Let's start with the sell-off in the markets today. What's intriguing to me is there's a sell-off in software companies and the premise, if you're a seller today, the thesis I should say is that AI is going to rapidly transform enterprises and software that seemed very valuable 2 years ago, 3 years ago, 1 year ago, all of a sudden is going to become obsolete quickly. At least the market reaction we're seeing: Salesforce down 7%, Workday 7%, all the private funds that invest and lend to this stuff, double-digit, 10% type declines. It's a huge, huge move today. What do you make of this and is this an overreaction or a proper reaction?
So, first, time will tell whether it's an overreaction over the next few years. But what I do know is when you read something in the paper, my one-loss record of now is a really good time to focus on it. And you have more victories than not. So, you're reading about obsolescence, about the alternative use, that you're going to be able to code with AI today, and that it's going to make the existing software useless. When you're reading about that and the markets are behaving that way, we were talking just a couple moments ago — what's the probability that within, call it, 24 to 36 months, that most software won't be used or the growth rates are going to be significantly different or negative? I want you to start with what you think the market is pricing the probability at. What is that? So, I would say it began the year at less than 10 and now it's 20, 30. So, 20%, 30%. It may be 30%. 30% that this is going to be a very rapid transformation. Um, it's going to be — growth rates are going to go flat. And by the way, the good news is even if that's right, that doesn't mean there aren't terrific opportunities. In fact, for what we do and I've been doing this for a while, this is what we get up for. This is so exciting when there's just a broad sell-off.
This is a good day for Steve.
Yeah. Well, it's not that we have all the answers, but there's dispersion. And the idea that all software is the same is what's exciting. And the market is just broadly — people are overweight, particularly in private credit where it's the largest industry group or subset of an industry group, which is technology and software is well overrepresented, often at 20% plus of funds. And so there's going to be a terrific opportunity because people want to get down. And we're seeing that. There's just indiscriminate selling regardless of what the prospects are and what the barriers or the moats are for each business.
So, when you — what are some of the opportunities, if you can get specific, that you're seeing out there? We've seen companies like Cloudera, which manages companies' data and data lake. Those companies have been hit — just before today actually, in the past week or 10 days. What are some of the — what do you see out there, opportunities?
Sure. So, if it has a lot of customer support, doesn't lend itself to just a database screening, something like an LexisNexis opposed to a legal database — opposed to looking at having installed customer support, interaction, heavy interaction with the customer, that's good. Heavy interaction with the customer is just very hard to just pick up and move. Then there's also — is this the right decision and how quickly can we make that decision? But if you have a lot of infrastructure in place, it's hard to make a decision quickly. Whereas, if it's just a database that's a better database, that's easier.
So you're talking about companies that have to make — implement this stuff. You're plugging really important software in to replace something else and you can't just yank it out immediately, right? This is complicated stuff to do.
Well, also if it's cybersecurity, what is distinct, idiosyncratic opposed to a broad database. You know, and people say, well, there may be apps that can use the AI functionality. Well, they haven't been developed yet. So, they could, but then we're talking about an unknown of an unknown. So, that's one aspect of the business. The other aspect is, well, what looks like it might be challenged and how's it priced? And we're seeing that those are priced as if they really have two or three years left or three times cash flow. When you look at the way software is, it doesn't require a lot of capital, you can buy some of these senior debt instruments at three times EBITDA. And EBITDA minus CapEx is pretty much the same thing.
In other words, they're going to pay their creditors more than twice over is your point here.
Well, where you're buying it, because a lot of these are trading in the 50s, 60s, 70s. That you are given a pretty good head start there.
Let me — let's talk more broadly about the state of private credit. It's been a hot topic today and obviously this industry has boomed. Lately there's been this debate — we all know Jamie Dimon famously reflected on the fraud and the bankruptcies at the auto-related industry companies, First Brand. Branch, Tricolor. He said, where there's one cockroach there's probably more. We heard from John Gray earlier that the private credit market is healthy. And other titans of the alt investing world have said this is all misguided to make a big deal about this. Where do you come down on it?
Sure. So, there are a couple issues here. First is, is fraud pervasive? In terms of — did the companies — because people are so anxious to put out money that they didn't really look that carefully and there was a bunch of First Brand type of investments in their portfolios. I'll take the under on that. And so, could there be a percent of the market? Sure. But, is it systemic? I'd be skeptical. If you look at — was the risk priced wrong? So, I'll give you an example: a lot of high-growth companies have low credit ratings. So, you look at xAI, which might have this huge market value, which just combined with SpaceX today. It wasn't highly rated because its cash flow is developing even though it has Twitter. And it just did a deal where the debt as a percentage of the equity was 10%, 20 times. So, it looked like your loan-to-value was very attractive. That type of financing is very attractive in private credit where there's a lot of enterprise value, but not a lot of sales and EBITDA. To the extent that those valuations are wrong, private credit is vulnerable. So, that's different than a fraud. And the reason why it goes to that market is because it's not ratings-dependent. If it's ratings-dependent and it's triple-C-minus, that shows up differently in portfolios that are more liquid.
So, you don't see an erosion in diligence in the hunt for yield here. Is this — you don't see something like that more widespread?
Sure. So, again, a different question. Fraud is different than careless and more aggressive. There's a reason why it was priced at 50% to 100% of the spread of a high yield index. If a high yield index is 280 basis points over Treasuries, that's a different risk profile and a different reward. Yes.
