Steven Tananbaum on iCapital's The Bridge - 2026

I love it.

So, let's start with the bull case and then the bear case. So the bull case is you can buy growing companies revenue and EBITDA for 70% off what private equity firms paid. Software is on sale. Now the bear case is if you look where corrections have basically ended, you still have several hundred basis points. You've only made about half the move. So it's usually gone well over a thousand basis points and you might be only six or 700 basis points from 400 basis points. So that's where there's a bull scenario, a bear scenario.

Totally.

First is you acknowledge you don't know. So therefore it goes to price and making sure from an allocation standpoint you're open-minded. You take for instance prior industries and how they behaved. You look at something like media and let's just say newspapers which is famously contracted significantly. But a...

Yes, many people's old stomping grounds. When you think about it, the internet in 2000 was challenging classified ads. But it wasn't until 2005 that the enterprise values began to fall precipitously.

You look at something like TV where there was still good nominal growth for almost 15 to 20 years. Programming there was still good nominal growth and valuation still growing in the double digits in terms of value creation for a good 10 or 15 years. It wasn't really until cord cutting that you saw the programmers feel the impact. So then it goes to price and what can happen. For instance in 2007 the purchase of Tribune was a disaster but by that time the trends in newspaper had already rolled over and you still don't have that in a lot of sectors in software and you're being able to create them at very good discounts. So I do think there's some interesting investments to make. You also look at the difference between where you can buy software in the public market and kind of similar types of companies will trade close to eight to 10 times EBITDA, two to three times revenue that you can create in the credit markets at around two and a half to three times EBITDA and less than one times revenue. So the valuation between the different markets is certainly pretty severe. So what I think is so interesting about this is that you see an ability to step into the space where a lot of people are running away.

So first is looking at our prior history, we have a good one-loss record doing this of industries that are going through transition. We've also are open-minded that not every investment we're going to make is going to be correct and we're going to increase the ones we feel have good momentum that are beneficiaries that are certainly not going to be extinct quickly and we also feel it's important to establish relationships with key suppliers, management teams, have a variety of sources to either prove or disprove what we're doing. And we're not only going long software companies, but you can...

Yeah, absolutely.

Sure. First is we try and envision what this should look like. So, if it's the horse and buggy industry, really tough. If you look at the directory business where we invested a couple billion dollars, a lot of that was debt that got refinanced out, but we made about $700 million plus. And what we did was when we were looking at the equity that we invested in, we were the largest investor in Thrive at one point. We were looking at credits that we felt assumed a pretty precipitous fall off in revenue and cash flow. And we also wanted to be with management teams. And this is so important in industries in transition. It's kind of like think of you may have the best preparation if you're a sports team, but if you don't have the leadership on the field committed to executing the plan, it's not going to matter. And we saw with industries in transition very often management teams try and reinvent themselves in areas that they have no experience in. And there are two reasons they do this. First for job preservation if we have an area that is a super grower. You were the one who did that and your team did and then second is scared about how precipitous the falloff on the legacy business will be. We want to be with management teams that are not trying to reinvent themselves. They may go to related parts of a sector where they feel is less vulnerable but not try and invent their business and if anything manage their business as if it is declining precipitously and we found that that has the best results.

You saw this with crypto. You see this with so many growth areas that there are some who will be extraordinary and there will be pretenders and non-pretenders and contenders. I expect there's a lot of pretenders out there.

Sure. Well, first is it's still developing. When you talk about the hyperscalers, it's clear their infrastructure is really in demand and that's why they're all reinvesting in the infrastructure and that's why the capex is going up so much. You also have the LLMs acknowledging that this is a huge cost of goods for them and how do they make their product more efficient to use less energy. So there's a scenario where what seems to be a no-brainer investment from the hyperscalers may be an overinvestment.

There are certain times you catch and there are certain times you pitch. We're certainly catching more. We're just observing, this last earning cycle. We've seen the companies that have made their earnings just holding the reduced levels and the companies that are missing their earnings being obliterated. If this becomes an accelerated newspaper industry and instead of taking five years, it's two years, they don't want to be along for the ride. So, it's interesting to me that usually when that's been the case, there's more downside than not in the pricing. And that's usually a good opportunity if you believe in some of the opportunities. One of the aspects of software and think of software as an industry is no different than something like retailing. Hermes has very different dynamics than Sears. In 2000, Hermes went on to amazing things and Sears didn't. There's going to be software companies that are going to be like Hermes that go on to amazing things and they're going to be ones that are like Sears that have to liquidate. And the issue is having conviction on which is which and also which management teams have the right vision.

There's two types of distressed. There's more industry distressed and that's an evergreen. There's always industries that are going through transition, whether it was media and telecom in the early 2000s, energy in the teens, directory companies in the 2010s. So...

Yeah. Although it wasn't as broad. I mean really FTX was the only one that was, you know, almost there was FTX and then Mount Gox was really kind of hard to invest in. So it wasn't as pervasive in software. That's clearly a significant industry going through transition. They'll be the suppliers to software. Some of the chemical names as an industry have been out of favor. It looks like their balance sheets, some of them aren't going to make it. But broadly speaking, to have a distress cycle, you need a bad economy or a bad underwriting cycle. And I don't think the underwriting cycle broadly was bad. I think when the software deals were conceived and called 2018-19, ChatGPT didn't get the scale that it had or the acceptance that kind of triggered everything and so in general I think it's going to take a bad economy to get a broader distress cycle. Now that doesn't mean that we always don't find things to do that are terrific but to get a broader cycle that's what you're going to need.

In terms of distress, one of the innovations from the sponsored side and I think Apollo did a good job with this with Caesars is figuring out how to have liability management exercises and to extend their optionality. So that's something that didn't exist 10 years ago and between loose covenants and different strategies that have proven successful have delayed basically some bankruptcies and the one-loss record in LME is not a great one-loss record, meaning a lot of these companies eventually do go bankrupt. In terms of opportunistic credit, what we think about it is how do we make double-digit returns and there's a broad playbook. Some of it will be private credit. Some of it will be stressed companies that for whatever reason, you take something like Michaels where a couple years ago had supplier issues with China. People were concerned they wouldn't be able to get that fixed. Simultaneously one of their top competitors Joann went out of business. So you would think wow, one of the largest competitors goes out of business they should do a lot better. But then they had can they get the product to sell and the bonds went to the mid-50s and then it turned out that they were able to get product, did a fantastic job. So that went from 55 to refinance just earlier this year. Then you have the war and the concern about can they get the goods again and then the bonds went down 10 points and now they're up and probably annualized that'll be almost 100% return last year to a 20% return this year. That's not stressed, that's just an opportunity. So we're looking for opportunities. It could be in private credit. We financed the Boots deal that was a terrific Walgreens that was part of Walgreens, the largest pharmacy in the UK and were able to get a terrific return. We were able to commit to that deal because there were timing issues about approvals etc. and shareholder votes. So for us, opportunistic credit is this long playbook. It could be distressed. It could be stressed like Michaels which we feel is a great company, differentiated company, very good return on invested capital as a retailer in terms of their business model or it could be something like Boots, it could be a structured credit. So it's a long playbook and we're always trying to grow and deepen that playbook and so that's what opportunistic credit is to us.

So part of it is also what type of capital you have because you don't want to have opportunistic credit. Sometimes it'll be liquid, sometimes it'll be illiquid and you want to match the liquidity with the vehicle that you're putting it in. I think that's very important. In terms of the opportunities we're seeing now, it's more idiosyncratic. So when we start at the, the valuations aren't too different. Whenever you have credit basically in the bottom quartile it's around the third to fourth quartile whether it's on price and spread. And then you have growth more than 2%, so you're basically mid-cycle growing with stretch valuations. How does high yield perform or credit below investment grade? Not that well. In fact, equity usually does better if the economy performs at 2% or better and if the economy disappoints, it's lower than 1%, you actually have negative returns. So the upside downside in credit isn't that great right today. Now that doesn't mean there's not things to do whether in structured products, security risk transfer, private credit because there are parties that are out of the market. There's certainly it's backed up and there's some attractive deals. Debtor-in-possession financings with First Brands, which people was a very large DIP, Tricolor also where people lost significant money and as a result we saw in the DIP financings of like a Sachs is much more attractive. As a result we also saw some of the liability management super senior which are really kind of top of the capital structure for stressed company financing be very attractive. So there is a variety of different areas but broadly speaking the market doesn't have great value.

So it's a debtor-in-possession financing. So a company goes bankrupt, they often need money for working capital and usually it's first in line and it's usually very safe. Now the problem is when you have businesses like a retailer that have working capital going up and down depending on the season or you have a rollup story in the case of First Brands where it's really unclear if they had a handle on their financings. Clearly to me it seemed like when they filed they had no handle on their financings, it seems like a fraud, and as a result they burnt through the money that they said they needed. Historically it's been a very good risk-adjusted neighborhood to be in and I still think that's going to be largely the case and I don't see a systemic issue. You just had a couple of bad transactions and I think that there's a difference when there's an ongoing business opposed to some bad behavior like what we saw with First Brands.

So there's a lot of unknowns. So, it looks like the economy should grow in the low to mid twos and that inflation will probably be in the mid to high twos. If we're wrong, we probably think we're more vulnerable on the inflation than on the economy. But, there's a lot of unknowns out there and we certainly don't want to make an investment where if we're wrong by 1% on inflation or 1% on growth, we've gone from a healthy margin of safety to no margin of safety. Clearly from a market performance standpoint, if I'm wrong and the economy performs worse and inflation is higher, I'm sure the mark-to-market will not be good. But from a margin of safety, we want to give ourselves a pretty good margin of safety.

We are not scenario investors. We pick a base case. We look for margin of safety and if we adjust our base case, we adjust our base case. And that's where I feel what I have tried in my career. I've been a portfolio manager for 36 years. I want to have if we're wrong on a base case, either the base case changed or the analysis was poor. And I don't want to necessarily go, well, we always knew that there was an upside case and we sold it too early or a downside case and we bought it too early.

We try not to. We try and have a base scenario and there's certainly, we understand what the upside could be or what the upside could not be. Like there was a chemical company that I don't want to mention, but we bought the third out at 11 cents. We think there's a 35% chance it's actually worth par. But we'd be surprised if liquidity isn't good for at least a year. And that means we're going to get 9 to 10 cents back on an 11 cent investment. So we certainly have different scenarios, but we try and have a base case and then make adjustments on the base case.

You certainly should get paid more being less liquid and you certainly should get paid more for being smaller. I think there's also how fungible a business is and what the terms of whether you can sell or not sell the piece of paper. There's some private credit deals that might have 10 holders. There are some private credit deals where we're the only holder and the business is unique. We also are always trying to look at the relative value between liquid, illiquid, and also duration of holding. So you tend to get better convexity in the private credit space relative to the primary market. I think something like 70% of loans are at par or above right now on the broadly syndicated market. So having something that is private credit where you have better convexity also will come into our analysis.

So CLOs, it's a great product for us. We've been issuing CLOs for about 25 years. We're very proud that we've recently won from Credit Flux, which is the industry standard, manager of the year for the third time. No one's ever won the award more than us. It's a product we're very proud of. How we've gotten the returns, a few ways. First is we have fewer positions. So what that means is our CLO business is smaller than some of the largest competitors, it's a medium-sized business, but we're able to overweight and underweight what we find is attractive. We also have the equity in a fund. So we actually have the largest CLO equity fund out there and as a result we're able to get economies of scale when we set up the vehicles. It's something that we've also are not afraid to sell for a loss if we feel that there's going to be issues because it used to be the median return of a distressed piece of bank debt was par. This is when we started out 25 years ago. Now the median's dropped a lot. But our view is, boy, if we really think that this is vulnerable, 94 cents isn't the right price. And so we are not afraid to sell out losses.

What I was referring to more is in the assets under management, not necessarily the size of the company. I think in general larger companies you have more people who care on. So, I think that's a positive. But in terms of assets under management, I think that having, we've always tried to rightsize the strategies, the size of our offerings to the ability to outperform and it's something that we take very seriously and we're proud of that we want to have more opportunities to invest in than we have capital. Not the reverse.

I think that the starting point, it's an environment which is not a great environment for credit investing just statistically. So that would be the top. It's easy to talk about complacency about what's happening with the war. But I think that the conventional wisdom is it'll work itself out in some way. Whether that's right or not, I don't have a view. That's just how the market seems to be processing the risk. You always have disrupted industries, but software is a large one. It'll be interesting to see the dispersion because there'll certainly be dispersion. There'll be winners and losers and who they'll be and how quick people will embrace them.

PIK, payment in kind. And good PIK versus bad PIK, as we've always defined it, is if you're doing it at the time of the underwriting.

Totally. Yeah. We're aligned in that interpretation.

Yeah. And want to be clear, there's definitely situations where you could say 85, 90, and 95 are all fair marks, but there's certain situations where you're like, how could you mark it at 90 when the underwriting is 50% below what was expected at the time. There is certainly a wide range of what's fair. But I think that the market is still developing what those goalposts are.

I hope it's not innovation. I hope it's standardization.

Well, it's kind of interesting when you hear people talk about their software investments. They love theirs, but they're quite concerned about everybody else's. It's hard to believe if you have 10 software investments that they all are great and they're not experiencing some of the issues that are out there.

Oh, totally. It's TBD. I do think that it's hard when the paranoia is maximum. I mentioned earlier how companies that are hitting their numbers actually are just keeping their levels that were down 10 or 15 points already and the companies that aren't hitting their numbers are now falling 30%. This is in the debt markets. So there's still a lot of fear out there.

What's always fascinated me on markets is they recover and they give an answer much quicker than what people anticipate. I've seen that in pretty much every industry. Now there are some situations like legacy media where there was people in denial but it was clear it was going bad and not getting better and that there was no endgame in sight or no residual value in sight. In cyclical industries like for instance energy, within 24 to 36 months you get the winners and losers. You see oil service which was an area we were involved in in 2020 and by 22 it was clear it was coming back really nicely and by 23 it was pretty much already back to where it had been in a prior peak for a lot of the subsectors that we got involved in. So my guess is 24 months you'll have a more clear perspective of the winners and losers. I use the example in retailing Hermes versus Sears. And I think you're going to be able to kind of put, you know, who has longevity opposed to who's very vulnerable.

I don't know. It seems like that's 70 to 80% with just different names. So most environments I've been involved in there are things to worry about. Do you remember when rates were high and we were going to have an automatic recession which we didn't have? There's always stuff to worry about. So I don't want to be trite about it but I also think it's where do you have the most conviction and how is that priced and what is the most uncertainty and how is that priced and then what's in between.