Building a Global Private Credit Firm and 'Trading' Planes with Victor Khosla

32:11When you have a company which kind of hits a really rough patch, you know, leverage buyouts, by definition, there's leverage. They hit a rough patch. They have really big financial problems. And when that happens, even really good businesses, Barry, shake. Right? You know, some of the businesses we are invested in, we own a toll road in Texas today, a toll road between Austin and San Antonio. We just bought Hornblower, which is we took majority control of it, which is a ferry business. The New York City Ferries. Oh, that's where I recognize that name. The Statue of Liberty Ferry, right? But all these businesses, these are good businesses.

32:59But they take on a lot of debt. there's no room for error. And everything shakes. You know, often we find some of the really good management teams, they get frustrated. Some of them leave, right? Because now you've got so much leverage. You've got a good business, but so much leverage and you can't figure out how you're going to pop your head up above the surface, right? So as a result of that, we find that when we are investing, sure, we have to recapitalize it so the leverage numbers go down dramatically. So let me ask you a question about what's just been going on over the past couple of years.

33:40If you're a leveraged company and that debt is what used to be LIBOR plus, it's no longer LIBOR now, it's the new measure, central banks raise interest 525 basis points. Suddenly, what was a manageable amount of debt might become unmanageable. How has the past few years of rapidly rising rates affected these leveraged businesses? It has been really tough for them, right? You know, you borrowed money when interest rates were zero, and you were paying all in 5%. Right. Now you're paying 10%, 12%. percent. Which is a lot of money. Right. And you are very levered. And by the way, these old economy businesses, they are not having that same growth like tech or software.

34:33Right. They're not AI. They're ferry businesses and toll roads. That's steady income, but you're not looking at double digit growth. So you can't really grow into your capital structure, right? so easily. You marry the two things together. Growth, but slow growth, modest growth in cash flow or EBITDA with much higher interest rates, like in terms of what you have to do. And by the way, remember, some of these businesses went through COVID where they had to take on even more debt to kind of tide over COVID, right? That was a double whammy, COVID and then the rate increase. And now what is happening is there are maturities coming due.

35:15There's a large maturity wall in 25, 26, 27. By the way, by our reckoning, there's almost 2 trillion of that 5 trillion of high yield matures in the next three and a half years. Really? So I heard an expression a debt trader used, survive till 25. You're suggesting, hey, 25 isn't good enough. You're going to have to get through 26 and 27. Exactly. It's creating issues. By the way, this is not like, oh, it's going to happen next year. It's happening already. It's been happening for the last 18 months. Well, given the high rates, that makes perfect sense. Our pace of investing has picked up substantially.

35:59Our pipeline has almost quadrupled over the last 18 months. This is is happening right now. Barry, don't get the wrong idea. I'm not trying to tell you there's some crash or something. We don't think there is. You seem to be enthusiastic about the opportunities ahead of you. Not that the world is coming to an end, but rather, hey, this is going to be a great period of time if you're an opportunistic distressed debt investor. Or if you're in a special situations, private equity investor. So let's talk about that. How do you define special situations? You know, we are in the business of trying to buy businesses at a good price.

36:38And then we're in the business of trying to improve them, sometimes even transform them operationally, right? Because they have been under-managed with everything I described. Right. To us, that's, you know, that combination, you can't really, if somebody is having an auction of a company and they have hired Goldman Sachs or Merrill Lynch to sell it, it's very hard to buy something at a really good price. Right. Right. You've got to be able to buy it, either you buy it through the debt, right where you buy it through by buying debt at a discount or you buy it bilaterally in a process without a process right the company has enough issues and there's a way to just negotiate a price bilaterally so so i think for us the opportunity set today is is to kind of buy it well, but that is just step one.

37:39Step two is to go strengthen the management team, build a new business plan, often to inject more capital into the business. Right, restructure it so it's not carrying all that debt. 14 of the 15 businesses we control have more employees today than when we took over. Wow, that's pretty impressive. Yeah, but I think it's, so this is not about just cutting. It's about kind of investing and looking to transform these businesses, which have been under-managed. And those together is what in our world, in our mind, constitute special situation private equity. Let's talk a little bit about hard assets.

38:21You mentioned infrastructure like ferry and toll roads. Let's talk about real estate, airplanes and power plants, I would think power plants would be very tied to the cost of energy plus whatever their costs are for modernizing and reducing pollutants and their output. Tell us about what you look at when you look at buying a power plant. You know, for us, about 60 % of what we do is corporate investing. So these industrial businesses, service businesses, right? Old economy, solid, ready, steady businesses that have run into a little trouble. Generally, very good market shares, right? 40%, 4-0 % of what we do are real assets.

39:15Oh, really? That much? That's giant. So give us some examples of, first of all, I'm fascinated by hard assets like airplanes. How do people get into trouble owning either a single plane or a fleet of planes? Can I tell you? Can we even start with infrastructure? Because Barry, the prevailing view would be infrastructure, toll roads, ferries, all these kinds of businesses, they are really, you've got a monopoly or a duopoly. They should be really strong. They should be good growers, and they should be steady, Eddie. And infrastructure today is bought by sovereign funds, big pension funds, with a view that it is very steady 7%, 8%, 9 % kind of returns, right?

40:10That's the prevailing view. Assuming you're purchasing it at the right price. Now, what has happened in infrastructure is there were a couple of very aggressive people who bought infrastructure, toll roads with 80-90 % debt. Not 40%, 50%. 80-90 % debt. No room for error there. And if you hit COVID or if you hit a financial recession, it's really hard to dig yourself out of 80, 90 percent debt, right? So what we saw was a whole class of toll roads, which are supposed to be core infrastructure, safe. A whole class of toll roads. The ferry business I'm kind of talking about, right? A waste to energy business in London we invested in called Cori.

41:06All these businesses ended up kind of crashing. Now, infra for us has never been distressed. There's no broad infrastructure distress cycle. But for us, it started about 10 years ago. We were one of the first ones who started to take apart infrastructure and say, hey, it's not like corporate, right? It's valued very differently than how you'd value a company. There's a whole, what it takes to operate it is really quite different. You need some really great government skills, by the way, to manage the agency which regulates you. A lot of complexity there. You're not just selling widgets. Yeah, it's different, right?

41:53And you've got to understand it. And we were one of the first people in our business to really drive into it. And I think we've been the biggest investors in our industry, in infra. So I got to ask, who the hell is buying a toll road with 90 % debt? I mean, it's one thing if you're buying your first house and you put 10 % down and finance the other 90 % because you're going to live there over the next 30 years and you got to live somewhere. But who would buy, like that just seems kind of reckless or am I? You know, it was viewed in the old days. It was viewed 15 years ago. It was viewed as such a safe asset class.

42:35Not only could, not everybody did it, okay? There were a few real outliers who did a lot of it, right? And they did it with 85 % debt, 80 % debt, 90 % debt. And by the way, most of the industry does not do this. You are very much confirming my long-held belief that there's no such thing as toxic assets, only toxic prices and toxic debt levels. It sounds like that's a key part of how you guys have grown. It is. It has been, right? But what's kind of interesting also is like, you know, that waste-to-energy business in London, right? When we bought it, they had a really great – I'll tell you this.

43:22Forgive me. I'll just digress into it. I'm fascinated. Right? So there's business, Corey, in London. So on the River Thames, you'll see these barges taking garbage. They take garbage from some of the richest boroughs in London. They take it to a plant called Riverside where they burn it, and they produce electricity for those same boroughs, right? This business, great business, by the way, right? Now, what they had done was they also had a landfill business. They also had a garbage collection business. And those businesses got them into real trouble. So the company itself got into a pickle, too much debt.

44:11and with this one really great core business and two other really troubled and so-so businesses, right? And what we ended up doing was when we kind of took control of the business, yes, we fixed and sold the two businesses which weren't so great. But at the same time, the core business, we invested in it. We hired a new chairman. We hired a new CEO and a management team. And by the way, the business itself had long-term, you know what makes infrastructure is when you have long-term contracts. They had long-term contracts for about 55 % of their output in Riverside. We increased that to 70%. We started to build a plan to expand the plant, to build a new data center next to the plant, right?

45:05Because they're so energy intensive. It is, because they produce electricity also. So you can create a data center kind of right next to it. So you can see the transformational work which is going on. It wasn't like, hey, we just bought it. It's great. And we subsequently ended up kind of selling it three, four years later, after we'd finished doing all that. And it was a very successful investment. But you can buy infrastructure. But if we just bought it and just put it on auto control, nothing would have happened. This isn't a passive investment. This is active management. I'm fascinated by some of the other hard assets.

45:46Tell us about what you do with aircraft. How do people over leverage themselves with either a jet or a fleet of jets and have to have a distressed buyer come in and take it over? We find that investing in aircraft, for us, two out of 10 years, we really lean in. It's not a steady state. Hey, we're going to invest X million every year. It's a very cyclical business. So, like take COVID, right? COVID happens, flying shuts down. Right, done. A couple of really large airlines. There's one called LATAM in Latin America. There's Aeromexico. A couple of large airlines end up kind of filing for bankruptcy.

46:36Now, they are in bankruptcy, and they have, like LATAM in those days had a fleet of 300-plus airplanes. Oh, really? That's a big fleet. Yeah. So, by the way, LATAM's a really big airline, right? Right. Mostly South America and Central America? and flying to the United States, right? They're the market leader in Latin America, right? But now they are, the people have given them the planes on these leases. They have leases with all these kind of financial guys, which is how they bought a lot of their airplanes. They're in bankruptcy. They want to redo the lease, recut the lease. And by the way, this is COVID.

47:24Lease pricing has collapsed. Right? So now all of a sudden, the leases aren't the person who's lent them the money on the lease. It's no longer worth that because lease prices have collapsed. And they are being reset right now because of the bankruptcy of LATAM. So for us, we ended up buying 23 of those airplanes from some of the leaseholders in LATAM. Buying the planes outright. Buying the planes. And then what do you do with that aircraft? We actually bought the debt. We foreclosed on the planes. So now we own the planes. Most of them we leased back to LATAM. Some of them, there were actually four very large A350s, which is like a wide body, large A350s.

48:22And we sold them to Lufthansa. We had to fix them. We parked them in the desert. We fixed them and we sold them. They can't sit for very long, though. They have to constantly be tended. So if you're going through a bankruptcy, you can't have a plane on the tarmac for 18 months. And so what's interesting to us about the airline business, when it's really active, like in those periods, right, somebody like us, we invested a few billion dollars buying airplanes in those two, three years. Oh, really? That's a lot of aircraft. We bought the aircraft. By the way, at this point, we've sold most of them, right?

49:00But we also ended up with a claim which became equity. So today, we are actually a very significant holder of equity in LATAM and Aeromexico. Really interesting. But what we find is this business of investing in aircraft, it's a very cyclical business for us because we have a very high rate of return expectation. So it's not an every year business. and what's really helpful for us as we do this, Barry, we own a company called Deucalion. Deucalion has 65 employees and they manage the aircraft for us. So when we take over the planes, if we have to park them in the desert, if we have to fix them, lease them, finance them, Deucalion gives us the arms and legs to kind of do it.

49:54You don't want to do this business just as a paper investor. You need those operating skills. And by the way, Decalion today manages 125 airplanes for third parties even away from us, right? So for us, having Decalion, it's a big piece of kind of what makes our airplane aircraft platform really work. Really interesting. Last hard asset, I have to ask you about real estate. Return to office has been only a part-way success, depending on the city you look at. It's 20%, 30%, 40%, 50 % vacancy rates. And what I mean by that is 50 % occupancy rates of already leased spaces, to say nothing of the vacancy rates that come up as leases expire and some anchor tenants move out.

50:50how are you looking at the world of commercial real estate these days, given the stress we see in the office space? There is a tsunami working its way through parts of the commercial real estate sector. Slow motion tsunami, isn't it? And it's around maturities of the debt, right? Where people are foreclosing, title of the property is passing over to lenders, right? So round numbers today. There's$8 trillion of commercial mortgage debt in the U.S. and Europe. $8 trillion U.S. and Europe that you think is going to eventually go bad. How much of that goes bad? 22 % of it is office. Oh, really? Yeah.

51:40So let's call that$2 trillion, almost$2 trillion? Yeah. A trillion here and a trillion in Europe? Exactly right, right? And to our point of view, a third of it is going to kind of go broke in this particular cycle. Away from kind of office, there are other sectors. So if you look at multifamily, right? Multifamily is generally a very stable asset class. But with these higher rates, people were buying multifamily at a 4 % cap rate. Today, public REITs, multifamily public REITs are 6 % or so cap rates. That means that prices have fallen 50%. Wow. Right? If you just take the four going to kind of six.

52:30Right. If you have to sell it or if you have to service the debt. Yes. Why does it always come back to too much debt, too much leverage invariably leads to a bad outcome? Am I overstating that? It seems that every one of these stories begins with, and they bought this with way too much debt, and here's what happened. Barry, I've made a career out of it. That's amazing. So I know I only have you for a limited amount of time. Before we move on from commercial real estate, a trillion in the US, a trillion in Europe, about a third is going to go bad. And it's a slow motion tsunami. In a way, that's almost encouraging because not to be glib, but$300 billion.

53:21It's not the financial crisis. It's not trillions and trillions and trillions of securitized debt blowing up. It almost sounds as if that's manageable over time. It's not systemic, right? So whether it is the corporate world, you know where I was describing all these maturities in a$5 trillion pool of high yield? Or this is not systemic. 2008, the banks were really levered, right? It became systemic, right? So I think, look, I tend to, economic growth is okay. It's not, it's much less than okay in Europe, but in the US, it's kind of okay, right? So I don't think one needs to kind of say, you know, that systemic stuff, which causes shocks across the economy, right?

54:18Look, we could be wrong, but we don't think that's in the cards. What's in the cards is just this very gnarly, all these kind of credit issues, which will keep biting for the next three years. And we'll just kind of work our way through them. Right. If you're in the wrong sector, you're going to get hurt. And if you've avoided that, it shouldn't have that spillover effect like we saw with securitized mortgage in 08, 09. if I'm hearing you correctly. So I also have to ask, I know you opened the London office in 2004. Did you ever expect that Europe would expand to just about half your assets? That seems to be really substantial.

55:02Tell us a little bit about what's going on in Europe, both their economy and the prospects for growth there, and what you're doing with your portfolio. Well, Europe is, if you just think about the broad market in high yield, 75 % U.S., 25 % Europe. For somebody like us, Europe is always just a much bigger part, a third, maybe even a half of our book. Why is that? Europe has more problems than the U.S. Right. And a lot of old industries and old businesses that might run into trouble. And every two years, there's a crisis there. Right. Right? Like the U.S. is fortress America. But when you look at Europe, right, whether it is Brexit, whether it is other Italian guys.

55:59The Greece debt. It's something every now that's going on. So you have frequent crises. You have economic growth, which is much slower than the United States, right? And by the way, they're suffering from some of the same high rates. And their inflation seems to be stickier and more stubborn than inflation rates here. It is, right? So you take all that kind of together. You know, what we find is Europe, when I think about it in the context of 20 years, we find that Europe just gives us more frequent opportunity, right? Just the way it's set up. And the second thing which makes Europe really interesting for us, we are really one of the market leaders.

56:54In Europe? In Europe. We are one of the acknowledged market leaders in Europe for what we do. And it's a world where there are much fewer people with the skills we have. In the US, there are more people. So you look at a market which is big, which gives you constant opportunity. You look at the marketplace positioning we have, right? You take that together. For us, Europe is much more interesting, which is why it always for us is a bigger piece of our portfolio than the market. That's really, really fascinating. Um, since we're talking about inflation and rates, um, you said something about a year ago that I very much agreed with.

57:40About a year ago, it was last summer, you said the Fed was behind the curve. Now it's 12 months later. Tell us a little bit about your, especially from your vantage at looking at debt and what the distress that's out there caused in part by 525 basis points of hikes in 18 months. Tell us a little bit about what you see from central banks here in the United States or elsewhere. You know, we are now on the other side of the, you know, we're now in the, we're trying to figure out how quickly do rates come down, how much and how quickly. So we're not really now, we're on the other side of the mountain, right?

58:25Right. And I think, and you've already seen it with Europe. Europe has already reduced, right? So I think our point of view would be these short-term rates, the 5.25%, 5.5 % Fed funds rate, it is going to be kind of coming down. And we can all debate, is it two cuts, three cuts, 50 basis points, 20? We can all debate that, but I think the path going forward is that what is different is just look at the 10-year, not so much the short-term Fed fund rate, right? The 10-year rate is 3.85%. It's not the 1.5 % or 2%. That era seems to be over. Yeah, that era is over. So the fact that rates are going to be higher now over the course of the next three, five years, I think that's the part we should all be just kind of focused on.

59:22Higher than zero, but isn't three, three and a half kind of normal or even reasonable? I mean, how do you contextualize the 10-year briefly kissed 5 % and then it's headed south since? If we end up at credit rates being in the three, three and a half percent range, 75 to 100 basis points below where they are now, what does that mean for distressed debt investing? What does that mean for the economy? It points to the fact that, you know, I think you were saying, Barry, live till 2025. Right. Survive to 25. Survive to 25. You get 3.5 % 10-year rates. Right. You add the usual 400, 500 basis point high yield spread.

1:00:13Right. You're borrowing at 8.5%. Which is not 12%. Which is not 12%. It's not four, but it's not four. So I think what all this kind of means is, look, things will improve slowly, right? As short-term rates kind of come in. But the problems which we've set up, they're here. You have a slower old world economy. You have maturities kind of coming up. you have to kind of default or you have to do some pretty unusual things to extend your maturities. Those problems with eight and a half percent rates, not four or five all in cost for a lender, for a borrower, those problems really now stay with us for a while.

1:01:06So not just to talk your book, but an opportunistic distressed den investor, these look like pretty good times coming up over the next few years. I do think they're good times, but I think, I don't think, but they're time, I'm talking my book now. They're really good times for somebody like us who can operate businesses, improve businesses. It's not just paper transactions. You are more hands-on than that. You know, most people in our industry, in my industry, are really focused on buying debt at 50, 60, 70 cents, trading it, having it kind of appreciate in price, and then trading out of it, right?

1:01:50That's so 1991. You've done that already. Now, this cycle, the one we are in, is not kind of that wholesale move down in prices. it's much more buying into these businesses through debt, sometimes through equity, transforming the businesses, operating them. That's the opportunity. It's not a trading opportunity in distressed debt, which is what we, we just don't think it's a trading opportunity now for the next three, four years. Really, really fascinating. I only have you for a few minutes more. So let me jump to some of my favorite questions that we ask all our guests, starting with, tell us what's keeping you entertained these days.

1:02:36What are you listening or watching? Podcasts, Netflix, what keeps you entertained? I like watching sports. Barry, before we - I know you're a big tennis fan. Yeah. I like watching Breakpoint. Oh, really? On Netflix? On Netflix. Sort of drive to survive, but for tennis. Exactly. I have that in my queue and I haven't started it yet. You know, I've been playing tennis for 50 years. Really? I should be better. You just need a good coach, that's all. But watching Breakpoint, at least for a while, transforms it for me. What's the worst part of your game? Backhand. Really? By the way, everybody who knows me, they are merciless.

1:03:18They hit at my backhand. Huh. I'm a lefty, but I've always played tennis righty. So the backhand has never been - Wow. How do you do that? You know, it's as a kid, they stick a baseball bat in your right hand. So I right lefty, I do everything else lefty. So the serve is my weakest part, but I find the backhand is easy because it's - It's natural. Right. It's almost natural. It's so crazy. Let's talk about your mentors who helped shape your career? I had a lot of support from people I worked for or worked with, right? At City and at Merrill when you were starting out. At City and at Merrill, right?

1:04:03And at Moore particularly, right? I had a lot of support like that. You know, a mentor, the word mentor means, I think also somebody who helps you grow, who helps you develop, who talks to you every few weeks or a month, officially, unofficially, right? You know, what I have found is the business I chose to be in was such a new emerging business where, you know, I kind of grew. There were no people with a decade's experience in that space. It wasn't like I had a, quote, mentors in the business, right? But what I found was, and by the way, every time you do something which is new and different and you're one of the first guys on the wave, right, it is you learn as you go.

1:04:51Sure. But having that support, right, from kind of all those different parts, I think that's kind of what I would say. That team approach of everybody kind of lifting everybody else. Let's talk about books. What are some of your favorites and what are you reading right now? I like historical fiction. So there's a guy, there's an English author, a guy called Khan Iggdalen. I don't know. He's written five, six books about the Roman Empire, the Caesars, right? He's written about Kublai Khan and the Khan dynasty out of Mongolia, right? Genghis, I love reading that sort of historical fiction. He just came out with a new book on Nero, the Roman Emperor, and it's a new series, right?

1:05:42Then I'm reading that. Huh, sounds really interesting. Our final two questions. What sort of advice would you give to a recent college grad interested in a career in distressed debt or credit investing? Be ready to work really hard, right? You know, the typical person we hire at SVP is we have two entry points, right? So we'll hire 26, 27-year-olds. So you should have gone to undergraduate school, couple of years at an investment bank with the$1 ,800 a week. Right. Two, three years at a private equity firm, right? And then you come work with us. And then the second entry point is you're that 27-year-old, you go to business school, and then you come work with us, right?

1:06:35So those are our two entry points. But when you look at kind of, you know, the people who are kind of coming in, by the time you're that 26, 27-year-old, you know, if you were in that class at Dartmouth or Yale or wherever, you are probably already that one in a hundred, maybe one in 500 kind of person to have made it that far, right? This is a tough, incredibly demanding profession. Just be ready for that. It is extraordinarily rewarding, right? And I don't mean financially, right? It's fun. You know, the people you work with, the culture of what you have, it is fun. Yeah, it's financially good too, but to position yourself to be in this world, right?

1:07:29Especially in a world like ours. Look, we're not looking for people who are just kind of, you know, paper investors. We want you to work with our portfolio companies, with our management teams. You've got to have the EQ. you've got to have the presence and the communication skills too, right? You look at kind of the training we need for somebody who can do that at age 30 or age 35, right? It's very much that sort of a growth track you've got to follow. Really quite fascinating. And our final question, what do you know about the world of investing today that you wish you knew back in the 1990s when you were first getting started?

1:08:13Oh, my gosh.

1:08:18Barry, I was in, when we got started, right, as a firm in 2001, somebody asked me and said, hey, Victor, what would you consider success in five years? And remember, this is when the world was young. Alts was really young, right? And I said, boy, if I could be running for 500 million in five years, wouldn't that be great, right? We went through 500 million in a year and a half, right? But I think what I've learned about investing, because, boy, when you do what I've done, you make mistakes. what I've learned about managing and growing people and developing people, right? It's like I have been in this laboratory of learning.

1:09:20So when I think about the person I was 25, 30 years ago, right? Running a proprietary desk at Merrill Lynch, right? To kind of the person I am today, right? In so many different ways, I couldn't even have told you. 25, 30 years ago, I couldn't even have told you what it would take to kind of be here. And I think you've just got to constantly be ready to learn, to evolve. You can't get stuck. And if anything, if my journey says anything, it is, you know, I've seen the evolution in the firm, sure, but I've seen the evolution in me, right? And I think if you were, if I was to give advice to somebody who goes down this journey, it is to have a lot of people around you who can, not just in your firm, but outside your firm.

1:10:19Some people you can trust, you can talk to, who can coach you, who can make you think, because you are in an evolutionary journey to grow up to be a leader in this business. Really quite fascinating. Thank you, Victor, for being so generous with your time. We have been speaking with Victor Khosla, founder and CIO of Strategic Value Partners. If you enjoy this conversation, well, check out any of the 500 or so discussions we've had over the past 10 years. You can find those at iTunes, Spotify, YouTube, wherever you find your favorite podcast. Be sure and check out my new podcast, At The Money, short conversations with experts about topics related to your money, earning it, spending it, and most importantly, investing it.

1:11:10At The Money, wherever you find your favorite podcast or in the Masters in Business podcast feed. I would be remiss if I did not thank the crack staff that helps put these conversations together each week. Meredith Frank is my audio engineer. Atika Valbron is my project manager. Sean Russo is my researcher. Anna Luke is my producer. Sage Bauman is the head of podcasts at Bloomberg. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio. Thank you.