Billionaire Leon Black - Investment Strategy for Private Equity

First of all, thank you for the nice welcome. My apologies for being late; we were held on the ground for 85 minutes. I was supposed to be the 4:30 speaker, but happy to be here. Drexel Burnham Lambert was a very unique experience. I'd say 12 years there were spectacular, a rocketship going all over the universe, and then the last year was a disaster as the rocket crashed and burned. Out of those ashes, my partners and I founded Apollo about four months after Drexel's bankruptcy. We were helped by a one-stop shop that backed us with about $800 million of capital, about half of that their own capital in one fund which was a managed account, and they also helped us raise our first $400 million account for Apollo. If you remember back in the spring of 1990, the world was going through a fairly sizable recession. Originally they had wanted me to get involved in building them an M&A platform, and I said there was no M&A; the credit markets were totally shut down at the time. But if they would back myself with a distressed approach as well as managing a high-yield portfolio for them, that's where we started 25 years ago. Fortunately, we've had a lot of good breaks over the last 25 years. Today, if you look at Apollo, we're basically doing many of those same things: we're involved in PE, we're involved in credit, and we're involved in real estate, which we also started with Credit Lyonnais back in 1993, only we've gotten a little bigger during that period. Today we manage about $165 billion. There's been a major secular trend since the last downturn seven years ago: one being low interest rates, so many pension funds can't meet their 8% liability bogey investing in investment grade, so they need to look at alternatives. Secondly, all the draconian regulatory restrictions placed on banks and investment banks were a very nice tailwind for us to grow our credit business, which today has grown from about $20 billion just seven years ago to about $110 billion today. And finally, we've also benefited from the growth of our real estate business.

At our core since day one, and the reason I gave you a little bit of the history, is to say that not that much has changed on the scale since day one. What has always defined us is being a value investor, a contrarian investor, an investor who doesn't mind dealing with complexity. There are many roads to Rome, but our secret sauce has always been to stay as a value investor, and we have gone about it in a number of ways. What do I mean by a value investor? We like to buy good companies at low prices. A lot of people say that, but the fact is we've developed multiple pathways in differing economic environments that have enabled us to execute on that plan. Pathway number one, which goes back to my Drexel training with Mike Milken and the whole high-yield revolution, is to analyze the balance sheet and buy at deep discounts the debt of good companies with bad balance sheets, buy enough of the debt to matter in a restructuring, and end up in a position to get control of those companies through a restructuring. The beauty of that approach is that if you know what you're doing, about half the capital we put to work in distress situations we succeeded in getting control of very good companies with bad balance sheets, whether it was companies like Charter Cable, LyondellBasell, or even going way back to Vail Resorts. But half that capital ended up being sold away from us because somebody else came in at the end of the restructuring process and said we'll pay more for this cleaned-up company. In those situations, we averaged about a 60% IRR on our debt positions, and we got to recycle that. Our entry multiple into distressed is about a 5x EBITDA multiple, so your risk reward is very attractive. Another pathway is buying companies in corporate carve-outs. They're usually under-managed, under-capitalized, complex, usually take 9 to 12 months to negotiate, and you usually get an opportunity to have an exclusive with the seller. This isn't unique to us; we just happen to do more of them than anybody else. The average multiple we pay on those is about a 6x EBITDA multiple on the entry, and these are very good companies. We feel we can create some value in these companies. It is more competitive; some of them are auctions, and one tries to stay disciplined, but maybe those go up to a 7.5x multiple. The upshot of all this is that our big differentiator is that we are a value investor. In this market environment, our Blackstone Fund was an $18 billion fund, the fund before it was a $15 billion fund. Those funds were put to work at a 6x multiple on average, in an environment where deals done at over $500 million in the PE world in the last 3-4 years were at a 10x multiple. So our companies are being bought at lower prices, there's less risk in them, they're less levered. Over a 25-year period with this secret sauce, we've generated a 39% gross IRR, which translates to about a 26% net IRR in our PE business. That's the differentiator. Two other quick things that differentiate us: we run our firm as an integrated platform. That means everybody in credit, everybody in PE, everybody in real estate talks to each other every day. Most firms silo them separately. This creates an informational library with everybody talking to each other among the professional investors. The last thing that differentiates us is that we go to extraordinary lengths not to lose money. We make mistakes like everybody else does, and we certainly have had our share, but one of the things I'm particularly proud of is that even in many of the situations where we've made mistakes and things have gone wrong, we have rolled up our sleeves. If a company gets in trouble and it's in our portfolio, we're willing to go in if we believe in the business and have conviction about it, buy up the debt at deep discounts, and create value that way. To fix the company, you have to be able to work on both the left and the right side of the balance sheet, improve it operationally whether it's cutting costs or taking advantage of acquisition opportunities, and also buy in securities when they're trading at a discount in the market.

Great question. On that segue, there was a company called Realogy, the largest real estate brokerage company in the Western Hemisphere, probably in the world. Some of their brands included Century 21, Coldwell Banker, ERA, Sotheby's, Corcoran. We bought it at a 6x multiple, and at one point we actually had marked it in our portfolio at about 10 cents on the dollar. What we did is what I just described: we rolled up our sleeves and attacked both the left and the right side of the balance sheet. We cut costs by half a billion dollars, added some opportunistic acquisitions, and bought in a lot of the debt of the company at deep discounts. This process took about 3 to 3.5 years, and we exited making twice our money. I think we learned a few things. Number one, after we did that deal and one other large deal called Caesars, which had similar characteristics, we basically said there should be no exceptions to paying higher multiples, no matter how good the brands are. That's just not us. It also gave us the feeling that it's never over, and that saving those situations is even more important than making new investments. The other two I'd mention: one was a deal we did very early on in our history that kind of put us on the map back in 1991. We got involved in the rehabilitation of an insurance company called Executive Life in California. We were able to work with French administrators, it took a long time, and we bought the portfolio at about 50 cents on the dollar. We divided it into three parts: those situations that we thought might be very good distress-for-control situations, those that were just a nice high-yield portfolio, and a lot of dogs and cats that we didn't think had a whole lot of value. What ended up happening was that the distress-for-control situations didn't work out except for one exception, the high-yield portfolio did very nicely, and the dogs and cats, instead of being worth a nickel on a dime, we got very lucky and they ended up being worth 20 cents. So it turned out to be a successful transaction, but not in the way we had originally envisioned. The last one I'd mention, and the one that personally excites me the most today and has for the last five, six, seven years, is Apollo itself. Building the firm has been a complex, long-term, challenging transaction. It's been strategic in terms of doing things we're good at and not straying too much from that, making sure we keep our good people and keep adding on people. We've gotten more global during that period. That's been a much more complex, longer-term challenge, but I'm most excited about it now, and also making sure we stay out of trouble, which is key.

Sure. I have a number of passions. I have four fantastic children; two of them are working with me, one is a filmmaker who just moved out to California, and my youngest daughter is in law school right now. They are a great passion. I've always been an obsessive-compulsive collector of art, which is a good motivator to keep me working hard, and that's something I'm passionate about. That's why I'm involved with MoMA, the Met, and the Asia Society. But the most recent passion of the last eight years is the Melanoma Research Alliance. Eight years ago, my wife had a melanoma on the bottom of her foot, stage two, and it was taken out. Mike Milken, a close friend who I worked with for 13 years, his dad had died of melanoma, and he's done a lot of work with prostate cancer. He asked whether we would start a melanoma research foundation. We said yes, but we didn't know a whole lot about running a scientific research cancer foundation. He said let me help you since I know everybody in the field. We put our own money into it, and we have since raised and levered about another $110 million, so about $150 million has gone into it. The whole field has really been transformed in the last seven years. Melanoma today is the poster child for advancement in cancer research. The whole field of immunotherapy, which is revolutionizing cancer research today, has been led by what's been happening in melanoma. We've now had 11 drugs approved by the FDA in the last four years, and we've been involved in funding all 11 of them. There are genetic systems between different cancer patients, so a drug that may help 15% of melanoma patients will also help 10% of lung cancer patients and 6% of multiple myeloma patients. Where this is all going is towards customized medical treatment and the development of cocktails, as it did with HIV. It's very exciting working with these scientists and doctors. Coming from a financial world where the scorecard is money, these devoted scientists and doctors just want to do good and help the world. I also have a company called Phaidon, which is involved in art, photography, and architecture, and has a big culinary line, so I get to meet chefs all over the world. The other passion has been the Jewish Lives series with Yale University Press for the last eight years. We've now published 20 books and have 40 more under contract. It's readable biographies by different authors matched with different subjects, from Abraham to Steven Spielberg. Amazon's killing everybody, but it's a passion. When you asked about passion, that gives me a new goal in life to make it into your library.

Oh, thank you all.