Apollo Explains How Big Tech Is Disrupting Credit Markets

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1:14Hello and welcome to another episode of the Odd Lots podcast. I'm Traci Alloway. And I'm Joe Weisenthal. Joe, do you remember those stories? I guess they were a bigger deal earlier this year, but they're still kind of out there. The stories about how the stock market is all about the big tech companies. Yeah, absolutely. So, yeah, it still is. It still is. But I think like at one point earlier this year, there was a number that caught my eye. I think it was like 30 % of the S &P 500 came from the Mag 7. So, you know, Alphabet, Microsoft, NVIDIA, and all of those. And I guess as all the hype and interest over AI has grown, the importance of tech companies in the equity market has increased in size along with it.

2:00Totally. You know what I think is an interesting stat? We're recording this on September 25th. If I look at the major stock indices for the year, the NASDAQ, or as we used to write, the tech-heavy NASDAQ, is up 28.3. The S &P 500 is up 20.35%, virtually the same. So I think it's telling the degree to which the S &P is becoming the NASDAQ. In fact, that we should, that would be a good story or a good headline that basically the S &P, by virtue of the dominance of these handful of mega cap tech companies that dominate both index, the S &P 500 is morphing into the NASDAQ. Listeners, you get to witness how journalism happens in real time.

2:42This is how we come up with headlines. You notice some numbers and you're like, oh, let's see if we can back a story into that. Okay. Well, speaking of everything becoming tech, I realized that like one thing we haven't really spoken that much about is what tech and all the recent enthusiasm for it actually means for the credit market, for the world of corporate bonds. Yeah, this is interesting. And there's probably a reason that we don't think about this very often, which is one is that if you look at like the really big tech companies and even like small companies, you know, a lot of it has not historically been credit funded.

3:15A lot of it has been equity funded and VC is equity. And, you know, these companies produce so much cash from their earnings and they can fund themselves out of earnings that credit to some extent hasn't been part of the story. But a few things, A, some of these companies mature and they start to issue debt and they do have debt and some of it's to fund buybacks. We're also in a period where a lot of tech is more capital intensive than it had been in the past and sort of project-based financing is more of an issue. And maybe that's like some some of the data center plays, et cetera. So I believe there are interesting credit stories that for reasons I can understand have not gotten much attention.

3:53There definitely are interesting credit stories. And I am very pleased to say we have the perfect guest today who is going to tell them. We are speaking with Rob Bittencourt. He is a partner at Apollo. He is the co-head of Opportunistic Credit. He's also a member of a bunch of different investment committees over there. Rob, thank you so much for coming on All Thoughts. Tracy Jo, very excited to be here, longtime listener and fan. All right. Thank you. So let me ask the basic question, but what does the co-head of opportunistic credit at Apollo actually do? Opportunistic credit sounds like something you might get at college.

4:30What is it exactly? So before I describe what I do within opportunistic credit, I think it makes sense just to level set. Where does that sit within the broader Apollo platform? So Apollo is an alternative asset manager in a retirement services business. It manages about$700 billion of AUM, 500 of which sits in our credit business. And I focus on the opportunistic pool of capital, which is about$30 billion. So what is opportunistic? It is not as bad as you make it sound. And it is really credit investments on the both public and private side, targeting returns of 8 % to 13%, broadly speaking. So in terms of what I do within that business, I co-lead a group of 20 analysts who are sector-focused and really are tasked with identifying, sourcing, and underwriting the ultimate investments that go into a series of funds that make that$30 billion AUM pool of capital that I mentioned.

5:30So it seems like, you know, I mentioned that, you know, you do have debt issued by tech companies. And sometimes they run across the headlines. Sometimes you read like, oh, Apple is selling a bond or Microsoft a bond. These do not sound like exciting areas for opportunistic credit at that level because they're pretty close to like AAA rate. Like if I'm lending to Apple, it's like the next closest thing to probably lending to the U.S. government in terms of the spreads and stuff like that. So when you talk about opportunistic credit and the opportunity to actually get those substantial returns, you said 8 % and 13%.

6:04Where are we typically looking? When I joined Apollo in 2006, high yield and the levered loan market were not synonymous with technology. People thought of those as ways for slower growing companies to finance themselves, companies that produce consistent, dependable cash flows. fast growing companies typically didn't look to the sub-investment grade market for financing, but that's steadily changed over time. So if you look at a lot of the private equity activity, which is a huge source of credit that goes into the high yield market, about 25 % of LBO activity today is in that technology space.

6:43And that's steadily increased over the past 10 or 15 years. It was about 20 % before the pandemic. So that's mostly been in software-related names. Yeah, right. So there are various PE firms that are buying these sort of middle market type software companies. Or even larger, multi-billion dollar companies increasingly. So the scale is certainly there. Today, about 15 % of the levered loan market is software-related. There's less of an exposure in the high-yield bond market. About 5 % is technology-related. But I do think you have that critical mass of technology names in both markets today. Obviously not as intense as you see in the equity markets, but it's definitely a market that's become more tech focused during my career at Apollo.

7:26So what does that mean for the things that Apollo specifically is buying? The growth of the private market, the rush of private equity money as well. Like, does that translate into specific things that you're doing, such as direct lending? Sure. So a lot of what we've been talking about right now is with respect to below investment grade. And you talked about the fact that the larger hyperscalers have largely self-financed themselves or have gone to the public IG bond markets. I think some of the more recent technology themes that we've seen, namely AI, which I know is something you all have spoken extensively about.

8:05I think what's interesting about this trend relative to maybe more recent technology trends like smartphones and mobile computing, which was relatively asset light, right? It was developing applications that sat on top of Android and iOS, which didn't really require a lot of capital. AI, which I think you referenced before, is very capital intensive. You need to build the data centers. You need to build the power to support those data centers. You need to build the chip making facilities to build the GPUs, which are used in the data centers. And that's all going to require capital. A lot of that capital is not going to be provided by the high yield markets.

8:42Where it will be provided, in our view, is from the private investment grade market, which, you know, when people think of private credit, they don't necessarily equate it with investment grade. But as an institution, over half our credit AUM is associated with our retirement services business, Athene. which invest primarily in long duration, investment grade credit. And so I think there's a huge opportunity for Apollo and others to invest those pools of capital that are looking for long dated investments, high quality behind some of these themes. And I can go into more detail around that if that's helpful in terms of some of the areas we've been focused.

9:23I have one question just before you do that. But if I'm an investment grade issuer, certainly if I'm an Apple or someone like that, why would I want to go into the private market to begin with? I'm IG. I can sort of, you know, dictate my own terms, presumably. Why would I even go down that route? Yeah. I mean, Apple's a tough one just because they're probably one of the highest rated companies in the world and one of the most profitable. Take an average IG rated issue. Sure. Take an average IG company. I think there's a couple of reasons. One is, you know, some companies want a diversity of financial sources, right?

9:55They want to finance themselves both in the private markets and the public markets. And so having access to multiple avenues of capital is just good risk management. I think specific to some of the themes we're talking about and some of this project-based financing, it's complicated, right? The underwrites, they take a long time. They take detailed diligence. Oftentimes, when we're looking at these sorts of opportunities, we're bringing in third parties to help us analyze the situation, domain experts. So that's really hard to do on a syndicated basis. The investment-grade public bond market prices on a daily basis.

10:31It's called a drive-by. A company will come in, hit the market, move on. For some of this project-based financing, that speed doesn't really translate. And it really requires bilateral negotiation and partnership to ultimately structure these deals which have more complexity than your regular way publicly traded bond. Before we talk about some of these project-based deals or these CapEx-heavy AI-related things, just going back to, you know, you mentioned in the mid-2000s, the sort of rise of PE-backed purchases, how much of that market emerged as a function of software as a service, specifically paying for software with subscription revenue?

11:11You have something, maybe like, you know, something that does dental billing, you get it in 80 % of a dentist's office, and then it's like, okay, it would take a lot for this piece of software to ever get uprooted. And so let's just lever it up, put a lot of credit onto it. And then you have this fairly predictable revenue stream for years and years. 100%. I think software as a service has smoothed out cashflow profiles. It's made those cashflow profiles more predictable, which credit investors like. And it's a relatively capital light model. There's not a lot of CapEx associated with these businesses.

11:48And as you mentioned, many of these software applications are very much embedded in the workflows of enterprises and very hard to switch out, which is why you have very high retention in a lot of that market. So I think that's certainly one of the reasons why that sector has gained so much popularity amongst some private equity firms. Okay. So we sort of outlined the growth of SaaS in credit markets, but talk to us about the growth of, I guess, AI-related tech in the current credit market. What impact is that actually having? Within below investment grade, few and far between. Recently, we've seen some excitement around increased bandwidth needs for data centers, so connecting the data centers that are being built.

12:31So there's a couple companies that operate enterprise fiber optic networks that have benefited and that have announced some partnerships with some of the hyperscalers. So I think that's a tangible example of some of this infrastructure build out infiltrating the high-yield markets. I think beyond that, it's really been more angst-inducing, honestly, with a lot of investors trying to figure out, are there going to be losers, right, as this technology? Oh, the disruption story. Exactly, right? And I still think we're in the first or second inning with respect to determining who the losers are going to be from this technology.

13:10There were some announcements earlier this year around Klarna, which was using AI chatbots for some of their customer service needs, which created some volatility in some of the call center operators. So I think that would be an example of a sector that has felt some impacts from AI. But for the most part, it's been somewhat limited.

13:47your best bottling plant employs 3 300 people how do you get 3 300 people working at peak efficiency your best store has reduced waste water and energy usage how do you make every store like your best store your best property has every guest raving how do you make every property like your best property? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one. EasyCater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor.

14:33In In addition to all that variety, EasyCater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. Joe, this reminds me of one of the fundamental realities of credit investing, which I think came up in a recent episode with Oak Tree's Danielle Pauly. But really, a lot of it is about trying to avoid the losers. Our brains went to the same place. Right. So when you're picking a tech stock, you want to pick the winners.

15:10And when you're lending to companies, you want to avoid the losers, which sort of brings me to exactly what I was going to ask you, which is like all credit investing, but all investing is going to have some sort of like, you look at the balance sheet, you look at the cash flows, you look at the metrics, and then some subject matter domain expertise. And again, if you're picking stocks, you're like, no, this is the company whose chip is going to be the winner. This is the company whose liquid cooling system for data centers is going to be the winner. Is the nature of sectoral analysis from a credit perspective a little different because it's about loser avoidance?

15:45So certainly there is less asymmetry just mathematically in bond investing or in credit investing, right? Your upside is capped. It's not necessarily capped at par, by the way, depending on the call schedule of a bond. Bonds can trade over par, but certainly you don't have the asymmetry that you have in the equity markets. So through that lens, I do think there's more of a downside protected mindset that credit investors bring to bear. I think you touched upon understanding the major trends and themes in a sector. That's something we spend a lot of time thinking through because of that risk that technology can potentially play from a disruption perspective, right?

16:27What are the major themes around technology in the market today? And how is that going to influence individual sectors? And that gives you a little bit of a guidepost in terms of maybe not what sectors to entirely avoid, but where to be very careful as you're making, analyzing the opportunities in a particular sector. You see that dispersion very much in the market today, right? If you look at the high yield market, which is trading at about 300 basis points from a credit spread perspective, and you look at the sectors that have the highest proportion, with spreads above 1 ,000 basis points. It's cable satellite, it's telecom, and it's broadcast TV.

17:12And in some instances, you see those heightened credit spreads because there's too much leverage on individual companies. But I would suggest that there's clearly something sectorial going on in those sectors that's creating some headwinds, which is leading to those elevated spreads. So speaking of losers and disruption, Could you maybe walk us through a specific example of like suddenly there's this new thing and it impacts a different credit? Are there specific instances that you've observed? Sure. So a recent example would be the satellite industry. Yeah. Say more about that. Right. Which company?

17:49Oh, in Starlink. Starlink. Right. Elon Musk's. It's a subsidiary of SpaceX. Starlink operates the largest low Earth orbit constellation of satellites. providing broadband at higher bandwidth than legacy technology with lower latency. Incredibly disruptive to some of the existing satellite communications providers. What's the name of one? I'm going to pull up a ticker on my terminal. SES is one of the largest names in the space. They recently merged with IntelSat. Okay, thank you. And there's a group of about five or six of those players within that sector. And so that's a very tangible example of a new entrant with a new technology that has advantages relative to the existing technology, which has created some headwinds in the broader space.

18:37Now, I do think the industry, and this is a trend that we tend to see, oftentimes when new technologies disrupt a sector, you actually do see more consolidation because it's a way for the industry to adapt effectively by getting larger, cutting costs, and then hopefully figuring out a way to better compete against the new entry into the market. You kind of anticipated my next question there, but what happens to pricing in these scenarios and how quickly do existential threats to a business model get priced into a company's corporate bonds or loans or whatever they might have outstanding? Because I feel like on the one hand, if you're getting a major competitor in the form of Elon Musk and Starlink, that's bad.

19:26But on the other hand, credit markets are notoriously slow compared to stock markets. And on the other side, it can spark defensive measures like consolidation or cost saving, which would be very, very valuable if you're a lender to this company. I think the market reaction time has increased over the last five years. And I think the reason is the first widespread example of disruption in the credit markets was retail. And everybody knows it. Amazon e-commerce, it's a pretty straightforward story. All of that. Dead malls. And I think that played out from sort of 2012 to 2018. You had a spate of bankruptcies and retail failures.

20:14And I think the market realized that it's hard to necessarily fight against a secular trend that powerful. So we better start paying attention to it. Interestingly, I would argue sometimes the market overreacts, right? And so counterintuitively, it could create interesting long opportunities. A great example, in our opinion, is the cable industry. So cable industry did very well during the pandemic for obvious reasons. There's been some normalization post-pandemic that's impacted their business. But from a secular perspective, the industries face competition from a lot of the old line telecom companies starting to build out fiber, which has created more competition.

20:54You've also seen the likes of Verizon and T-Mobile offer home broadband over the airwaves So that on the margin I think has created this narrative of disruption within the cable space Which has created quite a bit of volatility within the capital structures We still like the cable space. We still think it has a lot of really attractive attributes It's typically duopoly market in each region Produces stable consistent cash flow in the hierarchy of needs, you know, it's sort of air water food cable cable broadband. And so we use that as an opportunity to lean into the industry over the past 18 months.

21:31So it's not all bad news per se. I do think sometimes the market tends to overreact or maybe act too soon, right? Sometimes these trends do take quite a bit of time to play out. No, I mean, this makes a lot of sense. We can all look at say like, oh, you know what? Elon Musk is putting satellites into space. This is going to allow me to cut the cord at home, etc but we're probably overestimating when i just tell that story the speed at which i'm going to do that and i guess like just internally maybe there's a better solution for me but it would take me a while to get comfortable with the idea of just like cutting off my broadband internet access in my apartment inertia is a very can be a very powerful force i pay for a lot of things tracy that i just like i don't know why and then i get a bill and it's like some app i downloaded three years ago.

22:19Yes, there is that annoyance. Okay. So speaking of other things that have happened in recent years, a big one has to be the influx of government money into tech-related areas. So data centers, also clean energy technology, things like that. One thing we often hear when it comes to fiscal spending is the idea of crowding out the private market. And I'm curious, as someone who sits at Apollo and is basically in charge of directing a bunch of private capital, is that something you notice or worry about at all? We haven't seen any signs of that at this point. But certainly the fiscal situation from a macroeconomic perspective is something that at a high level we're constantly watching.

23:04Clearly, I think the budget deficit's at$2 trillion, which would seem to be unsustainable if it continues in perpetuity, but haven't really seen a crowding out effect per se. If anything, I think some of the more recent government programs that have targeted investment in specific sectors that are deemed to be strategic has been a positive development in terms of attracting - Crowding in. crowding in almost, attracting private capital alongside the government investment. So whether it's the CHIP Act, which allocated$50 billion to construction of the domestic semiconductor supply chain, I think that certainly had a positive impact.

23:49You have the BEAT Act, which is looking to extend broadband in rural communities. I think you've seen a lot of cable providers and other telecom providers talk about the opportunity there to potentially utilize that. And then obviously the Inflation Reduction Act has clearly focused resources on the build out of the clean energy infrastructure. And I think those align very much with some of the major themes in the economy and the infrastructure needs in the US. And so as a firm, we're very much focusing on those sectors with respect to semiconductors. We talked a little bit about it, But, you know, recently we announced$11 billion joint venture with Intel around one of their leading edge or their leading edge facility in Ireland, which, you know, I think is part of that major trend of bringing back or making sure that we have, you know, stable, secure supply chains for critical industries like semiconductors.

24:48Going back to satellites for a second, if a legacy satellite issue, and we're not going to name any names, were to go bankrupt or something like that. You know, obviously, as credit investors, you think about collateral. And there are obviously assets that a satellite provider would have. However, if a satellite provider were to go bankrupt, it might be because those satellites just aren't competitive anymore or whatever. How do you think about the value of assets that you could seize in a bankruptcy when there is a question that the reason that the company went down is because that technology is no longer competitive?

25:23So in a vacuum, it's hard to answer that question just because it's so fact-specific and so situational-specific. So talk to us about how you might. Right. So Intel Sat did go bankrupt. Oh, yeah. All right. Let's go. Let's talk about them. But it was a little bit of a different situation given they had quite a bit of wireless spectrum that was in the process of being repurposed to support wireless networks, which was a huge asset for the estate that ultimately helped underpin the reorganization of that company, which has been very successful, by the way. As I mentioned before, it's been acquired through a merger with SES.

25:57But we generally try to avoid sort of secular losers, if you will. Yeah, I would hope so. Because in my experience, predicting decline curves in businesses that are facing significant headwinds and technological disruption can be really challenging. If there is like true fundamental disruption versus angst inducing headlines, that might not answer your question directly. Generally, we want to avoid those sorts of situations. If we are in a position where we are invested behind a company that may face some of those challenges, thinking more broadly across the industry, as I mentioned before, disruption tends to be a catalyst for consolidation.

26:38Thinking through the potential value of those assets as part of another company can be one way to frame downside valuation in our experience.