in private equity specifically, it's the areas that are hard, meaning it takes a lot of work. It's not an auction process that you just submit your bid and, you know, go back to the golf range. And it's also things that are boring, things that might not be exciting, things that you might not want to talk about at a cocktail party. I think that's true. I can echo those comments. Look, I think we think about ourselves as not financial engineers, but operational engineers. And the only way you create alpha today in this market, and you have to step back again, like what market we in post GFC, we've had a shift from a cost of capital point of view.

4:32Interest rates are changing drastically, global macro dynamics happening politically as well. they are all kind of leaning into creating value and how do you create value it has to be an alpha generating kind of returns and that to us has always come in the form of what's in your control operational improvements so a value creation plan i said well you've checked the bingo mark of value creation plan but tell me what you believe that is because to me that means a lot of different things and there's one thing about saying it but how do you actually execute upon it but we believe in a value creation plan of a carve out from a standalone to create a standalone entity.

5:08There are multiple pitfalls and multiple traps that you can fall into. If you don't do things correctly pretty soon, it doesn't just become boring. It becomes a bit of a minefield and you have to be mindful of how you work through that. So for me, the operational kind of engineering platform that we've created, we've done 37 corporate carve outs in 20 years. It's been a labor of love now creating our own playbook, understanding the business and going to places where other people will shy away from, which is back to somewhat boring for some people. But for us, it's been, you know, it's been very rewarding.

5:40Boring for some people, exciting for others. You guys have one of the most unique founding stories in terms of how you started from Platinum Equity. Talk to me about that and how that affects how you are as an organization today. Obviously, I'll speak on Andrew's behalf here and he won't mind me saying so. I think Andrew joined Platinum in 2001, left in 2004. He spent time actually, ironically, in LA and in Paris. Their original office was in Paris for Europe. It later moved to London, which is when I joined them. So it was kind of a nice kind of sliding door moment between Andrew and I. We didn't work together, but we got to know each other pretty quickly.

6:16The DNA that you learn through Platinum, honestly, it's an incredible firm. And you see where they are today. And you have huge credit because they've gone into other strategies like credit and others that other big firms have had to do too. But at the core of that, the DNA of how they go to market was origination, execution, and operations, three distinct pillars, which Andrew built at Oakengate. He took that finding principle and said, I've learned something here and I think this is replicable. So all of that led to foundation, but also an opportunity. So Andrew left in 2004, set up Oakengate in 2005.

6:51And his story is remarkable. I mean, Andrew grew up in Vancouver, moved to Los Angeles, went to USC, basically at the age of 25, six, basically took a$30 ,000 out of his 401k, rolled it into a formation of a company and started trying to do a deal, found someone who wanted to back him on the deal, realized that he could actually just flip the business pretty quickly and take out a significant portion of capital in a deal, almost in the form of a deal finder, if you will, and introducing a deal to someone, which was then the foundation of Andrew having capital to go and source deals, to go meet management teams, to go due diligence.

7:31That was in 2005, 2006, 2007. He brought on my partner, Julien Legrès. Julien's based out of Paris. He founded the European team and has done a fantastic job in Europe. And the story of that from 2005 to 15 was we basically invested our own capital. And for full transparency, I joined in 2012. So my story of those earlier years is I'm intimately aware of them, but they did a fantastic job of rolling all of the recycling, all of the capital they had, because it's all they had. 100 % GP commit, everything they had was in that business. And they put that into recycling any dividend. They didn't take dividends.

8:11They just went and used that capital to go and put in and make several other investments. I was there for the back end of it between 2005 and 2015. And it turned out to be an incredible story. story. You know, it was Europe, US, and this is kind of part of the journey. It was never really, what can we do? It was always a case of how can I take from one, if I put$1 in, how can I make five? But it wasn't really about the equity story. That's something that came a little bit later for us. We went in by doing, coming in, carving businesses out, standing them alone, and then creating a larger enterprise by improvements of the business.

8:46There were in many ways making money on the buy. Yeah, it was right. I'll be candid with value investors. To find value means you have to be willing to step into complexity and take on things that people wouldn't do. And in 2007 and 2008, if you go kind of all the cast of mine back to that timeframe, the global financial crisis was on us. And the story of them buying a business in the automotive sector, and they turned that around and made a good outcome of it two and a half years later. So they sold it to a strategic. So they basically found a system that works. And then in 2012, when I joined, we then kind of accelerated that by bringing in myself and a few other individuals who I would say had more institutional background, had been at larger firms and funds.

9:29And then we really kind of accelerated that over the next three years. That was the vision to say we should go raise a fund. It's one of the second order effects of having a specialty is you start to be known in the market as you do this kind of thing. And the more unique it is, the more of a market position you have. Did you find that over a certain amount of time, you became this complex corporate carve out firm and people would just find you for the next year? Yeah, we never relied on that to be candid. When I joined the firm, I came in and led the origination team. We always had a mindset of, we always had this imposter syndrome that we shouldn't be in the room for these conversations, but we are.

10:03And the reason why we were is because how we went to market. So we went and spoke to the corporates directly. And we never called the corporate and said, hey, Mr. Corporate, what are you selling? because 10, 15, 20 other people were doing that. This is back in 2012. Now 50 people are trying to do that, probably all through AI. What we did at that time was we were there focused on speaking to the corporate, head of M &A, the CFO, the CEO of these public companies, and talking to them about their business and their sectors. So we quickly took a sector approach, which also became a distraction, which we should come back to because it's a fascinating lesson learned on our side as well.

10:39but predominantly in front of these larger corporations to understand what their m &a activity was not what they were selling but what they were looking at what they were looking to do so we were playing the longer game and so every single investment that we have made from 2006-7 to to date there's always been a story and a connection we weren't just waiting for a banker to call us and go oh you guys are the corporate car vet guys i mean then they're obviously making 20 30 other calls so we were in front of the corporate ahead of time and there's some great stories of that leading to transactions that have come to fruition where we've been the buyer.

11:13There was a story where we bought a business in 2016-17 where we were in head of the process, we were way in front of it, speaking to the corporate team, in front of the board presenting to them what we wanted to do and buy. And it was all because this was a business, so this was a zinc chemical business, not the most super sexy business to many people, but the parent company had sold their larger upstream part of their zinc business, their zinc mining business. So, okay, so you have two distinct divisions below that. What are you doing with them? It was just a simple question that if you're an equity research analyst, you would ask as well, what are your plans to do with the downstream elements of the business you just sold?

11:51We were in front of that. We had that conversation. We presented a scenario where we could buy both. They said, no, no, we can't sell both. So, okay, no problem. But they wanted to sell one. We said, okay, great. Well, let us take a look. We take some information. We start to enjoy back and forth conversations. We're going back to Brussels, which is where they're based to have these meetings. And then the CEO one day pops up and says on this public earnings, we're considering alternatives for our zinc chemical business. So then process stops. Every man in this dog picks up the phone and says, well, I just saw that you're thinking about selling that business.

12:25They hired an investment bank. They hadn't hired an investment bank. And so we're now saying to ourselves, Are we going to be able to compete? And we did. So we were in front of the process and we had that connectivity. And most importantly, we had the credibility of doing so many corporate carve outs and saying to people, this is what we're going to do when we actually do it. That was a credibility that I think gave us a big step up in the European market, both with the banks involved because there were some real banks involved. And so sourcing to us was a very critical item of how do we get in front of the corporate community as quickly as possible.

12:56And then we always talk about this as a bit of a – we're just talking off camera about the Knicks and what they've done this year, but the triangle offense, right? This is kind of – The Chicago Bulls. The Chicago Bulls. The 1990s. Exactly. And being a Brit, I got pretty clued up on this pretty quickly. But Andrew loved this analogy. He's a huge basketball guy. But it was very quickly the triangle offense. And how do we work? So it was corporate focused. It was executives led. So working with executives in the industry who are subject matter experts. And then you have the investment banking community, which is where you triangulate all of that information to make sure the intelligence you're gathering through that process of sourcing these deals really resonates and you have a higher success rate.

13:39But it's also, and this is probably the British part of me, which I think it took Andrew a little bit of time to get used to doing that, was where I was just like, we're not going to push as hard as, quote unquote, the American kind of mindset may be. It was more consultative. And I think that really resonated. And as I said, it's put us in good stead. That's really credit to kind of the team here. So expert calls have always been one of the most powerful ways to build conviction. But today, investors are asked to cover more companies, move faster, and do it with leaner teams. With AlphaSense AI-led expert calls, their TGIS call service team sources experts based on your research criteria and lets the AI interviewer get to work.

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19:49Learn more at alpha-sense.com slash how I invest. I want to distill the distinction in your sourcing versus traditional sourcing. There's different variations of sourcing, but what you're talking about is a lot of private equity firms will wait until bankers reach out to them or they'll come to corporates and they'll ask them, what are you selling today? Your process was different. Maybe you could distill as a layperson why your process was different and what exactly about your process was what led to the excellence. Great question. I think ultimately what you see for most people is they get a banker pitch book list of opportunities.

20:27We think these guys may do this. And what bankers are trying to do at the end of the day is to spark something that they can go back to their client on or a prospective client and say, we have a potential buyer. We were doing that ourself. So we are in front of the corporate spending time with them to get an advantage in the deal because back to that imposter syndrome, we didn't think we should have been in the deal. because there was other people who had large funds and firms who could easily do these deals. But we had to present ourselves differently, quickly and efficiently. So our biggest way that we focus our time and energy is speed and certainty.

21:00That's how we win deals, speed and certainty. But if we're doing the upfront work of being - Meaning speed, meaning you act faster than your competitors or larger funds have multiple layers of governance. Correct. And certainty, you're more likely to close or you have a reputation of closing. Correct. especially with the corporate community you can continue to say and we've bought businesses from multiple sellers multiple times so we have a credibility in the market and so we leaned into it with specifically with the corporates by getting in front of them positioning yourself early being a known quantity to them so we weren't just saying hey mr corporate what are you selling and picking up the phone we know the head of m &a we know the corporate corporate strategy team we know the cfo and we've had a dialogue with them over the years and so that has really compounded over time Obviously, these M &A professionals are always thinking about what they're selling.

21:47You were a thought partner for them before they decided to sell. How are you front running that process? It's research driven. You're spending time ahead of time. You're looking at... Are you ever telling them what they should be thinking about selling as well? You don't like to tell people what to do, but you kind of plant a seed here and there. And I think that's helpful. Look, I think it's kind of the investment research is critical to it without question. But you are looking at what they've done and what they're doing. You're looking at the reporting of their businesses. But you're also kind of like now, and this has evolved.

22:14So I'm talking about originally in 2012. As we have evolved as a firm, we've become more sector focused. And that sector is within the industrial sphere in particular, means that we can talk the language of a chemist in many deals. So on the chemistry side, we can look at chemical deals and understand all the different nuances of those businesses. So we're now having an educated conversation with the corporate M &A guy or with the divisional lead of these businesses. Sometimes we've gone to the divisional lead of the business unit that may be sold and built a relationship there, knowing that that will filter its way back up to the corporate M &A team.

22:48So it's all been intelligence led. And by the way, the investment banking community is a big part of that, too. I mean, friends of ours and mine that we've had now over the years, we're going to them and planting a seed with them, knowing that they're going to do the same thing. And so the triangle offense is that if people are coming together, then something will start to hit at some point. The Roger Federer kind of quotes of, you know, 51 % of games, matches he won. But the rest, Dartmouth commencement. Exactly. What an incredible speech. I mean, it's still to this day, I think. But like you look at those moments, like we don't have that hit rate.

23:18Private equity, you don't. You typically have about a 5 % to 10 % hit rate on deals that you are in late stages on at certain points. And that you want to increase the certainty of that over time. And for us, we've put that in a foundational way and understanding of how we know the corporate and what's important to them. Perhaps a dumb question, but certainty. Why does that even matter if there's a banker process? 50 firms submit their offers. Why does it matter that you have certainty? Is it that some people win the auction, don't close? Yes. Happens a lot because they tell them what a lot of people will say and do.

23:51So there's two points to it. First of all, speed and certainty together is a very, very powerful kind of... Even during an auction process? Yes. Yeah. The ability to move quickly and do the work and lean in on those things is incredibly important. Even in many ways, speed is a subset of certainty. If you work really slowly, at some point, the deal might die. Yeah. And they turn around and say, well, you're not credible. The amount of times we're in a situation where they're saying, why have you not marked up? Or you may not have capital or all these downstream consequences. Anyway, I'm going back and forth between the pre-fund stage and the institutional phase of our life.