Andrew Milgram - Full-Contact Capitalism - [Invest Like the Best, EP.436]

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1:12 Hello and welcome, everyone. I'm Patrick O'Shaughnessy and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. If you enjoy these conversations and want to go deeper, check out Colossus Review, our quarterly publication with in-depth profiles of the people shaping business and investing. You can find Colossus Review along with all of our podcasts at joincolosis.com. Patrick O'Shaughnessy is the CEO of Positive Some. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Some. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

1:54 Clients of Positive Sum may maintain positions in the securities discussed in this podcast. To learn more, visit psum.vc. Mm. My guest today is Andrew Milgram. Andrew is the founder of Marble Gate Asset Management, an alternative investment firm that invests in credit opportunities and special situations.

2:15 He joins me to discuss his unique approach to distressed investing in the middle market. Revealing how middle market eBita has declined twenty to twenty five percent since two tausin nineteen. creating what he calls the K shaped economy. His investment stories are legendary. Particularly his six hundred million dollar bet.

2:30 on New York City taxi medallions, which we go into in great detail. We discussed Marble Gate's approach to negotiation, sourcing deals directly from hundreds of regional banks, and understanding the human element in distress situations. Please enjoy this great conversation with Andrew Melkram. Andrew, I think you and I have talked about doing this for five years. On and off, I think that's right. You don't do this a lot or ever?

2:53 I love the category of guests that are the first and only interviews of this type. And so I'm so excited to do it with you and I'm especially excited because your style is so distinctive. Then we'll talk about a million things related to how you invest and your personal story and getting here. But I thought a framing exercise that would be great starting place would be for you to describe this notion that you have of the K shaped economy. You do something that's very specific, and we're gonna talk about all aspects, but I want to start broad. So tell us what the K shaped economy is from your perspective.

3:24 Yeah, so it's a notion we talk a lot about with investors and with the companies that we invest in. Everybody in the US economy, at least, has this underlying sense that there are some parts of our economy that are doing exceptionally well. But at the same time, they have this internal notion that there are other parts that are just worse than it seems. That there's a nagging slowness or a nagging underperformance to the economy in. Broad areas.

3:50 They can't quite put their finger on it. Because they look at C N B C and Bloomberg and they read the Wall Street Journal. And there's green arrows in the ticker tape economy. Those Companies and Those wealthy individuals who have access to

4:04 capital, who have access to resources And Can drive Unbelievable profits and Great outcomes.

4:13 But there's a broad part of the economy, and I think we see this in the political sector being expressed pretty acutely. The broad pieces of the economy that are just dissatisfied with their earnings power, with their ability to benefit from the promise of the American economic system.

4:30 That discrepancy, I think, is really hard for people to understand. But when we say K shaped economy, it immediately resonates with people because they see it themselves. They feel it in real time. They understand intuitively that there are those who are having fabulous success, but they also understand that there are people and companies that are just not getting their piece of the pie. There's this amazing data set that you've just spent time exploring. I want you to explain the data set and then all the findings. What I want you to focus on is so if you think about the K shape, we all know the upper part. It's the S P eight or calling it now, fang stocks or whatever, AI companies.

5:08 We know the story that's Going well. So maybe talk about this investigation that you've done recently about what's going less well and why and what you learned. Well I'll start with but Marble Gate, we focus on the middle market. And the reason we focus on the middle market is A, it's one third of US economy. And by the way, over time, it has represented something north of two thirds of all restructurings, bankruptcies, et cetera.

5:32 So it's the area of the most, let's say, action. It's also the area the economy people know the least amount about. The companies there don't File publicly. Their financial statements, they typically aren't listed on stock exchanges. So the only people who really have an insight into how the middle market is doing. Are individual

5:52 Lenders to it. to individual companies. or individual owners of individual companies. And so a lot of the talk about the middle market tends to be anecdotal. It tends to be self referential. It's inferred.

6:06 But there's not a great data set that gives us a good insight into a broad section of the US middle market. A good friend of mine ran a company called Rapid Ratings. Rapid Ratings does credit counterparty risk assessment. For The Fortune 500. So they'll assess the supply chains, the vendor relationships, trade relationships. Of large companies.

6:27 They rate their vendor relationships and other supply relationships. And create a financial health score. that then that Fortune five hundred company uses to determine terms of trade and how they're gonna deal with that supplier or trade counterparty. We worked with them taking that anonymized data.

6:44 And winnowing it down to the US middle market. And for us, that's companies between a hundred and seven hundred and fifty million of total enterprise value. And we said, Okay, let's strip out everything that isn't a US company with those characteristics. We were left with a data set of just over twelve hundred companies. We've been looking at this data now for several years. We measured it pre COVID period and then over the past three or four years.

7:07 In those three or four years post COVID, what we've seen is a real decline in the earnings power in the US middle market. No. We look at a lot of factors. We look at EBITDA, we look at margins, we're looking at pure cash flow. We're looking at leverage and liabilities. And importantly, we focus on interest coverage.

7:27 Because At the end of the day, companies can remain insolvent for a long time, but My first boss on Wall Street used to say, Nothing so focuses the mind like a coupon payment. Yeah. That is very true. When you have to make that

7:40 contractual payment. That is I'll say generally speaking non negotiable. You get to a point where you have to make a hard decision about do I need to restructure or can I persist. When we looked at the data set over time, we've seen a few important characteristics. The middle market, EBITDA.

7:58 essentially deteriorates every year. It just gets worse and worse and worse. Now we compare that data versus public filers and we look at the Russell three thousand. So in that same period those companies have public market access, so they tend to be better capitalized. They have

8:13 Let's say broader management teams. They have more access to resources. Those companies have done persistently and consistently better. Ebada is strong and growing. margins are steady.

8:28 Generally in the mid teens. In the middle market EBA dies. Challenged. I mean, there's no other way to put it. I think over the measurement period in the most recent data. Ebada has been down twenty, twenty five percent since two thousand nineteen.

8:43 That's a really a difficult place to exist. margins in the middle market. are also much, much, much narrower. So if the public market on average has a mid teen starting EBITDA margin.

8:56 In the middle market, we're talking about mid single digits. So there's just less room for maneuvering, less room for error. Those companies do also tend to have structurally constrained or more difficult balance sheet. So they're strapped up more by their lender. Middle market tends to access bank finance rather than let's say Broadly syndicated loans or private credit.

9:18 Which will have more flexible Covenants and characteristics to their credit agreements. So it's a tighter less flexible capital structure they're starting with. When we look at cash flow in those two areas, we see net profits after tax in the public market strong, persistently growing.

9:36 When we look in the middle market, we see that That net profits after tax is down. Almost two hundred percent over the measurement period. So that is consistently negative over the past two years. It's a troubling place for the

9:50 Middle market. Like I said earlier. There's this nagging feeling that everyone has that there's trouble in the economy. What we do in that data set is put some numbers to that. We can illustrate to people. Look, we understand what you're seeing in the ticker tape economy. We understand what you see when you turn on

10:07 Jim Cramer and he's screaming about it's a buy bye bye. But we also understand that when you go home at night and you're Thinking about the world, you have this feeling that things are tough. So there's a third of the economy that has this aggregate problem.

10:22 I have three questions. You can take them however you want. One is Who owns these things? Who's the equity in these things? Why is this happening? And what does it mean?

10:31 Prospectively. Who owns them? It's a mix. It tends to be smaller sponsors. Families. Some individuals.

10:39 These are companies that A lot of the management teams have grown up inside the companies. Maybe they're families that control them, maybe not. If they do have Professional management teams oftentimes These are not management teams that went through the GE training program.

10:55 As a consequence, they're making intuition based decisions or pattern recognition based decisions. They're not relying on what you and I might think of as data driven decision making. Your second question was

11:09 Why is this happening? You get this what sounds like a hollowing out of a third of the economy. In fact, that's the exact language we use. And there's all this decline even declining cash flow, interest burdens that are higher, scary sounding stuff. If you had to narrow down the couple of reasons for what's driving that.

11:26 What do you think they are? I think market power, so the Middle market companies typically don't serve the end consumer. They typically serve the larger public company.

11:36 So those larger public companies which have pricing power with their customer, who tends to be the end consumer. also have pricing power over their supply chain. So they're pushing costs. They're pushing financing. down onto those middle market companies.

11:51 While taking that margin. It's like a corporate class system. It is. I mean, there's no other way to understand it in that the rich are getting richer and the poor are getting poorer. Again, I go back to We see this expressing itself in the political spir. Because people are looking for some kind of outlet, some sort of expression of this frustration.

12:09 Because they feel it in their everyday lives and their businesses and how they go about work. So These companies just have fewer resources, they have less to stand on, and so they have less bargaining power. Yeah. What do you think it means? Is this just an exorable trend that's gonna keep going and

12:25 The rich are gonna keep getting richer. We'll talk about the workouts and bankruptcy and all that fun stuff next, but just before we close the chapter on What's going on? What's to be done about this, if anything? There's a few different ways this can resolve itself, but it probably will resolve itself with a bang in some way.

12:40 Now that bang can be a long drawn out Something that looks like You say the early two thousands where we had just a Years of persistent restructuring across large portions of the economy. It could also look like the late eighties, ear nineties, where we had a real credit contraction as people dealt with over leverage from the direct lending crisis. Some people call it the SNL crisis of the late eighties, early nineties.

13:06 That feels like the world we're heading into. There are other scenarios you could imagine that are more punctuated. Let me go back to what I said earlier about debt service coverage. So interest coverage is a funny problem because again, you gotta make that coupon payment. If you're unable to make the coupon.

13:23 You have a couple of options. You go to your lender and try and work something out or your ultimate resources you can go petition the courts for protection. In the two thousand twenty three data. We saw that

13:35 Almost twenty five percent of the companies in the data set. couldn't make their debt service coverage. So surprise, surprise, in two thousand twenty four business bankruptcies hit. Like a four-year high. Fast forward.

13:46 The twenty four data that we're living with now in twenty five showed that Another twenty percent of the data set. couldn't make their debt service coverage. So Based on the data we see to date and the

13:58 bankruptcies that we've already seen in two thousand twenty five. We would expect two thousand twenty five to show persistent and possibly higher number of Business bankruptcy filings. Uh we're also interestingly starting to see some larger companies suffer that as well. So

14:13 goes back to as much as the infomercial that is C and B C. wants to convince you that everything's great in the economy? It's just clearly not. How do we resolve it? I think there is broad based weakness in this economy. We can spur growth.

14:29 Get everybody buying. There are some macro things you could do. You could pump more liquidity into the economy. course you risk an inflationary spiral. Which we're probably on the cusp of again. You can

14:40 Do some sort of wholesale debt restructuring and try to get through it. Quickly. That would be recasting a resolution trust company type idea. I don't know that there's even the beginning of the political will or Discussion to do that at the moment.

14:54 So I go to the meander solution is way this Probably goes where we just slowly work through this over time. And

15:04 We solve problems one by one. It's a good time to ask for your definition of distressed investing. It's a great question. Like distressed investing covers a lot of things. The term has been I would say abused in recent years. When I got into the business, it meant buying the debt stock of an individual company and then exercising the rights and remedies under the credit agreement.

15:25 to drive an outcome that generally involves some amount of operational improvement. Back when I got into the business credit agreements were tighter. And so companies got themselves into tougher spots. in a narrower range. The covenants were such that

15:42 If you're Performance started to decline. Yeah. bat it back into the middle of the fairway or Deal with the problem.

15:49 Today covenants are much wider. And as a consequence, when you violate a covenant or get to a place where you need to restructure one way or another, The business is just worse off generally and needs a much bigger operational reworking. So when we think about distressed investing, it is provisioning capital into difficult situations that are capital constrained. Now some people look at distressed investing as

16:13 When the market pukes out. We're gonna step in and buy. And Watch it ride back up. That happens every ten years, there's a big puke out. That's a tough investment strategy to

16:25 Yeah, yeah. Yeah. The reality is that the data is pretty clear in each and every year there is some portion of the economy that is running at a two to three times That average default rate. in the system. So that is to say there's

16:39 Several sectors, a handful of sectors that have a much higher than average default rate. That can be as a consequence of sector risks or some sort of factor input that impacts broadly across that sector. It can be a change in consumer preferences that impact a number of companies, change in government policy. All sorts of things. What is it today just like ground people in what are the couple examples of those sections? Unfortunately today it's everything.

17:03 The most acute is of course the tariff risk. And by the way, we have some data, we have some thoughts about what that might look like for companies, but the indecision of tariffs did they uncertain to yeah. Think about it. Somebody said to me recently, Well, Christmas is canceled.

17:19 Why is Christmas canceled? Well you have to put your orders in now. So if you're a business trying to make a decision. About what your Christmas book is gonna look like. How do you even make that choice today? I think it's a really tough time to be. uh corporate manager.

17:32 I think there's lots of Challenges in the economy. People are having to make big bets. You don't know. Which way anything's gonna go.

17:41 Are you gonna be able to Have your supply chain continue to be In China? Or we're gonna have a persistent trade problem with them. Tariffs.

17:50 Hard data. Looks at Again. Cross the middle market and then we look at the public market and we say What are the likely impacts and how does this work through the balance sheet and what

18:00 Would you suspect happens? I can make a pretty strong argument. that public companies will actually benefit from the tariff regime. And Again, I'm gonna assume that the West Wing is being thoughtful in its analysis and its deal making strategy, and they've probably come to a similar conclusion.

18:16 I think the Treasury Secretary speaks pretty confidently and directly about this and I agree with their assessment. For the ticker tape economy. The tariffs are not gonna be Terrible. In fact, they could be constructive.

18:28 For the middle market, though. Anything above the five or six percent tariff. We'll have a Devastating impact on margin. And consequently on the ability to service their that stock. So

18:40 Any persistency to tariffs will crush the US middle market. I like your definition of distress that we talked about earlier, which is basically just like capital where there's no supply of it. That's right. And so just say a little bit more about what it feels like to do your style of investing, maybe even the layout a little bit more about Marble Gate and how you prosecute things. Because obviously this style one might be really useful and important in this workout that you're talking about.

19:05 But also for people that are interested in returns, could also be a source of high returns. Especially if there's limited capital chasing it. So say a bit more about Marble Gate and what you do, and then we'll talk about some fun examples. Sure, so Marble Gate started in two thousand and eight, two thousand and nine, two thousand eight. My business partner, Paul Earoway, called me up. He was at Bear Stearns. I was at another distressed investing firm called Epic Asset Management.

19:28 And he said, Look, all great distressed investment firms are born out of crises and this one's ours. We sat down and talked about How would we go about building an investment firm and how would we go about accessing investment opportunities in the distressed market. Paul and I had

19:43 done a lot of business together over the years, and we liked focusing on the same types of businesses. We saw this middle market. Area as being Wildly underinvested. As we grew up in the business and I oftentimes refer to Paul and I as the

19:58 youngest of the old group of distressed investors. What we saw were the oak trees and the Apollo's and those folks who had cut their teeth. Investing in distress. Getting bigger and bigger and bigger. And a lot of that

20:12 mimicked or mirrored the growth in the LBO market. We oftentimes refer to the LBO business or the private equity business. is our manufacturing division. Because they will. produce a certain amount of problems.

20:25 Pretty consistently. So as the LBOs got bigger, a lot of the investors who had been built to invest in their problems similarly got bigger. But that left an entire Higher. portion of the market.

20:37 Just underinvested, under prosecuted, underlooked at, underanalyzed. We saw it as pretty rich pickings. So when we set around to build Marble Gate, we said, look, we're gonna focus on that middle market. At the time. We were convinced that there was

20:51 going to be good opportunity, we couldn't have imagined that it would persist. With as much duration as it has. Now you also Our focus in accessing that is around the US banking system. The middle market continues to get most of its capital out of the banking system. We hear a lot about private credit and at Marble Gate we talk a lot to private credit, think a lot about it. have a lot of views on it.

21:16 We think about the broadly syndicated market also. We think about all sort of forms of corporate credit, but the reality is We access most of our investment opportunities out of the banking system. So We built Marble Gate. With the idea that we would go

21:30 Talk to banks. Source our product. directly from them. So we built a sourcing team. And our sourcing goes out. talks to hundreds of lenders across the United States. I like to say that we are the number one buyer of steak dinners in Middle America.

21:47 We also built, of course, an analyst team. We have in house financial restructuring. So Today

21:54 A lot of the folks that call themselves distressed investors, again, I view them as buying cheap high yield and participating as pure financial investors and portfolio traders. But They will outsource all of that critical thinking. At Marble Gate we say there is no outsourcing of critical thinking.

22:11 And so we think about the financial restructuring in house. We also built an operational restructuring team in house as well. Again, going back as Paul and I looked at the market evolve, we saw those covenants widening and the businesses deteriorating. And so we knew that when we were taking control of them or inserting ourselves into their capital structure and their

22:31 ongoing operation and resolution. That We needed to bring to bear resources. Now There are some great firms out there, FTI, Alvarez, Alex partners that specialize in doing that, again, particularly on behalf of

22:46 the portfolio investors who are more traders in this space. than investors. But A those firms are large, they have large cost structures, and they're generally more than a middle market firm can bear.

23:00 And you're very much a roll up the sleeves guy. Like I think you've had personal security at times'cause you're dealing with things that are really hard. This is a full contact. version of distressed investing. And so I want to talk about all aspects of it, but I want to start with maybe like a story. So the first story you ever told me, I don't know if it's the best one, but it's the first one you told me and I remember it viscerally was you buying some crazy percent of the taxi medallions in New York City.

23:24 Can you tell that story just as a representative example of the sort of thing that you do? Sure. My partner Paul came into my office and said I'm talking to a bank who wants to sell some loans against New York City taxi medallions. And I said that is the worst idea I've ever heard. And he said, Okay We went about our way.

23:44 few weeks later he came back to my office and I just spoke to that same bank again. And they want to know if we'd be willing to look at those loans against taxi medallions. remains the worst idea I've ever heard. This is peak Uber Ascension. Exactly. It was two thousand sixteen.

23:58 And so Uber had come to New York in two thousand fifteen in a big way and had made a huge push into the market through fifteen and sixteen. They were subsidizing every ride and The real problem, by the way, this is super interesting. There was this perception that they were taking riders away from taxis, and that was not at all the case. The data was super clear. They were expanding. Point to point.

24:21 car service in New York. They were taking drivers away from yellow. And so Yellows were stacking.

24:29 parking themselves, not generating revenue as a driver went to Uber. And the driver was going to Uber. Because Uber was subsidizing every right. So the driver's earnings power was Accelerating. But people were making rational choices, by the way.

24:43 More people were switching into Uber from other modes of transportation, bus private car service. Subway. Because Uber was subsidizing New York. New Yorkers are the most sophisticated price sensitive consumers in the world.

24:59 They were getting brand new cars because all the drivers were going out and buying new cars. They were getting brand new black cars and subsidized service. New Yorkers do this every day. So Uber was having a tremendous amount of success and they were pulling those drivers away. The interesting thing is when we started doing our research and by the way, we spent two years researching it before we ever did anything. I mean my favorite party trick actually. Is

25:25 As part of that research. I became a New York City taxi driver. And I still go out and drive. That's funny. Yeah. Well you have to stay connected to the market. But we've spent two years researching the space, a lot of time in Queens, going garage to garage, learning about the market, learning about how it works. Cause it's a pretty complicated ecosystem, to be honest. It's emerged over a hundred years.

25:49 And employs literally thousands of people in New York City. It also is an important on ramp. to American commerce for the immigrant population. When I did my taxi driver's license, you have to do a pretty complicated and long set of classes. It's no London But it's still demanding and expensive. But I was the only native

26:10 born American in the room. Everyone else had come to the United States in search of a better opportunity. So It's an important spot. For New York commerce in particular. And by the way.

26:22 What people don't realize is the bulk of New York City taxi medallions are owned by individuals. That are driving the Taxi. So

26:31 It's a small business. in and of itself. By the way. Pre Uber coming to town. Taxi medallion said.

26:38 been worth over a million dollars. They've keeped it one point two million dollars. Yeah. For one medallion. For one medallion. And by the way, again, if you look back And look at it purely on a cash flow basis and where interest rates were and alternatives. Not the craziest thing to have happened.

26:55 You or I would never have done it, but I can understand why somebody might have made that decision. Not a decision I would make. But not the craziest thing. Now that being said, the average unpaid principal balance of a taxi medallion loan ended up being about five hundred and fifty thousand dollars. So the average taxi driver owed five hundred and fifty thousand dollars on their medallion loan. It was a lot of money.

27:19 We did a bunch of survey work. We came up with our own understanding of what an Uber driver's net earnings were. And what also became pretty clear to us is that Uber was taking advantage of an information asymmetry. So they understood that a driver didn't really understand their full picture of their cost structure.

27:39 And that they were making a very cash based decision. But they were pushing a lot of those non cash or non-immediate cash costs onto the driver. They were taking those liabilities on And ultimately when you adjusted earnings for all of that, the driver was really under earning what they should. And

27:58 You also saw a lot of turnover in those days because I think drivers were coming to the conclusion over time that their own individual return on invested capital wasn't sufficient. So We started understand that. In fact, when I was out talking to one seventy year old garage owner who I think had grown up as a taxi driver, his father, I think, had bought

28:19 medallions in the thirties. He said to me, Andrew. The reality is Nobody's reinvented the economics of driving a car yet. And until that happens.

28:29 Taxis remain the most durable cash flow in the system. And over time we proved that out to ourselves at least. We convinced ourselves and Obviously our investors that What was available here was an unbelievable market that for lots of reasons

28:44 had been underinveste in terms of operations. So there've been lots of leverage put into the system. I would say that folks who had owned medallions and operated fleets. had been extractive. So they hadn't been investing in the business, they hadn't treated the driver the way they should.

29:02 I used to begin every conversation with somebody in the space the same way. Tell me who your customer is. Do you know what the answer was from hundred percent of them? Who would you say? I don't know the writer.

29:12 Right. That was the answer everybody gave. I, as the medallion owner, have absolutely no economic relationship with the rider. The driver pays me. My customer's the driver. Everyone gave me the exact same answer. They gave me the passenger is the answer.

29:25 Yes, but the driver pays you. Oh well, okay, sure, I guess. They weren't treating their customer. the right way. They were Being abusive.

29:35 It was obvious what was going on. So there's really negative relationships in the industry. The industry was as a consequence sort of set up as combative. Even though all this capital had gone in and it was literally billions of dollars of capital that had gone in. There were thirteen thousand five hundred and eighty seven New York City taxi medallions. And if I told you what the average unpaid principal balance was, the math's pretty easy.

29:59 So You're talking about billions of dollars of capital that had gone in. And by the way, fleet owners on yachts. And taking helicopter services out to the Hamptons. While the drivers were struggling to make ends meet.

30:12 It was just the worst imaginable. Didn't you also at some point go into some government office and ask for some data set and they're like, Yeah, no one's ever asked for this before. Can you tell that part? So the TLC, who's a great Agency inside of city government. And at the time. The commissioner was Mira Joshi, who later went on to become Deput mayor in New York.

30:31 The current TLC commissioner is David Doe, who's terrific to work with. But we went to the commissioner and said, Can we get some of the data you have on the taxi market and Uber and Lyft and all of these guys. She said, Sure, just put in a FOIA request. We're happy to serve. So but what are you looking for? I said, Well, all of it.

30:51 What do you mean all of it? Is it everything. So she gave us terabytes and terabytes of data, ride level data, right? Ride by ride, the entire data set. It was a lot of data. We tried to load it into Excel. Excel was like you gotta be joking me. So we have couple of data scientists on staff at

31:10 Marble Gate ingested the data into various. data systems. And we started to cut it up. And what we found again, there were some Immediate insights. The one I mentioned earlier where Uber wasn't taking

31:22 rods, they were taking drivers, that popped out immediately. We also saw really interesting data. In when people were making choices to take Ubers versus taxis. Every New Yorker has an algorithm in their head.

31:35 Time of day, where am I going? What am I wearing? What's the weather? What do I think the traffic pattern looks like? Day of the week. With that algorithm, they make a decision. Am I gonna take a taxi, an Uber, a bus, a subway, a private car? Am I gonna drive myself? They are figuring that out real time.

31:54 What popped out really quickly was If you were gonna go east west. In Manhattan, you're almost always gonna take a taxi. If you were gonna take a ride on a Saturday night From

32:06 The Upper West Side to Tribeca for dinner. You're probably gonna call an Uber. And when we looked at the data. What I love about data analysis in companies and sectors. is when you really dig into it.

32:19 The truth pops out. And it's obvious. It makes sense. You can relate to it into Uber's killing all taxes. Exactly. And so you saw how New Yorkers were making decisions. And like I said earlier. It's squared with the economic reality. Uber's gonna subsidize my Friday night date.

32:36 Great. Let's do that. So how New Yorkers were making decisions, how drivers were making decisions was also super interesting. because we could track individual driver behavior. So we could tell.

32:49 successful driver behaviour looked schematic. It was symmetrical. They were Following Almost predetermined patterns. Now not the same pattern. Each driver had their own system that they had developed. But it was thoughtful and looked thoughtful and looked

33:06 Intentional. Drivers who were under earning. looked like a Rorschach test. It was just a scattergram of behavior. And as a consequence, they were under earning what we thought they Could and should.

33:19 By the way, fast forward later when we set up our own operation. We ran a bunch of experiments with drivers where we said, Look You're likely to make let's say Two hundred dollars a day at that point. Yeah.

33:31 We'll guarantee your two hundred dollars. But We want you to run an experiment with us. So If you will just follow these patterns of behavior we see as the most profitable We'll guarantee the two hundred. And by the way, if you earn more than two hundred, keep it.

33:46 We ran dozens and dozens of experiments. How many payouts did we make? Tons of payouts above the two hundred. So we paid nothing. the driver always out armed when they follow the data driven decision making. I mean, my favorite was what I called the NASCAR loop.

34:00 So the data showed that if you picked up at the bottom of Broadway You were high probability around Clumbus Circle. you were gonna drop off somewhere north on Broadway.

34:12 Make the left turn. Because the data also showed if you picked up at the top of Broadway, you were gonna drop off somewhere mid town around the bottom of Broadway. So we just run that NASCAR loop. Left hand turns only.

34:25 And turns out to be a super profitable circuit. And there's lots of pockets of opportunity around New York. The other thing, by the way, is the fleets did a terrible job of telling their drivers when there was a Nix game. Did a terrible job telling him when there was a Rangers game. Terrible job of telling when concerts were going to be all at MSG, obviously. And I know you're a Knicks fan. You've come out of

34:47 Yeah, where the hell are the caps? Don't they know there's a game letting out? The answer is they didn't know there was a game letting out. As I said to you earlier, most of the drivers are not native New Yorkers. We later on opened what we call a taxi clubhouse.

35:02 I can go into why we opened it. pretty pedestrian reasons, but it's been wildly successful. in there, we have TVs on. Our drivers are soccer fans, football fans, they don't pay a lot of attention to the sports that drive Americans or New Yorkers. So there's just like a cultural divide. They don't know all the time where to go.

35:21 The best drivers figure it out over time. And again, develop a system. We took all that data from the TLC and we immediately got tons and tons of insights as we got invested into the space. We started pulling more data. as we built our own operation, more data. All that data goes to data driven decisions.

35:40 Because again, as I think about distressed investing. Broadly. One of the things we talk about is moving companies. Earlier I said. management teams make

35:48 intuition or pattern recognition based decisions. We want to move everybody, whether you're A middle market manufacturing company. Or a taxi driver. to a data driven decision.

36:00 That data driven decision has more persistency to it. It has a higher probability of Because it's informed. It also you can push decisions down. Where they're not top driven.

36:11 Yeah. Operator driven. And the operator is going to use that data to make the decision and where they need to adjust around the edges. then they can use their intuition or their pattern based decision making to shape it around the edges.

36:26 But we're starting from a better place. So you you get this insight, and all of a sudden it goes from the worst idea you've ever heard to like oh maybe feasible. Talk about the transaction or transactions to buy into the space. So a bank As the loans. Your counterpart is the bank.

36:42 And you get comfort with the value of the medallions. And so then what do you do? What are the investing steps? So actually our first investment was Definitely I knew at the time, but clearly in retrospect, the riskiest trade that we did was we went around and talked to banks, they would say, Well, hasn't been really any transactions like many markets. One of the good indication of when a sector or a company is gonna

37:07 tiple over is it gets super illiquid in its securities or loans or whatever. The taxi market had gotten super liquid. There were no medallion transactions happening. Buyers and sellers move too far apart. Nothing ends up happening. One of the all time great indicators of when something's gonna really sharply move. So there'd been no transactions. And the banks were saying to us, Well if there's no transactions happening We'll give you a discount'cause we know it's not great out there.

37:34 But we think maybe three hundred and fifty thousand dollars. her medallion. Is where we would exit them. So Not gonna pay that today.

37:43 And we think that you're gonna have to restructure large portions of this market. So there's a lot of work and time that's gonna go into it. Both of those things we and our investors are gonna need to be compensated for. So we were walking around talking to all these banks and really nobody wanted to transact with us. And then

37:58 God smiled on me one day. Guy by the name of Gene Friedman, who the post used to like to call the taxi king of New York. Had gotten in a fight with his lender, which was Citibank, and Citibank had exercised remedies against him, seized his collateral, and were going to auction it off. Now the auctioneer was a guy Uh

38:16 Brooklyn. That we do. And we called him up and said, Hey Do you have a stalking horse bidder for these medallions? By the way, it was 48. Outright medallions, not loans, outright medallions.

38:28 Said talking works better. We're gonna go to the airport Marriott and open outcry this. I said listen, call the lender up and tell him that. I'll be a stalking horse. Is it okay?

38:40 What price? I gave him a price that was Way, way, way below. Three hundred and fifty thousand dollars. O hundred and fifty thousand per medallion. And said, Well, they'll never do that.

38:52 But it's a free option. I'm the backstop. We'll do the open outcry where you're backstop. So he said, Okay, well I'll call them up. About an hour later, he called me back. He said, they won't do a penny less than 160. So I said, Great, you're done. We went through the auction and the way the auction rules worked.

39:13 you had to buy all of the medallions or really didn't satisfy the lender's needs. And the truth was the combination of the way we structure the bid and the auction rules. It was gonna be really hard for anybody other than Marble Gate to win the auction.

39:31 So we walked away with forty eight outright medallions. But most importantly, we had created a mark. that we then had hand delivered. to every lender. in the space.

39:41 Now they had direct evidence of a meaningful number of medallions transacting at a level way below where they had previously estimated it would. And by the way, we did that to them at the very end of November, beginning of December. So they're looking at a year in Mark.

39:56 That didn't feel so great. Surprise, surprise, come January, conversation becomes pretty serious with the number of the lenders we had talked about. And they wanted to engage it. much more reasonable levels. We ended up buying the largest

40:09 portfolio available from a federally chartered bank. It's an important understanding when you're dealing with banks what their regulatory scheme is. State chartered banks, credit unions, federally chartered banks, they all have slightly different ways they operate and how they're regulated. Because at the end of the day. Banks always make

40:30 Decisions. For three reasons. Regulatory, regulatory, and regulatory. People think of banks as economic actors. They're not. They're regulatory actors. So this compromised their regulatory position. For a federally chartered bank, those tend to be much larger banks.

40:44 This was a very small piece of their portfolio. And so they can more quickly get to a place From an earnings power impact. And a balance sheet impact that they would dispose of the portfolio at a sharp discount. So we went to the federally chartered banks, we went to the largest portfolio and began a negotiation with them.

41:02 moved through that pretty quickly and took that portfolio over. Uh automatically made us the largest independent lender into the space. Also

41:13 Now you have multiple transactions. The largest group of lenders into the space were the credit unions. credit unions faced with the prospect of a sharp decline in the asset value on their balance sheets. found themselves essentially insolvent because Prior to two thousand fifteen or

41:32 Ultimately two thousand eighteen nineteen when Merci. Part of the story is happening. Taxi medallion loans were considered gold.

41:40 is they remain an important part of New York City's infrastructure. When you talk to New York City To the regulators to

41:49 Transportation departments, city planners, transportation consultants, all of them point out. New York City has a hard time operating without Taxi medallions. Also, it's a meaningful portion of the New York City budget. So

42:02 For all of those reasons, we felt like New York City would take a pretty active role in supporting it, the market understood that for years and years. So A haircut on a credit union's loan.

42:15 It was next to nothing. If you were a credit union in New York, you could not lend to the space. It was so profitable. Now with the sharp decline in assets the NCUA, which is the FDIC of the credit union space. essentially seized a number of those credit unions. So

42:31 It ended up that the largest lender to the space. Was the federal government. That Allowed us to begin a conversation with the federal government with the NCUA. About acquiring those assets.

42:42 That took a long time. For one really important reason. The NCUA wanted to make sure that the way we were gonna deal with The borrowers in the space. respected the dignity of the borrower, that we were not going to be rapacious.

42:56 All of these loans had personal guarantees. And so Drivers who had levered up to buy a taxi medallion. had really at risk their home, their Livelihood, everything. And the NCUA

43:09 understood that we needed to be commercial, but also wanted to make sure that we weren't going to be abusive to the borrowers. And so they spent a lot of time understanding How we were dealing with problems. Yeah. A part of the story I left out earlier is that

43:24 We ended up with Forty five hundred individual line items in this portfolio. Prosecuting that is just a huge lift. You have to send out bills every month. You have to

43:34 collect. You have to call people when they don't Hey. So there's a servicing aspect to this. We want to speak to virtually every servicer out there about Could they help us? And

43:45 The answer for ninety seven percent of them was Absolutely not. We want nothing to do with this. Politically sensitive. Tough space, tough borrowers. Borrowers will spend two, three months out of the country, typically going back to their home to spend time with family.

44:01 Just a setup that a lot of servicers didn't want to Take on. The servicers who were even willing to have the conversation, which there were only a couple They're pricing Was self extractive.

44:12 There was no way we could do a deal. So we actually stood up. A servicer to service the space, which today has almost thirty people in it, a collection of lawyers, paralegals, Bone bangers, people sort of calling borrowers. Anyway, as we thought about

44:27 taking down the government's paper. They wanted to understand how we were doing that servicing and how we were enforcing If that was necessary, and what our thoughts were about ultimate resolution. So when we got deeper in, so we ultimately became by far the largest lender in the space by far the largest participant. Does a sense of scope of that, the number of medallions. What's the dollars deployed or something?

44:52 So it was over six hundred million dollars deployed into the space. Wow. We had over four thousand individual assets. On the balance sheet. out of thirteen thousand medallions. Thirteen thousand five hundred and eighty seven. Now you're the taxi king of New York. But I think one of the

45:10 Good pieces of advice that we got actually from Risa Heller, who runs a firm called Heller. Communications who has advised us throughout this. And Risa had come out of Chuck Schumer's office and as a great connectivity into the New York political scene generally. She said to me very early, you need to go explain everything you're doing and plan to do to every regulator and politician that touches this or is interested in this.

45:37 And so we spent a lot of time going and seeing individual Council members. individual regulators went to the mayor's office, sort of laid out for them, look, these are the problems we see. This is what we think the solution set looks like.

45:52 We think it's gonna be difficult, but we think the outcome looks like the following. And By being transparent about what our plans were, even though we weren't advertising ourselves. Or what we were doing.

46:05 Broadly, we're making sure that the people who would be most interested And the people who were gonna have the most political sensitivities to this were informed and well informed. So By going out and getting in front of that, as we became Large.

46:20 We I would say had a very constructive dialogue with Everybody in the system. I think the other thing that we did Again, I think that has worked. to our benefit over time.

46:31 I described earlier there was this contentiousness in the space. labor, operator, capital. Nobody really even talk to each other, much less light talking to each other. As

46:44 People figure it out. that Marble Gate was playing a larger and larger role. One of the first things that happened, our offices are here in Greenwich, Connecticut. We were picketed. by the Taxi Workers Alliance, which is the de facto union for the space. Now one of the things I'm most proud of is we had water and sandwiches delivered to them.

47:03 It upset my team. I actually don't even think the Taxi Workers Alliance knows this, but I actually put on a baseball cap and a T shirt and Went out and marched with them and talked to the drivers and showed me a license. It goes to driving a taxi. I want to understand what we're on your mind. Tell me what you need. Tell me what's going on. We ultimately did do that across the table from each other in a conference room, but the reality is you get a sense of things by really going and speaking with people and understanding really what's driving their decisions and how they really are interacting with you or the problem that they're facing. And

47:39 By Spending time with drivers In informal settings like that, but also formal settings with the Taxi Workers Alliance and particularly with the leadership of the Taxi Workers Alliance. I found their concerns to be completely valid and real. I thought that the pressures they were facing were obvious and unavoidable. It was very clear to me that the system was not working for them, and in order for the system to thrive.

48:04 Again. They're my customer. I needed it to work for them. And so we began a really constructive conversation and relationship with the taxi workers alliance. I'm very happy to say and I think the leadership of the Taxi Workers Alliance would agree. We continue to have a very constructive

48:21 productive and partnership like relationship. How do you think about that now? So you you're X amount of dollars in you own four thousand something on medallions. Walk us to the current snapshot of the story. Actually just a few weeks ago we took our entire taxi operation public.

48:37 Oh wow. That business will Persist. It should have a very durable and persistent cash flow that should be able to be valued by the market. And I think there's some pretty exciting and compelling things that we can do.

48:50 And continuing to grow that operation. add other services, other pieces of the ecosystem in because the ecosystem does work. It had been too disaggregated. There were too many people taking a profit margin out of it. Reality is needed to be much more efficient. We needed to be much more cost constrained. needed to be much more operationally

49:11 focused on efficiency and delivering to the customer. the customer wasn't getting enough value out of the relationship. The only way you can give that customer more value is that somebody else gets less value. And the only way you can squeeze those margins is through consolidations and efficiency. So that's where this market ultimately goes, where I think the obvious sort of candidate to do it.

49:30 Why take it public instead of sell it to some huge private equity firm or something else? I think there is legitimate concern about what the shape of this market looks like as we go into things like autonomous vehicles. What does the future hold? I think the almost simpleton's answer to that. is oh well you can't fight technology and

49:51 The reality is While I think autonomous vehicles pose a real threat to the livelihood of the individual driver, when I separate driver from asset. And I think about what are New York City's interests. I think the medallion has Again, persistency to it.

50:08 The medallion system was introduced in the nineteen thirties by Fiorella LaGuardia, the famous mayor at the time under what was called the Haas Act. Because in the days during and after the depression, New York City streets got super clogged because people were out of work and they would get in their car and drive people around As a service. The Guardia looked at the system and said, This is terrible. Nobody can get around. We need to shrink congestion.

50:33 Get cars off the street so that the city can operate. introduced the medallion system. Like that. Basically Intuition, that basic imperative.

50:42 hasn't changed. In the world of autonomous Actually, I think it accelerates in some ways. You and I are sitting in Greenwich, Connecticut, while we were doing this interview in a fully autonomous world. Theoretically.

50:55 We could sit down and send our cars to do a little work in New York while we're doing this, they'd be back by a certain time. That's not great for New York City's operation. I would also say that people with less scruples might say, go down to New York City and work, but Don't take any rides. North of Hundred Twif Street.

51:13 Things that would just be Absolutely repugnant. Operationally. But also in strict violation of New York City's operating rules around taxis and how rides can be

51:24 Taken and service. So I think the city has an ongoing and vested interest in regulating the system. The method of that regulation is the medallion. I also think look, there is a true moral imperative to the city persisting around the medallion system. By far, look, we're large participants in the space, but the largest set of owners in the space continue to be individuals that own medallions.

51:49 So the city, and we can talk a little bit about this, we caught an unbelievably forward looking deal with New York City. to protect individual operators. City has essentially invested a huge amount of money in protecting those drivers. and their livelihood and the capital that they've put into the system. If you were to completely displace that capital

52:09 It would obviate all the work and investment that the city has done. I don't think the city has a real interest in doing that. And

52:18 While Autonomous will probably someday displace The driver. And therefore displace their earnings power. you can swap that earnings power for the ability to contribute capital. So the medallion becomes a capital asset that they contribute into the system. And they can cut an individual economic relationship with what other autonomous operator is in the system at that time. If you look back on this, relative to everything else you've done with investing, how good of an investment would you say this was?

52:45 And why? Is that an IRR? Is it a risk adjusted thing? How do you measure it? So we do think about risk adjusted returns. The companies and assets that we invest in. They're distressed.

52:56 I always say to our investors, we don't have the benefit of opening up the paper and saying, Well, I think this Google thing's got legs. Let's put some capital in it. We're looking at problems. The problems that we end up chasing as investors are problems we think we can solve. We think that there are structural fixes, we think there are operational fixes. But importantly, there are fixes that we think we can tackle. These are challenged businesses.

53:19 The risk is real. And so We we insert ourselves into a company or a collection of assets and we use the rights and remedies that are

53:28 We're both using those rights and remedies to drive value, but also contain risk. And you have to work on both legs of that. And so it is risk adjusted return. What are the big investing lessons that you take away from this specific story that you feel are generalizable to

53:45 What makes great investments of this type possible. So distressed assets, you said it earlier, and it's a line we use all the time. It's a full contact sport. You have to be willing to engage. If you're investing in distressed assets and you are not taking an active role in both the financial and operational restructuring. You're just taking

54:03 Weird and unquantifiable risk. that you are not participating in. I I would argue it's almost like investment malpractice. to invest in a distressed asset not Taking an active operational role in addition to

54:18 The financial Restructuring role. Yeah, it's an incredible story, one of my favorite investing stories. Probably no one's ever thought of the New York City medallions as an asset class or something. Maybe to zoom out a little bit, I'm curious how you would describe the key components aside from the steak dinners of interfacing well with banks. If that's the channel through which you find everything. And that they're motivated by regulation, regulation, regulation.

54:41 What is it like? What sorts of things do you see? How do you know what to dig in on? What makes for good relationships with that key counterpart of yours. Well, a good relationship with anybody is about respecting their needs and constraints. One of the things that I think we're really good at is understanding the needs and constraints of our counterparty, whether they're a bank, a borrower, a sponsor a taxi driver, anyone. We spent a lot of time thinking about

55:05 The other guys need. I told Everybody at Mars It's easy to know what you want. You look in the mirror and tell it to yourself every morning.

55:15 The real exercise the real effort has to be focused on understanding the other person. And that understanding can come both from conversation and that's a easy and direct way. I think it's an important way. You always have to put boots on the ground. Lots of the investments that we've made. Uh

55:32 management teams who said, Well, you're the first Lender. Ever to show up. And see the facility. Crazy.

55:39 So we spent a lot of time just getting to understand How a counter party is thinking. Again, we also spent a lot of time looking at data. Because

55:49 People have an intuition about what they want, what they need. Data sometimes says something different. No, there are times where we want to share that data with somebody to help them understand their own needs. There are other times maybe we want to keep that data to ourselves in a negotiation. But we're looking at all dimensions of how to inform ourselves about what the other person's needs are. understand what their real

56:11 hard constraints are. One of the things that Every time I deal with somebody I try to guarantee them is you tell me You've got a hard constraint and we can

56:21 understand that that is true, that you have that hard constraint. We're gonna respect it in the negotiation. Any negotiation, any resolution can't be a zero sum game. It has to be that both sides have to get something out of it. By the way, also when we're selling assets. You have to leave something in for the next

56:39 owner If you try to extract all the value that they're gonna get, well, then they don't wanna do the deal. So Trying to understand what the other guy needs. is a huge portion of what we do.

56:51 You've done a lot of negotiation in Interesting, unique circumstances, often as you point out, very hard circumstances for people around the table. Any other ironclad principles of negotiation apart from the one that you just laid out that you sort of live by? Yeah, so you know that saying I learned everything I need to know in kindergarten.

57:08 That's really true. Treat other people with dignity, treat them with respect, be honest. Yeah. As transparent as the situation demands, so you don't have to Show all of your cards. You are playing poker to some degree.

57:22 But you want to deal with people on a heads up and honest basis. Uh, you also want to operate On a reasonable pace. Um

57:31 Pace is an important part of any deal discussion. People get an intuitive sense whether or not there's something to do just by how you're engaging with them or how they're engaging with you. So That doesn't mean you need to hurry to things. But if you're not moving things along

57:48 People get anxious. Time kills deals. Time kills deals. Yeah. I'd love to talk about other types of transactions that Marble Gate will engage with. We were talking earlier about an example with the federal government of some credits that you were buying up. And the reason I like this example, which you could tell briefly

58:04 Is understanding why the opportunity can exist. Very often when something sounds too good to be true. You start wondering why am I so lucky that I can get such a great risk adjusted return. So maybe use that example as one where there is an incredible risk adjusted return that you can walk through, but also very keenly the reasons why it's possible in the first place when usually there's smart people like you looking for places to earn a great return and yet it's still available. We

58:29 been buying something called the employer retention tax credit. And so now this is an opportunity that comes out of the CARES Act. Everybody's seen these commercials that ran Almost. Every

58:40 commercial break on every channel at one point. Get twenty six thousand dollars per employee payroll tax refund. Because the policy imperative at the time was get as much money into the system as they possibly could. Now, the problem is like the federal government is a big place. The IRS is overburdened already.

59:00 And there's lots of changes in the RS, lots of new one agents, now a lot of agents coming out. They're charged with covering a lot of territory with not a lot of resources. So they got foisted on them this new thing where there was a separate filing. That had to be done by companies. The language of the legislation which passed under the CARES Act. Is that a company

59:21 who had either a twenty percent decline in their revenue during the measurement period. Yeah. had been substantially impacted by a government order. By the way, not a federal government order, a government order. So state, local, anything. Qualified.

59:37 That's really loose language. I think If the authors of that had opportunity to go back and rethink it, they might have, and there's been a couple of attempts to Problem is getting anything done in Washington's

59:48 Hard these days. So it is the law that's on the books. Companies. started to apply for This it is a separate filing.

59:57 It is a paper filing. It requires you to go get some sign off from your accounting firm or your auditors. You have to

1:00:06 If you're gonna do it responsibly, you need to put together a package that explains should you be ashed. Why your claim is valid. It's a fair amount of work. And then the government was really slow in processing it. Again, we have an overburdened IRS and an overburdened number of people that are working there, so

1:00:24 Processing was just slow. I think when the government did this, we've heard some Estimates that say they anticipated it to be a fifty billion dollar program. About a year in they had paid out two hundred billion. Holy cow. That was a year ago.

1:00:38 So the numbers are Unbelievable. Again, it's probably a Poorly written law. So we started going out to companies to

1:00:48 tax preparation firms people who deal in tax credits. Law firms payroll processing firms and saying to them. Look, we'll buy those credits from people.

1:01:00 Now the reality is it's not a credit, it is a transfer payment. The government sends you a check. It took us a while, it took us several months to design that system. It's complicated. There's a lot of paper to process. There's just so much manual labor required. We started processing credits looking at individual

1:01:18 companies who wanted to sell us their claim. Now we passed on huge numbers of them, particularly because at the beginning It was pretty loosely written law. And we said We wanna be Caesar's wife and our underwriting here to make sure that we're

1:01:32 well within what we believe is reasonable. Our standard was much tougher than what the government ultimately had. So we were buying credits that we felt really, really good about that would be non controversial and would get paid. We were paying about eighty five, eighty six cents on the dollar.

1:01:49 One of the provisions of the law was that From when you filed the government owed you an interest rate? While you waited for the refund? That was six or seven percent. So

1:02:00 We were also at earning a natural rate on the capital provided. As a safety mechanism, we also built a system that allowed us to put back claims should they become problematic with the government, should they be disallowed or there be some sort of deficiency found. And if we were able to put back. The company owed us our capital back. Plus a rate.

1:02:19 So you might ask yourself, well, why were the US government calibrate crazy why would you do this? Goes back to what we were saying earlier about the K shaped economy. Most of our sellers, if not all of our sellers, are in the middle market. All of them capital constrained, earnings power constrained. they saw this asset that they could monetize. And we were

1:02:39 Relatively easy to work with, I would say. We try to process things pretty quickly. We could have an answer turned around. And documents done within two to three weeks. And I know you it's a similar order of magnitude of capital deployed is what we talked about with the taxis. That's a big amount of capital to go in to get a minimum return ish of twelve percent, a lot higher if everything goes as you think it's gonna go. counterparties of the US government.

1:03:02 This is very different than taxi medallions. Taxi medallions at the time, of course, you tell this narrative was like, Oh God. Whereas the US government, I don't know, probably gonna pay. Why was this available? Why didn't Apollo do this? Or why didn't some big enterprise why didn't distressed Bowpost guys do this? What makes it so that this was available given that it was a big amount of money? What seems like a no brainer

1:03:24 type of return. Why is this possible? Well, look, A, I think we do a pretty good job looking in nooks and crannies. Yeah. Seeing things first. We want to be detail oriented thinkers. And I would also say All profits emanate from the variant view.

1:03:41 If you have the market view, you get the market return. If you want to generate an above market or a differentiated return stream you have to Think in a differentiated way, have a variant view, and prosecute your investments in a variant fashion. Going back to the foundation story of Marble Gate, when Paul and I sat down, we said, look, the world has a Howard Marks and

1:04:01 The world. has a Mark Rowan the world has a lot of things. What doesn't it have? And In order to grow our business, we've made sure to try to do things that we thought were interesting.

1:04:14 Unique. The other thing is we like the intellectual challenge. We like to Think about things other people haven't. Thought about it. Years ago we did some investing around Native American gaming assets.

1:04:27 The Reality is that sits on sovereign territory. How you restructure those is super complicated. And how do you generate a return that is sufficient? And so we had to explore new space in order to

1:04:40 Find the pathway through. We like doing new, we like exploring ideas, bringing new technology, interesting ways to look at things and access that value to bear in our investing style. It keeps it interesting. What is the Hardest.

1:04:55 thing that you've ever had to pull off. as part of Marble Gates' entire story. We're constantly seeking new challenge. When we were Starting it was Paul and I and an analyst and our CFO.

1:05:07 We couldn't exercise a huge amount of control. We had fift million dollars in assets under management. It was the Late winter of two thousand and nine, the world was falling apart. the strategy that we prosecute today is the same strategy that we prosecuted, then we just do it on a slightly larger scale. In those days

1:05:27 We had to be clever, we had to outthink the competition in order to make an impact. And so we've always maintained that. framework of thinking. We also in those days locked up capital was not available. So we started our business in an open ended structure. Now it had long commitment terms, but it was essentially at its core an evergreen structure. And so it demanded that we have this discipline of how are we gonna get that capital back.

1:05:54 to people. And that Process of Getting capital. allocated into a distress situation and then

1:06:02 Finding the resolution mechanism that brings it home. is built into the DNA of the firm is how we think about investing generally. Yeah, the interesting thing about distress is You have to use capital to get capital back. There's this cycle of capital, capital contribution.

1:06:19 Resolution that cycles and so You're always thinking about how am I gonna drive this investment and create something else out of it, then I'm gonna create something else out of that. And you create this daisy chain of opportunities, one thing leads to another. If you had to isolate the most difficult workout or the thing that kept you up the most at night, is there one or there's just always a component of that? One of the things that my partner Paul always says is every single investment is both a complicated business problem and a human drama.

1:06:49 And each one of our investments has had some greater or lesser mix of those two things. To the individual in these situations. We do this for a living and we've done it essentially our entire careers.

1:07:03 It is familiar to us. We understand how things are gonna work out, how they don't work out. We're comfortable with a level of ambiguity and uncertainty that other people generally are not. And so each one of these are the most difficult thing that the other people in it are ever gonna go through. And again, you gotta be sensitive to that reality. It goes to their decision making. It goes to how they engage with you, how they engage with the business or the assets.

1:07:32 Each situation is difficult in its own way because that human drama tends to be the unknowable thing as you're walking into a situation. I'm curious, since it's people going through the hardest thing they've ever gone through, how often that spills over onto you? How often do you feel like they believe you're the villain in the story? And how do you deal that would seem very stressful to me. Do you just become stoic about it? Does it happen often? Talk about that.

1:07:57 We are the Avatar. of people's frustrations. I don't love it. It's not I don't wake up. Nobody's excited about this. Yeah.

1:08:06 There's no saying. that I repeat often, nobody finds distress. Distress finds you. And that's true in business is true as an investor. Nobody graduates from college and it's like, you know I'm gonna go into companies and be reviled by management and argued with by sponsors and yelled at by banks. It's not something that people go into. Yeah.

1:08:31 So it tends to find people and it self selects people. The way we deal with it is Again, back to first principles. Deal with people with dignity, with respect. compassion for the reality that they exist in.

1:08:45 compassion for the fact that This is the hardest thing they're ever gonna go through. And that they don't like this. It's upsetting to them. It's having an impact on their home life, on their kids. Oftentimes destroyed their life savings. It's a big deal for people.

1:09:01 And so They are gonna be angry at you. They are gonna be angry at the decisions, the hard decisions that you're making on behalf of those assets or that company. But I always say, look, we're the eat your vegetables guys. We're not doing this because we have some personal animus to you. I've never met most of the people that we deal with. But we are doing what's in the best interest of the asset and what we believe is in the best interest of generating a durable

1:09:28 Return and a durable business. What motivates you? If I kept asking that question eight layers deep. Where would I get? I like the problem solving of it.

1:09:37 My partner Paul sometimes I said that my superpower is being able to find that intersection of needs and wants in a multi party. negotiation.

1:09:49 I just love that problem solving. I like finding a way through. I like Taking things that are undervalued, misunderstood. And getting them back into a condition where they can be

1:10:02 Again, durable, profitable, and a success. If I was to go see your whole life story in a movie or something, let's say pre college. early part of your life. And isolate the stories or the things that were most formative that most shaped who you are.

1:10:17 What are those things? Hands down, and it's not a thing I talk a lot about, but my father passed away when I was very young. How old were you? I was About eleven years old. He and I were super, super close. We did everything together, including

1:10:31 We used to Sit together and go over The Wall Street Journal stock pages every day. We tracked certain stocks, we invested together, even though I was really young, he brought it to a level. that I could understand. My dad was an immigrant to the country. Loved the American system, loved that his son was an American.

1:10:48 Loved to participate in American commerce. He was an entrepreneur. And dealt with unions and dealt with large capital projects and used to bring me the meetings he would have. He would come to New York on business he would bring me. I grew up in a little town in south east Texas. We would go to Dallas and he'd wear a suit. He'd sit me in the corner and I would just listen.

1:11:11 So from really early ages, we spent a lot of time together. So when he passed away, he had a heart attack, we were on a boy scout camp out. And that Was actually a Devastating time.

1:11:22 And uh devastating moment. And what shape two I am, and shape two my sister is. completely reshaped my mom's life and how she saw herself and what her role was. It changed our whole trajectory. And also, by the way.

1:11:37 Showed the colours of people around us. So there were People who I would say we thought we're Good.

1:11:44 friends and close and reliable counterparties. And at the moment of truth. People don't like messes. They don't like difficult situations. And we saw people retreat. And I took a lot away from that. At the same time We also saw people.

1:11:59 of real character. Lean in. People who to this day I consider family because they just Embraced us. And took care of us.

1:12:10 people who have become entrepreneurs, who have shape the world around them. Very strangely, the most common pattern is someone that lost their father at a young age. So many of my mentors have this pattern. And so I'm very interested in it. Because it's a tragic thing.

1:12:26 Which nonetheless comes to define and shape people in a very unique way. And the common pattern that I see is on the other side of it, there's tremendous amount of agency. Almost like the person wakes up in that moment and realizes, Oh I need to be agent tech. I need to take care of business.

1:12:41 And I'm curious if you had that experience. Coming out of that. Tough time. And any other reflections you have on Agency and the importance of agency in life. So my mom grew up in southeast Texas for a while as a child, she had lived in the Middle East in Baghdad.

1:12:57 Interestingly. When the king was overthrown, she and a lot of the Americes were taken hostage. It's a super fascinating story. She and her mother and brothers while the men were forced to work. By the rebels.

1:13:09 So my mom had had this really interesting life, but had married my father at a pretty young age. And my father had a big personality and himself had had a pr interesting, colorful life. So when he passed away. She was thirty five years old and had these two

1:13:27 young kids. My sister's seven years younger than me, so she was really a baby. And my mom really Hush us. to take control of things and to make decisions on our own. and get out and challenge ourselves and drives to create our own outcomes.

1:13:44 and find our own path. She really pushed us. I love my hometown. I love the community I grew up in. It was super nurturing and really a lovely childhood and Always other than the one we discussed.

1:13:58 Great people. But she really pushed us to leave. She said, I want you to go out into the world and find your own way. I come from a good tradition of that my grandfather when he was just after Barmitz age was Living in what is now.

1:14:12 Ukraine. It was Part of Romania then? But he and his oldest brother Walked down to the Black Sea, caught a boat, ended up in Curaçao.

1:14:22 And would make enough money to bring each Brother. Five brothers total over. They moved their parents into mandatory Palestine. And then Ultimately they'd go back for

1:14:35 The shit for the arranged marriage. And as they were. Ultimately not a lot of Jewish girls running around in Latin America in those days. And so He had gone to Eritz Israel to get married. My father was born there.

1:14:48 But then raised in Latin America, came to this country. For education. Couldn't get a visa. There were Constraints on Jewish immigration in those days. And so went back to Venezuela.

1:15:01 had met a guy here in the United States that He had gotten to be pretty friendly with and They had this correspondence back and forth about how to start a business and what would they do. And ultimately My father, after several years, was able to come back to the United States and he and his business partner.

1:15:19 Went to my hometown, Belmont, Texas. And started their first business was a precast country business. And they grew that and they grew that into a number of other businesses that ultimately service the oil industry. This is the stuff of the classic American dream and story. To map that back to where we started with the K shape.

1:15:38 economy. Give us your just sense your state of things and how you feel about it. having been a person produced by one of these amazing stories and then a group of people that came here for that story and have challenges. Love your closing reflections on that.

1:15:55 America is like the greatest system that has ever existed. It is the greatest economy, is the greatest economic system, greatest political system that has ever existed. But

1:16:07 Countries. like companies are delicate. The fragile. They require care. And feeding.

1:16:14 They require respect. They require engagement. And they're subject to abuse. So look, I don't like what I see in the K shaped economy. I don't think that it's great that we have this growing divide between

1:16:27 The haves and the have nots. I think that the magic of America is that Anyone can make it. My father included. And I think that it is magical that a kid from Beaumont, Texas, who

1:16:39 lost his father at an early age, could end up in Greenwich, Connecticut, sitting across from you talking about the things we're talking about. I mean, that's a really remarkable opportunity that doesn't exist anywhere else in the world. I mean, it really doesn't. So In order for the Next. Abe Milgram, my father, who came to this country

1:16:57 And then nineteen. Fifties. In order for him to be able to come back. As The next tomb ever.

1:17:05 We need to have a system that works for everybody. We need to have a system that provides for opportunity and access. It has to be a system where you can work hard and earn a good living, but you can also take entrepreneurial risk and be rewarded for it. When we Design a system or allow a system to calcify such that the haves

1:17:25 Yeah. perpetually have and the have nots will perpetually not have. That's a system that is doomed. And it's not the American way, it's not the American system. And I think that

1:17:36 We stand at a moment in time where we have some hard decisions to make. By the way, this is not a political comment on any individual party or person or Any of that. It's more a philosophical view on where America is and where the system is. I think we as a систем, we as a country.

1:17:54 have to have a lot of grace for each other and a desire To see Not just the guy in the mirror win, but the neighbor. We need to see our neighbors win. We need to make sure that the people Oh

1:18:07 Make America great. Enjoy its Prosperity. Is there anything about the world and how it works on the investing side that we haven't talked about that you think is most surprising? Or interesting.

1:18:19 your style of investing is very different from the style I normally Feature here. I think there's lots of interesting ways that people are investing. I'm always interested in how Friends, colleagues.

1:18:30 People I need. Or allocating capital, how they're thinking about things. I would say I sense a lot of laziness out there. I think there's a lot of wash, rinse, repeat. We do it this way because we do it this way.

1:18:44 Or we're investing to model or It's just the only way that I can describe it is lazy. That A I think is intellectually bankrupt, but I also think it's worrisome because When we go on to autopilot.

1:18:59 Things don't tend to work out. And I feel like large portions of the investing world are now on autopilot. Where do you see that most acutely? And big parts of the credit market.

1:19:10 Say more about that. So the primary vehicle credit creation and corporate credit over the past ten, fifteen years has been the CLO. So COs are a magical device. Just describe them for anyone that doesn't know what it means. Clarise loan obligations. So these are a package of loans that are

1:19:27 Assembled as a Group of assets. And then against those assets, there is a stack of liabilities that are sold with equity. Underneath. So an individual investor will put up the equity.

1:19:40 And then A number of lenders will provide stacked layers of capital, so orders of priority. Which allow The purchase of that.

1:19:50 portfolio of assets. The investing relies primarily on diversification and overcollateralization as its method of risk control. There is this pretend system that's going on at the moment where there are analysts looking at each individual credit. And I don't want to disparage the entire CLO industry. There are some unbelievably good CLO managers out there. They're smart and sophisticated and thinking very Hard about

1:20:16 How they are. Managing those pools of assets. But there are a lot that are not. So you're getting this laziness that's happening. I would also say one of the things I don't like that's happening out there is the productization of investment decisions.

1:20:31 There's a lot of outsourcing of critical thinking. Because I can go to this person that'll make this decision for me and I'll go to this person Will make that decision for me. And so again, we're bankrupting the decision making process.

1:20:46 The investor, if that's even what you want to call them. And they're not actually doing anything and I don't think adding a whole lot of value other than Choosing other people. To do the thinking.

1:20:59 Who by the way Are misaligned because those folks are motivated by a stream of fees rather than an investment outcome. I don't love What is happening?

1:21:09 Yeah. the CLO system, I think that there's a big opportunity to be much more active and engaged in that. Now It probably means that you can't be

1:21:20 hundred billion dollars of CLO capital thinking like that. That being said, there People were gonna do a hundred billion dollars of CLO. Yeah. We'll do just fine under the system that exists.

1:21:31 So I want to disparage everything that is happening, but I do think that there is an opportunity to be much more actively engaged in that portion of the market. So any other commentary on private credit? And private credit markets in general, and then also on equities. You've such a unique vantage point. So just big picture view on those two big spaces. Private credit in particular is a really interesting space. In two thousand and eleven, the federal government issued an update on what is called the guidelines on leverage lending.

1:21:57 And that is the perspective on the rules out of the center, because we do bank regulation in a really interesting way in this country. So Policy is set at the center. Primary policy makers are the Fed. The FDIC and the OCC.

1:22:10 And they issue guidance. individual. And independent. Federal Reserve banks around the country. That apply.

1:22:18 The guidance. So it's up to the individual Fed regions, Fed presidents and boards and employees as to how that regulation is applied. Policy set at the center. And uh guidelines on leverage lending that were issued in two thousand eleven.

1:22:32 created the dynamic That pushed. More leverage credit. out of the banking system. Because after the financial crisis, the federal government adopted

1:22:43 Correctly, I think. The perspective. that they wear the ultimate risk in the banking system. And so he who wears the risk Makes the rules. They said, look, we're wearing this risk. We don't want

1:22:55 Anything above X leverage in the system. So we want that out. That allowed the private credit market, which has always been there, but really to flourish. in the aftermath of the financial crisis.

1:23:08 And there's been an immense amount of capital that has gone into the space. Where there is over allocation, there will be mistakes, and I think we see those mistakes rearing their head today. According to Fitch, about eighty two percent of The private credit market exists in the single B minus and lower

1:23:27 credit quality space. Like we have forty years of data that tell us how various Credit. quality equivalents perform. Triple Cs, for instance, default at about a

1:23:39 three year thirty percent cumulative default rate. So the largest portion of private credit According to Fitch. Is in triple C equivalent. Show me a private credit manager who reports something north of a one and a half percent default rate.

1:23:53 How's that happen? Well, one of two things is true. Either in the aftermath of the great financial crisis, we have some private credit managers have invented a new way to underwrite credit. Which Avoids all losses, risks, and defaults. Or

1:24:08 They are misleading you about what the actual default rate is. And how do they do that? Well, defaults are the most easily manipulated statistic in the world. A default doesn't exist unless I, the lender, call it. So if I don't want defaults in my portfolio, I simply don't call them. I always tell people don't ask the default rate of a private, ask the waiver rate, ask the amendment rate.

1:24:28 How much are they having to put hands on their credit? to reorient the documents to fit the reality of the company there. operating in. We have some evidence. in the BDC market.

1:24:40 the BDC market, so business development corporations are essentially public direct lenders. And There's an instrument or a device in credit called Pick that are you familiar with that at all? You can explain it, but yeah. The formal name is payment in kind. So rather than pay you a coupon, I will pay you more debt.

1:24:59 Now We oftentimes say Pick means payment isn't coming. Because when you look at the data, what you see is when there's a lot of pick in a particular instrument, typically that company is gonna default and you ultimately will not recover that pick debt. It's a bit of a mirage that

1:25:18 Individual loan officers or credit committees will use to disguise maybe A less Then Let's say fulsome credit decision.

1:25:31 Or by the way, there are legitimate uses for it, but if a company can't pay you A cash coupon. you are taking some amount of equity risk. So the larger the portion of pick debt in a particular instrument, the more equity risk you're taking in that investment. Pretty straightforward.

1:25:46 We see some portfolios in the BDC market that have Seventeen, eighteen percent. Picked up. They're no longer lenders at that point. They're taking massive amounts of equity risk. In companies

1:25:59 that are probably again, they exist mostly in that middle market space. So they're under pressure. They start from a more difficult position with declining margins declining, earnings power. It's not a great setup. I don't

1:26:12 see great things ahead for large portions of the private credit market. That being said. There are some private credit firms that are Spectacular. I mean superior. That list is pretty straightforward. Firms like Ares or let's say Gollup are

1:26:27 Stellar at what they do. And they have great credit cultures. They have really complete teams that deal with underwriting and Workouts should they get to that. The private credit universe used to be a direct origination.

1:26:42 Business. There is some direct origination that goes on in private credit today. but it's largely a brokered market. Which is a dirty little secret. People don't like to talk about the Houahans or the Lincolns are doing a huge amount of placement of private credit. So

1:26:59 naturally what are they doing? They're going to the biggest, best, most well known lenders first. Aries Gollib, et cetera. If they pass, then they go to the next cadre and the next cadre and the next cadre. So there's a real tearing. In terms of access. The biggest best known firms.

1:27:16 do have the best portfolios because they get first choice and they have the most complete access to capital and the best teams, et cetera. So I think there is great things happening in private credit. I think there are some scary things happening in private credit. What's your commentary on private equity, which is a key counterpart to that. I love those guys. That's my manufacturing division.

1:27:38 Like everything. There are some people who are doing really interesting, really compelling things. The firms that I like are fundamentally value based investors. They do what I would call scratch and dent type private equity. So they're buying carve outs or assets that are a little unloved.

1:27:54 or difficult in some way, and then really applying force to them. But I think just like in our business, If you're just a financial investor. You're in some way a traitor. If you are Bringing to bear real resources to drive the company's operations forward.

1:28:12 Or to reimagine how That business operates. That I think is really interesting and really value added. And there's going to be a future. For that kind of investing in that style of private equity.

1:28:24 I think the standard group of great deal makers who know some allocators or rich families that will back them in buying companies, but they don't actually Do anything other than buy the company and show up for board meetings. I think those firms are troubled. I don't think they add a lot of value. They probably don't have much of a future. Looking to the future. What do you most hopefully?

1:28:46 You get to do more of that Marble Gate becomes Where will you spend your time and attention based on your interest right now? We sit at a really interesting moment in asset management. I think that what we do in our business And our investing is

1:29:00 acquire assets that are troubled. reimagine what they could and should be and then apply force to make that happen. I think we have to look at our own business that same way. I think we're at this moment in the asset management space where people are asking hard questions. The right questions about

1:29:18 Who's adding what value? And how should that value be compensated? And What are the Collections of

1:29:26 services that Asset managers should be providing to their customers. How should we think about our relationships with our customers? Is it really a customer relationship or is it more of a partnership relationship? I think that partnership model is the model going forward. I also think that we have to think about where we're accessing capital. There's a big push to go into the retail channel.

1:29:48 I can make and I buy the argument that large portions of the retail market are underallocated into Private markets. I think that there are large portions of the retail market that are probably not super well equipped to have a Ton of exposure.

1:30:03 We're gonna go bump in the night trying to figure out where those lines exist. They're gonna be People will make mistakes. Investors will make mistakes. as a management firms will have false starts. But I think there's product design opportunity.

1:30:17 That Is exciting. There are some things that have gotten a lot of heat interval funds are Getting a lot of attention. There's some strengths and some weaknesses to that.

1:30:26 Everything that's happening in the insurance space. Is super interesting. I think there's lots of ways to think about that. The annuity driven investing profile is super interesting and it serves a real need an opportunity. I think there are other composition of insurance assets out there that are also interesting that are Probably less well explored at the moment. So I think there's a lot.

1:30:49 That's going to happen. The world of asset management that I grew up in is not gonna be the one that I exist in. Going forward. we're undergoing a lot of change and I think the people who embrace that change are gonna succeed.

1:31:04 And the people who live a comfortable life and are happy to play golf a couple of days a week and Go have Big expensive lunches. That's probably not gonna be the successful model going forward.

1:31:16 That has never been your approach. You're one of the more unique investors that I know. I love talking about investing. I think what you do is different and obviously it works. I think you know my traditional closing question for everybody. What's the kindest thing that anyone's ever done for you? Right after

1:31:32 My father passed away. This Family that I still Consider Very dear to me.

1:31:37 My mom was overwhelmed. Yeah, tear up thinking of how to actually They would take me to their house for breakfast every morning and they drive me to school. And they really embraced me.

1:31:48 And provide a lot of stability. To me at a really trying time. There were other families that did the same thing. That was a really, really tough moment. And they leaned in. I try to think about what I can do. to pay forward that kindness.

1:32:03 Beautiful closing story. Andrew, thanks so much for your time. Thank you. If you enjoyed this episode, visit joincolossis.com where you'll find every episode of this podcast complete with hand edited transcripts. You can also subscribe to Colossus Review, our quarterly print, digital, and private audio publication featuring in-depth profiles of the founders, investors, and companies that we admire most. Learn more at join colossus dot com slash subscribe.

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