Ep.87: Liz Truss Resigns & Goldman Sachs Restructures Again!

Okay, hello and welcome back. It's episode 87 of the Market Maker podcast, and if you are watching this in video format on our YouTube channel, you can see Piers has morphed into Stephen. Stephen, how you going?

Good morning. Yeah, I'm very well, thank you. I'm gonna try and do as good a job as I can filling in for Piers, who I think is on a beach somewhere, which is very nice.

Well, perhaps he's in the— what is it? The Dominican Republic with Boris, just chilling, waiting to come back. His return is—

his time, yeah, calling MPs.

Yeah, well, look, on that, on that note, of course we do have to talk a little bit about Liz Truss, uh, the circus that is UK politics at the moment. I think we're right up there at the moment. Lots of tweets about us and Italy, uh, not the Euro finals but more like UK politics. We're neck and neck at the moment for what's been going on. So we'll talk about that, the latest state of play, and, and more importantly, how markets have been reacting. It's been quite interesting over the last kind of 24 hours. And then really want to make use of your experience and your expertise, Stephen, and talk a little bit about one of the main headlines that we saw this week was Goldman Sachs going through another major restructuring. So, you know, what's going on? Why are they doing that? what is the result of that type of action. And then the other headlines were quite private equity focused, and two real main things I want to discuss on that side. One is about what's been happening to some of these firms who IPO'd during the kind of post-pandemic, pandemic boom. I was looking at the likes of a couple of them. I think it was DoorDash, a few others, Robinhood, Lyft, I was looking and they were down like 80-odd percent, some, some huge numbers. But one of the things, and where private equity comes in, is about, you know, they're circling, they smell blood in the water. And then linking to that, this talk as well, separately, um, about this idea that private equity firms are taking the leverage out of leveraged buyouts, which I thought was really interesting, and I wanted to know Why is that and what does that mean? How long-lasting might that be? And so on. So that's what's on the agenda for the next however many minutes we go for. But let me give you a quick roundup of UK politics, and I'll try and keep this as brief as I can. So Truss reversed the top level of tax. She then sacked her chancellor and scrapped the plan to keep corporation tax down. She then appointed Jeremy Hunt to run the Treasury, someone who had actually backed Rishi originally when the two were facing off. He decided the whole economic strategy was wrong, had to go. He told the Prime Minister, checkers, pretty much the day after he came in. And then the rest was history from there. I mean, the writing was somewhat on the wall. The Home Office um, secretary left, and then everything just snowballed from there, and it happened quite quickly. So Liz Truss resigning just 45 days means that she's broken British history as the shortest prime minister. So what happens next? We're all kind of up to speed with, with where, how we've arrived at this point. So candidates to succeed Truss, um, they have until 2 PM on Monday to basically garner support. Now, how this would normally happen is there would be a certain threshold where Conservative MPs— you need to acquire, say, 20 of them to then put your hat in the ring, if you like. And normally it's like an elimination process. So there's quite a few candidates to start with. If you remember when Boris first came in, and they whittle it down, they need to really fast-track this because, you know, we're in an economic situation where speed is, is necessary. So basically the threshold is 100 MPs, which is actually very high. So we're probably going to end up with just a handful of candidates. Um, so the fast tracking then should be completed and a new PM declared. They're aiming for within a week's time, which is like super fast comparative to normal, normal times. The decision itself, because you might think, okay, yeah, so what do I pop down the voting booth and cast my vote who I think should be Tory leader. No, you don't. It's not in your hands, I'm afraid. It's in the hands of Tory MPs and possibly the Conservative Party members. Candidate-wise, nobody has made their intentions to run clear just yet because what will happen is you've probably seen lots of pictures of Rishi leaving his house very early this morning, because he's now going to be going around messaging, meeting all of the different Tory MPs to get them on side. And so will all the other front runners be doing the same. Sunak is seen widely as the favorite and most likely to make the cut for the final two, which will then go into a runoff. And then Boris is back. I saw, um, there's a hashtag, uh, that Jacob Rees-Mogg tweeted this morning BBB, bring Boris back.

Bring Boris back. That's a scary thought, isn't it?

So, so Boris Johnson is, uh, for the bookies, second. Yeah, in the running with 38 currently, as of BBC News this morning, MPs throwing their support behind him so far. Another 16 went for Penny Mordaunt to make a bid, um, so she's sounding out people at the moment. It's kind of all very light touch for now. And what it does mean though is you're probably likely to hear lots of headlines and rumors and things that over this weekend because the deadline's Monday, basically, effectively, to put your hat, put your hand forward. A couple of things here. Polling— obviously the Labour leaders jumped on this situation, as have other opposition parties. They want an immediate general election. Now the reason for that is the rolling average of the latest polls for British pollsters puts Labour at around a 30.6% lead over the Conservatives. That's never been that high since the end of that long era of Conservative rule when Tony Blair and New Labour came in, kind of that landslide victory in '97. So this is all what's happened, good news for Labour and their popularity, but the idea here is that an actual general election is highly, highly unlikely because effectively Tory MPs have to vote for them losing their job and control of government. So we're very unlikely to head there at this point in time. So just to make that crystal, crystal clear from a markets perspective. So interesting because yesterday I felt really bad for Liz Truss, actually, because can you imagine you're leading a company or an organization, or in this case a government, even though it's for short? But the same actually happens, as you know, when you see a CEO, a bank or a listed company leave. Typically when someone leaves, it's very rarely that they resign because of old age and yeah, it's just my time to hand over the mantle. It's normally because you're a listed company and you're not performing and you get pushed out. Or in this case, your political agenda is not working, you get pushed out. And so actually removing the negative agenda unshackles then the uncertainty, and we had a relief, quite a powerful one, in the pound yesterday. Um, but relief, as I always say, is a, is a feeling, is very short-term, it doesn't last very long. And the pound is lower now than it was prior to her resignation. So I guess that from a market perspective, um, really it's about the economic challenge which remains exactly the same, irrespective of the winding back that Jeremy Hunt has done so far. Retail sales out this morning in the UK below expectations. Consumer confidence in the GfK overnight were about as negative as we've been since the depths of the pandemic. You know, we are still in the same situation as we were in before this. So, um, I thought a good summary was from someone who, if you don't recognize his name, he's definitely worth following. He's quite active on LinkedIn. He's called Mohamed El-Erian. And this guy is the head of Allianz for the strategy side, I think, these days. But he used to be the head of the biggest— the world's biggest bond fund, PIMCO, is what he's more known for. And he, I think, summarized it in 3 key areas that we need to focus on from a market perspective. And it's all about can the UK pivot to higher growth but ultimately do it in a financially responsible way, which is exactly what Kwarteng got wrong, essentially. Um, so here the 3 things he's looking at are details on the growth plan, including verdicts by independent parties such as the Office of Budget Responsibility. So this is a key element that was missing, of course, where Truss tried to rush through as soon as she came in, this big proposal, but ultimately without it being verified by independent parties, markets don't really believe about how it's going to be funded in terms of these ambitious plans. So the second part is then more details in what will happen to the energy price subsidy, because remember Hunt has brought that from, what was it, 2 years to April, I think, for review. Now I think that's intelligent wording personally, because by saying we're going to do it to April with a review, you appease the markets by pulling back on your commitment of the amount of spending, but at the same time you're not saying you won't roll it over depending on the situation. So I think it's a— it's kind of a central banker's textbook play where I'm not committing but I'm kind of committing, satisfying the markets as long as people don't get too cheesed off about it. Yeah, because we might roll it over. It's one of those. Um, and then the final point that Arian makes is that, um, the markets have made it clear that you cannot go down the path of unfunded tax cuts. And so what's going to be interested is that, you know, as far as Hunt has been concerned, there could still be other things to come. So it's about the devil in the details with all of this.

It's been a— it's been really, really tough to find any good news in all of this. And your summary, Anne, suggests that it's all relatively negative. And even if we peel back a couple of the layers to actually get deep into what's going on in this country, there's not a lot of good news. I was, I was thinking about this, I was trying to find some good news from what's been going on over the last couple of weeks. And I think although Truss lasted 44 days, it's a good representation of checks and balances in our system actually working. So the way that our UK political system works is you have the executive sitting within the legislature, which is really messy. You know, it's like the president sitting within the Senate in the US. It's really, really messy. But that is designed for the legislature to kick out bad actors, inexperienced politicians, bad leaders, and it worked. So, you know—

Did that work for Boris though in that, in that way?

It took a bit of time for Boris. I suppose it did. Honestly, if he comes back, then, you know, ignore what I've just said. It's a disaster. But the other thing that I think we should be feeling a little bit more comfortable about from a markets perspective is you can't mess with the playbook. You cannot mess with fiscal responsibility, with sounding out the Office of Budget Responsibility, with consulting the key market participants before you do something, and with working closely with the Bank of England. So you've got to do this stuff. This stuff is important. It's not just a nice to have. So there's a little bit of kind of return to the mean. Which is comforting. Yeah, you didn't need to go through this turmoil though.

Well, I, um, I guess this is one of the things about Jeremy Hunt, and you know, whatever people's thoughts might be about him, what he's done in the past, um, one of the things is he was— he's communicated throughout. And I say this because I think this is important for how central bankers, um, chief executives all operate. It's about that continuous reassuring commentary. You don't necessarily need to have the solution or the answer. So tactically, looking back in retrospect, how I guess Truss could have played that differently was that she wanted to get a big splash, really assert that dominant position immediately. But you could have done so by communicating your intention of what your ambition was whilst also sounding out those parties, as you said, to verify the checks and balances, and then bring the two together. So you're accelerating, you're satisfying that acceleration of communication side to make your stand, but you're also doing it in a sensible, responsible way.

But yeah, I like to—

Lack of experience perhaps, like you said.

If I like to use a football analogy, firstly, you know, not many football managers stay at the same club for the amount of time that the Tories have been in power, right? You know, we, you need refreshment and you need change, but if you do get a new manager in, Don't just fire all of the players and change the name of the club, you know. There's got to be some continuity, you know. That's basically what Trust did over, over the last few weeks.

Yeah, yeah. I guess it's such a tough gig, isn't it, being in politics? Because obviously her and Kwasi were, were tight coming up in the system, and, and you have to— it's a game where you have to have people who've got your back and you're— yeah, trust. But at the same time, even though they're experienced in some ways, they're not experienced at being at the top of that pyramid, if you like, of control. But yeah, well, look, let's see what happens. I'm sure there's plenty more to come. And by this time, you know, next week, I look forward to talking about Boris Johnson returning as Prime Minister.

And, uh, yeah, there's, there's, there's an emerging, there's an emerging trading strategy going on, which is, which is tracking flight tracker. So the most tracked flight was the, was the Queen coming down from Balmoral. The second most track flight was Kwasi coming back from, uh, the UK.

Yeah.

And now we're going to be looking at the flight tracker on Boris. Let's see what happens.

Uh, or Piers Karen, who knows.

Yeah, wherever he may be.

All right, well, look, the, um, the situation at Goldman Sachs, because I know there's a— there's generally with our community a lot of interest in this, whether, you know, it's, it's kind of seat at the table of what they do or working at them as a potential employer. And I think this is, you know, important in that regard as well, because there's been a large-scale reorganization. And in fact, it's the second significant restructuring under David Solomon, the chief exec, who's only been in that role for about 4 years. So it's a lot of moving parts here happening. I did see their earnings come out, and I saw the, the kind of pitchbook they had for this strategy. Um, but yeah, your thoughts on that. Firstly, why— what, what's happened, and why have they done this?

Yeah, so essentially, yeah, as you said, you rightly said, and this is the second major restructuring of Goldman Sachs in the last few years since David, uh, Solomon took on the reins, uh, of the organization. Now I think we need to step back in order to understand what's going on today. Goldman Sachs has been around for 150 years. It's a very storied institution, incredible on the investment banking side, incredible on the global market side. But it's always acted— well, it's been a partnership, it still is a partnership, and it was only IPO'd in 1999, 24 years ago. It's quite a long time ago, but it has the institutional memory of a freewheeling, high IQ, low EQ partnership where lots of money was being made, but there wasn't a lot of institutional infrastructure, and it didn't feel like a corporate. I used to work at HSBC. When you walked into the doors at HSBC, it felt like a corporate. There were hierarchies, there were chains of command, there was bureaucracy, there was all of these things that resulted in the organization HSBC being boring but being stable, right? And from an investor perspective, if I'm investing in Goldman Sachs or Morgan Stanley or JP Morgan. I want to see stability in revenue, stability in strategy, and some really, really good boring revenue streams coming in, right? So, so when David Solomon took the reins 3 or 4 years ago, this is a bank that has been dominated 70-80% of its revenue from investment banking, so advising companies on their strategy. Very, very high quality M&A house, very high quality equity capital markets house, but that's super volatile. We've seen this in the markets. M&A's come off totally this year, so you can't rely— I think they're— I think Goldman Sachs is down 65% in their investment banking, uh, wing this year. And then the other side is the global markets. Now, the global markets, they're a, you know, pretty fundamental part of markets infrastructure, you know, provide a lot of liquidity, market making. But that's expensive from a capital perspective, and it's also super volatile.

Yeah.

So when David Solomon comes to, you know, comes to Goldman Sachs— he's been around for a while but comes to the fore— he's looking at Goldman Sachs' valuation. Relative to its big rivals Morgan Stanley and JP Morgan. Two things he looks at, probably: the price-to-book, or the price-to-net asset value, and the price-to-earnings. And in each of those, um, earnings rate— um, earnings ratios, Goldman Sachs trades at a significant discount to its rivals. So he's got to ask the question, why? So investors don't like volatile earnings. They don't really, really like— they don't love the investment banking in the market side. They would much prefer there to be a significant part of the business that was focused more on very stable, very boring banking. JP Morgan does it well with Chase. Morgan Stanley— Morgan Stanley does it well with their wealth management division. Goldman Sachs has been trying. So I don't know if you've, you know, spent a bit of time looking at Marcus, right? Yeah, Goldman's consumer division, which I think it raised— I think it's got about $100 billion of deposits from consumers, which is not bad. That's cheap deposit base for all of their other activity, but it's cost them a lot of money to get to that stage. Their asset management arm, they bought a couple of companies over in Europe but it's still very, very small. So fast forward to today, David Solomon's trying to get the share price on a par from a multiples perspective with Morgan Stanley and JP Morgan. So the strategy, as was announced earlier on this week, is merge or kind of join the trading and investment banking divisions together. That's a lot of egos. Yeah, yeah, which we'll talk about in a minute. Put the asset and wealth management divisions together. That kind of makes sense. And stick Marcus somewhere in there as well. Maybe pay it slightly less attention because it hasn't been super successful. And then create this new platform solutions group, which is a, which is a brilliant way of Goldman Sachs trying to say that it's a tech company. This happened with BlackRock a few years ago when it said, no, no, no, we should be valued as a tech company because we've got 15,000 engineers. Well, no, you're an asset management firm. But you can see what he's trying to do by elevating those three pillars and making them of equal importance in the hierarchy of the organization, to say, look, we want these to be the three major revenue streams. And it's not just investment banking and markets leading the way with these two afterthoughts. They're all up on the same level. So you should start markets, investors, you should start valuing us at the same level as you do JPMorgan and Morgan Stanley. Share prices pop— the share price popped a few percentage points. Obviously there's a lot of ground to make up. Jury's still out as to whether this can actually happen in a company that has got this slightly freewheeling, you know, excitable lack of governance background, is this, is this something that can happen? We'll have to wait and see.

Yeah, so this makes total sense why DeSoul has been out at all the music festivals, because he's, because he's engineering a more boring work life, he's got to have this little side hustle where he's DJing, you see. That all makes sense.

Well, the question is, is he using the Goldman Sachs private jet? To go to Lollapalooza and all of these things. That's, you know, they haven't disclosed that yet. It's going to be quite interesting.

So, so question I think I asked you earlier in the week that I'm quite keen to know is that, because I have seen other titles in like a Morgan Stanley, who you say Goldman's are trying to emulate in some ways in the structural sense of things. I know at Morgan Stanley there's like co-heads. Yes. But can co-heads coexist when, oh, in MS and JP, it's been matured as a hierarchy or a structure. When it's brand new like in Goldman's and you've got— I, I can just imagine a head of IBD. Yeah, the head of markets. There's a lot of friction there.

There's a huge amount of friction. And I think the answer is yes, it can work, but only under a certain series of circumstances. So I can totally imagine it working within the asset management and wealth management division it's actually a similar range of products and a similar perspective. You know, those two divisions are quite similar divisions. Now, when you look at Global Banking and Global Markets, they are— they're very, very different product types, even though they're still part of the kind of broad investment bank. The type of people that rise to the top in Global Banking are advisors, bankers, used to working long hours, spending lots of time, you know, fastidiously analyzing companies, doing due diligence, all of this kind of stuff. And then the global market side is, is obviously a lot more fast-paced, it's a lot more reactive, it's a lot more intraday, and it's kind of in its approach. Now, if you've got two big personalities with two big egos co-running a newly amalgamated unit bearing in mind this is still a partnership, so there's still that element to kind of consider. And if they both consider themselves as in with a chance of taking the top role, this could become pretty poisonous. So it's going to require some really, really clever crafting and communication and management by Solomon to get these two people I don't know their, you know, I don't know their profiles or their backgrounds, but get these two people singing from the same hymn sheet in the context of us restructuring, which is trying to elevate two other pillars almost at the expense of the investment bank and markets. So this is going to be fascinating. I have no idea whether it's going to work.

Yeah. And the other thing I can't help but think is take the current situation and then the initial COVID situation. So during COVID we had low interest rate environment, everything was going up, deal making was through the roof, but markets were dead boring because the market wasn't really moving. That's flipped on its head right now. So you get these massive swings within one singular department between then extreme revenue generations going like this. And it's, you know, tussle.

And it's, it's, you know, it's a, it's a, it's a decent business model. There's nice dovetailing. When one is down, the other is up. But if we're looking at annual bonuses, quarterly reporting cycles, and I feel like I, you know, you're a deadweight loss and I'm dragging you along because where's the fees? Yeah, it's going to become quite difficult to have those conversations, even if they're mature bankers. We're so short-termist in our approach, you know, these days, that to think actually this is a good 10-year strategy is probably not something that they're thinking about at the moment.

Does that, does that feed into the general perception of the Goldman environment where it's like they want to engineer a place where you are a little unsure, you do have to perform day in, day out, and that's part and parcel of being part of that firm and their culture?

Yeah, it's a really interesting one, and it's kind of fascinating that from our perspective and working a lot with students, Goldman's is definitely put up on a pedestal as being the place to go to in investment banking and markets. It's very alpha, it's very competitive, it's, it's a brilliant place to have in your CV. And then actually thinking that the markets don't value it particularly highly at all, you know, it's a trades on a 6 or 7 times price earnings. So there's this quite interesting dislocation there. Yeah. With regards to, can— I think it's, can you change the internal culture of an organization that's been around for 150 years unless there's a transformational acquisition? I don't think so. I think that Goldman Sachs is an investment bank, global markets player. And trying to, you know, trying to— leopard changing its spots, you know, trying to re-engineer without doing something pretty transformational, buying a big retail bank, you know, that, that is of a similar revenue profile. I think we're still going to be back at this kind of relatively hard-edged, competitive Goldman Sachs environment that you speak of.

Yeah, but we're a tech company.

Yeah, no, I was looking, they've got 11,000 engineers, you know, that's brilliant. And there's some interesting stuff going on with their platform solutions business. I mean, you know, providing, is it banking as a service? That's what they call it, providing the infrastructure or the rails of banking for the likes of Apple Pay and things like that. That's a nice business. That's a high margin business, but is it going to be as big as their bread and butter businesses? Not, not within the short term.

All right, well, look, let's, um, let's talk a little bit then about the private equity situation. Now, there's two sides of this, so how, how do you want to tackle it? Uh, let's go IPO side. Always let's go IPO side.

Let's go IPO side first. Yeah, good idea.

Cool. So the, the main headline from this week was that three-quarters of large US companies that went public during this— we just mentioned this pandemic kind of bull run marketplace— they're now, three-quarters of them, trading below their initial offering price. Uh, some are deeply underwater, uh, like really bad, 80% type margin. Um, and what this is resulting in is it's forcing some to move back into private hands in a fire sale valuation. So yeah, I just thought it was a really interesting headline because it felt like, you know, the market just went nuts 2 years ago. And yeah, throw SPACs in the mix and all the rest of it, and now here we are, um, just, you know, 24 months later. Quite—

yeah, it's, it's, it's really interesting to, you know, so we all, we all look at history and think and look at hindsight and think, how did we get wrapped up in this irrational exuberance of the markets in 2021? Wasn't this just like 2000? And if you, if you If you're a follower of Ray Dalio, he loves looking at historical patterns to better understand what's going on at the moment. But I doubt whether we would've done anything differently from a markets perspective and from an IPO perspective and from a fund flow perspective, even if we were given 20/20 hindsight. It's just what happens when there's so much money sloshing around and not enough places to put it. It was totally logical in a sense that we had the mega IPO binge that we had in 2021. But it's also totally logical in a sense that come 2022 and a very different macro environment and a very different Fed, uh, outlook, uh, and an activity, we're going to see some of these speculative companies that IPO'd during the good times fall off a cliff. And I think one of the most interesting stats that I read, trying to pair, trying to understand this 76% of IPOs trading below their IPO price, in 2021, 72% of US IPOs, the companies that IPO'd, were loss-making. Almost the exact same number. I'm sure there's some difference there, right?

Yeah.

Whereas in 2009, post-financial crisis, only 19% of companies that IPO'd were loss-making. So if, you know, if you extrapolate to 2021 and 2022, you're thinking, well, this is obvious, you know, a bunch of pretty average, potentially not ready to IPO companies take advantage of an incredibly fertile environment, they're going to fall off a cliff the next year. And this is, this is exactly what we're seeing.

Well, that's a, that's a really interesting stat. I didn't know those numbers. But yeah, I mean, and, and the connection then that we have here to, again, private equity's interest. So is this a case of as well that private equity was sat on a lot of cash during a period of COVID and they're the— then now this is like the perfect storm for them. So one man's loss is another man's gain because they can deploy what's been a war chest building.

Yeah, so they, they've got a massive— private equity has got a huge, huge war chest. I think they've got $500 billion in the US alone to deploy. So, you know, in the good times they harvested and they've saved, and now they've got this war chest. But what I think is really, really interesting about deploying this war chest, especially circling this 70% of— 76% of post-IPO companies that have ended up trading below their IPO price. Most of these companies, or a significant majority of these companies, were on the venture capital treadmill or escalator, not necessarily the private equity treadmill or escalator. So venture capital in its model is very, very different from private equity in its leveraged model. Venture capital, you go through the funding rounds and you get more funding if you can show superior extreme growth. Then you get to the next funding round that fuels the next round of growth. Don't worry about free cash flow, don't worry about profits, we're going to get to economies of scale, and we're going to get to a dominant market position, or we're going to build up a significant moat so that we can really start cashing in. So what happened in 2021 is off the end of the escalator came a bunch of VC-backed companies straight into IPO. Now, often, or previously, these companies would be more mature before they IPO'd, or they'd get bought by a strategic, another company that sees logic in buying this high-growth, loss-making business and integrating it. But that didn't happen in 2021. So you've got all of these companies that have been drinking the VC Kool-Aid. Feeding off of, you know, lots and lots of capital to grow, but don't necessarily have a great deal of financial prudence. They don't see a particularly clear route to positive cash flows, and now they're stuck in a public listing where the stock market, the investors in, in public companies, don't like them because they're seeking safer havens. And private equity, although they're circling, the traditional private equity model has been buy a, buy a boring, not particularly well-run business, pump it full of a decent amount of leverage because it's got free cash flows so that it can service and pay down its debt, turn it around and sell it. So the private equity model slightly jars with the companies that are in this no man's land of post-IPO but not yet profitable. So this is going to be the interesting dislocation. Private equity, $500 billion of dry powder. Are these companies the right type of companies for private equity to buy? I think that's the big question.

And just from a timeline, I, I— the one example I saw was someone called ForgeRock. Yes, which I'm sure you read about, but again falls into that tech catchment, of course, which probably makes up the largest proportion, a business software firm. And it's, well, it's just that they've gone private just over a year after its SEP21 IPO. I mean, it's crazy. SEP21, uh, they agreed to sell itself to a private equity firm, uh, Thoma Bravo, for $2.3 billion. So presumably though, the bank— the investment banks are back in picking up some fees on, on these transactions.

Yeah, yeah, that's a big fee day for that just over one year. And it's, it's really interesting. There's— so, so Fortrock is a great example. I've been looking at— been looking at mattress companies. Oh yeah, I think nothing says bubble more than VC-backed mattress companies. So mattress companies, your kind of Eve mattresses, your Caspers. So there's been 5 or 6 that have been very well venture capital backed. They're not a tech company, they don't benefit from massively high gross margins, they don't have network effects, they're just mattress companies. So Casper IPO'd in 2020 well below its private funding round that happened beforehand, so IPO'd at about $500 million. It was sold recently to private equity for $300 million, so a decent haircut, but it's not likely to achieve positive free cash flow until 2024. So it's still not a mature business, it's still not a business that most private equity firms would touch with a bargepole. So this maybe leads on to, to the other article that I think we're going to discuss— private equity firms giving up leverage.

Yeah, and then this is one of those— I, I guess what could be useful to start with is finance students will hear a lot about LBOs. Yeah, so perhaps just a quick skinny on what is an LBO. And if you have not yet been on the AmplifyMe YouTube channel, Stephen puts out some incredible short-form lessons. They're like 2 to 3 minutes. He did one last week that was highly relevant for the market side because, you know, I meet a lot of students and it's like we do like a mock interview, right? And I'll say, tell me about something in markets. And they'll go, yeah, Credit Suisse credit default swaps. I go, okay, so tell me about credit default swaps. And then they go, um, I'm not quite sure actually. I know it sounds cool, but what actually are they? What's their purpose? And other than Credit Suisse's 5-year CDS and things spiking and the inversion of it. Like, they say it, they don't actually understand it. But I know you do a great series on that, and perhaps on the LBO side. Yeah, it's a quick—

yeah, so super, super quick. Um, so look, I rate— I'm a private equity firm. I raise a billion dollars in equity from investors, pension funds, endowment funds, etc. That one billion dollars I need to turn into as much as I can over a 5 to 7 year window. I see a really nice boring company that's generating decent free cash flows that I think is probably not particularly well managed or could move into a better market, and its acquisition price is $1 billion. I go— but my first option is, well, I've got $1 billion in dry powder here, maybe I could just buy the company 100% equity. That's my fund done, fund closed. Let's focus on this company. Or what I could do, since the company's producing decent free cash flow that could pay down debt, that would definitely be able to service debt, is I go to the banks and go, well, if I put in $300 million, do you mind putting in the other $700 million? And suddenly I have an asset worth $1 billion that I bought for $300 million. I've stuck $700 million of leverage into that transaction And my goal throughout the 5 to 7 year process is to pay down some of that debt, or at least service it, increase profit margins and increase the profitability of the company, and hopefully sell for an increased multiple. So these are the 3 levers of private equity, right? Leverage— use— using leverage sensibly and paying down debt during a transaction. Increasing your multiple on exit, your acquisition multiple on exit, so you get more equity back, and also increasing your profitability throughout the 5 to 7 years so that that multiple obviously is on a bigger denominator. Leverage has played such a fundamental role, and private equity has managed to build up so much dry powder because in a low interest rate environment it's free money. You know, your cost of capital, which is a fundamental part of a private equity equation— your cost of capital has been incredibly cheap for the last 7, 8, 9 years. So private equity firms have, you know, have generated incredible returns, and money has piled in. You know, 10, 15 years ago, you wouldn't get really, really boring, um, pension funds, touching some of the more exotic private equity firms. But over the last few years, they've had to, to get the returns that they want. But now this is all changing, and the whole private equity business model is, is starting to be questioned or compromised because that's getting more expensive, right?

And that's the— that's the— then the, the final kind of headline for this week. Which was talking about— I like the way that the FT talks about them, the, the debt-addicted corporate raiders. Yeah, yeah.

I wonder which side of the fence they fall on.

But they're talking about, as you say, taking the leverage out of leveraged buyouts. So this next period ahead then, we're to expect more— like you gave that, that example of the billion Yeah, and I'm taking out this company. So the process of that is to just— because the dry powder is so large and that the borrowing rate is so expensive, it's just as simple as that. And until the macro environment shifts, you know, they can go as long as the, the war chest has money.

Yeah, there's, there's a couple of points there. So, so there has been, you know, so the article was talking about all equity private equity transactions, which hasn't been seen for a while. I think the first kind of pullback from that article is that yes, there are a few all equity transactions going on, but that by no means means that the transaction will be all equity throughout the tenure of that acquisition of that holding. So yes, I might acquire with 100% equity because I can move really quickly, 'Oh, banks are, you know, are not playing ball at the moment. Interest rates are incredibly high. My cost of capital's high. But in 18 months' time, if everything starts to smooth out a little bit, then debt will come back into the mixture.' So in these models that private equity firms produce, they're not necessarily thinking all equity for the next 5 to 7 years. They're thinking equity for the next 6 months. Let's see what happens. Let's see what happens with banks. Let's also see what happens with private credit. So private credit, which has been a massive growth industry in finance over the last 10 years, sits alongside private equity as an investment vehicle to provide credit, to provide debt to private equity-backed companies. They've started to pull back from the market, which is quite surprising. But it won't take too much for them to get back in and start lending. So first things first, you know, this is not, this is not an enduring phenomenon, I don't think. And then secondly, if there is, if it does become slightly more enduring, or at least the leverage part takes a slight back seat, you're now going to be really, really focusing on those private equity firms that are operationally excellent. So the firms that are really, really good at turnarounds, at implementing really, really high-quality strategies and executing on really, really good process within a firm, because the profitability of the, the firm that they take private or the firm that they acquire, that's going to become a bigger mover of the ultimate returns of the business because leverage has taken the back seat. So you'll find those firms that just boss it, and, and a lot of them are the traditional private equity firms that boss it from an operational, from a governance, from a management perspective. Still doing all right. We're not going to see the returns that they received in the last few years, but those guys are probably going to be okay.

Cool. Well, look, let's, um, let's wrap it up there. Uh, just clocked the time, so thank you very much, uh, Steve. And don't forget, um, thank you. And don't forget to check out the show notes, anyone listening, if you want to take part in one of our Finance Accelerator simulations. They're still happening, the public events every week. And we've got the daily newsletter that goes out, which we put out a really cool application tracker with our partners at LSE. So that is super useful, um, and I shared that out to the community this week. So stuff like that is coming all of the time, uh, all with the objective of trying to, trying to help you out. So, you know, let us help you.

Absolutely.

Um, so Stephen, have a great weekend. I'll see you next week, and take care, everyone.

Thank you.