00:00Back in November, Diameter Capital Partners announced it raised $4.5 billion for its fund,
00:05aiming to seize on market dislocations. Jonathan Lewinson is managing partner and
00:09co-founder of Diameter, which manages $29 billion, and he joins us now. Jonathan,
00:14thanks so much for stopping by. Thanks for having me.
00:16So that was at the end of last year, and it certainly feels like there are dislocations
00:21out there. Where are you finding the most compelling opportunities? What is dislocated
00:24right now? Well, thanks for having me. I thought the U.S. Constitution required that you start
00:29with a question on private credit. We'll get there, I promise you.
00:31Sure, we'll get there. Look, I think the question is, what is there to do in credit,
00:36and what are dislocations? And so everyone is always looking in credit for a recession.
00:41Credit guys famously call kind of nine out of every three recessions. We're obsessed with it,
00:47and usually wrong. The opportunity set for most of my career in credit in dislocations has not
00:53been recessions, has been what we call microcycles. And whether it was Meredith Whitney blowing up the
00:58community market after the financial crisis, the oil and gas in 1516, California power. When you
01:04have industries that have debt and either have technological transformation or policy volatility,
01:09you get microcycles. And I don't have to watch Bloomberg TV all day, though I do,
01:14to know that there is a lot of policy volatility and a lot of technical transformation. And so where
01:18do we see it? We see it in places like telecom, which used to be so boring, and they just
01:23raise price.
01:23And then all of a sudden there's competition. You have fiber, you have fixed wireless, you have low
01:28orbit satellites, things like Starlink competing. And so nearly every global telecom and cable company
01:34has had some kind of dislocation. We've been investing in that for a while. You have housing.
01:38Americans went crazy in housing when rates were low. Everyone moved to refinance their mortgage.
01:44We went from five and a half million home sale sold every year to four. Four seems too low,
01:48but it's been too low for a while. And you have a lot of LBOs that have kind of interesting
01:53availability. And then you have sectors that, like packaging, who would have ever thought
01:57packaging gets dislocated? But packaging is, but it's hard to know when it comes back because
02:02habits are changing. And then obviously software, which is threatening what could be kind of the
02:07granddaddy of them all in terms of dislocations. For software specifically, how do you make sure
02:13when you're jumping in that it's not a value trap, that it's not being sold for a
02:18reason? Because AI is going to disrupt the whole thing. Is there actually value out there to be
02:22had? This is the big question. We're all kind of using cloud code or other things to create
02:29dashboards that talk about moat and talk about threat perception. And everyone's got their own
02:33fancy dashboards. We're just trying to do what we always do, which is credit analytics and forecast
02:38businesses. It's just hard because we really don't know exactly how AI will develop. I think an
02:44analogy is helpful. So if you go back, they put a lot of makeup on me, so this will surprise
02:50you,
02:50but I was around in the nineties as a human being. Perfect skin, Jonathan. Thank you. Thank you. It's
02:55nice to say. And they did a great job back there. But in the nineties, when the internet was starting,
03:01there were questions about what is it going to disrupt? And I remember that there was a number you
03:08could call for the weather called call the weather. I was not allowed to use it. It was close to
03:13like
03:13being as forbidden as a mini bar in a hotel room. You had to pay for it. And if you
03:19needed weather
03:19between say the morning paper and the evening news, you paid $2.99 for it. You didn't need to
03:24be a financial analyst in 1997 to know that call the weather was toast due to the internet. It was
03:30gone. And I'm sure it wasn't LBO'd, but it disappeared or shriveled. There was a bigger debate
03:35over whether people would buy clothing online. That actually took, we didn't know the word brick and
03:40mortar then. Right. Will people want to try on pants in a store or at home? And that really took
03:45until even you could argue COVID for that debate really to be understood. And so if you now then
03:49say, Hey, how does that apply to today? If you are using cloud code or other products to build dashboards
03:55and then thinking about, Hey, I have a software company that does data visualization.
04:01They're probably call the weather. Yes. Right. If you have a company that's doing,
04:05let's say, um, data standardization or workflow optimization, maybe they have a problem.
04:11If you have businesses in areas, let's say security, and we know that, you know,
04:15mythos and others are going to upend that they will be disrupted. Right. Who knows exactly how.
04:20And, and that's a lot, that's like buying pants in the store. Right. We'll see.
04:23But with all of this, and I think back to an interview you gave roughly about a year ago with
04:27Shanali Bassic, where you basically said the reason that private credit is looking better than other
04:31private credits is just because they're not marked to market and a reckoning has to happen.
04:35Given all of the software fears, given everything you're talking about,
04:38has that reckoning happened yet? Well, it's certainly, um, it's, there's a reckoning
04:43threatening. How's that? Sure. And I think obviously people are, uh, trying to withdraw money where
04:48they can from private credit and that's created something. And, uh, if you look at kind of what's
04:53gone on in the last three or four months, as people have tried to get money out of private credit
04:57funds, it's reminiscent of what you've seen in other kind of bank runs in the sense that people
05:02wanted to get out of Lehman before you needed to know what the real estate assets were
05:05worth. People wanted to get out of Silicon Valley bank before you knew whether the mortgages and
05:08treasuries were correctly marked. People want to get out of private credit before they can
05:12know the answer to these software questions we're talking about. The problem is private credit
05:16generally does not have an asset liabilities mismatch. We're seeing an opportunity to buy
05:20loans that are being sold, but it's not a torrent. It's not the type of run that you get with
05:25a
05:25bank that doesn't have a gate. And the bigger issue is that private credit, which is a fine asset
05:30class. And by the way, very, very big. There's many different types of private credit. I'm old
05:34enough to remember when we were talking about companies like first brands and asset backed
05:38finance for private credit, which is very different than the loans to software companies.
05:41But in direct lending, what you saw was an industry that grew into where banks kind of moved back.
05:48So after the financial crisis, banks couldn't do loans that were highly levered. And what were
05:53highly levered loans? Software. So a bank would look at a software loan and say, this is eight times
05:57levered. It's too much. A private credit firm would say, wow, 95 percent retention, 80 percent gross
06:03margins. Let's do this. And so that and the ability or the desire to not have cyclical assets and to
06:09say, hey, private credit is not that cyclical. We don't worry about a recession created a situation in
06:13private credit where many funds didn't do the type of portfolio construction and diversification that
06:20you would kind of need in any type of investment product. And that's unfortunate because private
06:24credit has capped returns. In private equity, which, let's say, has 18, 15, 18 percent in software, at least
06:31you're making 20 percent. If you have a private credit fund that's a 35 percent software because all you were
06:37doing
06:37was doing software loans and other asset light and all you can earn once it's at par is the coupon,
06:43that is an
06:44asymmetry between diversification and return. And that, I think, is the reckoning that is threatening to happen.
06:50So so what does that reckoning actually look like? And we're just about out of time. But when we sort
06:55of
06:55get to that point where funds have to face this, maybe loans come due, what happens? What is the end
07:01result of this? You're going to have dispersion of returns in private credit, which has never happened
07:05before. And firms that did a lot of diversification, portfolio management, monitoring, construction
07:11will be fine. And those that don't will at some point either provide disappointing returns to
07:17investors, or we'll have to slowly sell loans. What do you think is the split between that of like
07:22those that actually did do? Are there a lot of like stinkers out there just looming in the market?
07:26Look, obviously, far be it from us to talk about it. I think we're proud of the fact that our
07:29our private
07:30credit BDC is four percent software. I think you'll find many others are 30 percent. And when you put them
07:36through your model, it says really it's 60 percent. There's a lot of underlying difference in private credit
07:41funds. We are seeing some of them needing to sell. But again, they don't need to fire sale. It's slow,
07:46just like the
07:46development on the asset side. And they're trying to sell performing things because you want to sell things that
07:50give you the most money. But I do think what you're going to see is like in any asset class
07:54that grows, what really
07:56mattered was, did you hire a manager who was doing portfolio management? And that'll be finally differences in an
08:02asset class that for a while. Look, there was nothing more boring in the past than a panel on private
08:07credit because
08:07everyone said the same thing. And all of a sudden in your business, it's going to be interesting to have
08:12different
08:12people on.
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