Blue Owl Capital Inc. (OWL) Earnings Call Transcript & Summary

Okay. I think we're just about set. Hello, and welcome to the S&P Global Ratings Webinar, a North American Leveraged Finance Series. Thank you for joining us today. My name is Andrew Watt. I'm the regional practice leader for the alternative assets, financial services, infrastructure practice here at S&P Global Ratings. And I'm very, very, very pleased to have Marc Lipschultz, Co-Chief Executive Officer of Blue Owl Capital, as our guest for today's series. Just a couple of pointers. Although we're in a virtual environment, we do want to hear from you. We encourage you to ask questions at any time during our webinar through the chat function, and we encourage you to type them into the Q&A box. We're looking forward to a fascinating discussion with Marc. And as a reminder, today's webinar will not be recorded. Before I introduce Marc, it's here in the Northeast, we're having a pretty hot weather period. We actually started the series calling the summer pool side series. So I think we should have stuck with that 3 years ago. And in the past, we've had wonderful guests, including Ken Kencel, the CEO of Churchill, Professor Ken Rogoff, Aswath Damodaran, and we expect to have future guest speakers of that caliber here, and we're absolutely pleased to introduce Marc. Let me give you a little background on Marc before we get started. Marc Lipschultz is the Co-Chief Executive Officer of Blue Owl Capital, Inc. He's a member of the firm's Board of Directors. Marc also served as Co-Chief Investment Officer for each of the Blue Owl Capital Credit Advisers. Previously, Marc cofounded Owl Rock Capital Partners and the predecessor firm Blue Owl's Credit Platform. Prior to cofounding Owl Rock, Marc spent more than 2 decades at KKR, serving on the firm's Management Committee and as a Global Head of Energy and Infrastructure. Marc has a wide range of experience in alternative assets, including leadership and -- leadership roles in private credit, private equity and infrastructure. Prior to joining KKR, he was with Goldman Sachs, where he focused on M&A and principal investment activities. Marc serves on the board of the Hess Corporation and is actively involved in a variety of nonprofit organizations, including the American Enterprise Institute for Public Policy Research, the Michael J. Fox Foundation, Mount Sinai Health System, Riverdale Country School and Stanford University's Board of Trustees and the 92nd Street Y. Marc received his MBA with high distinction. He was a Baker Scholar at the Harvard Business School and graduated with honors and distinction with a Phi Beta Kappa from Stanford. Welcome, Marc. Happy to have you.

Thank you. Good to be here. I only wish we were poolside. We'll do that next time. If I earn a return trip, we'll do it poolside next time.

We'll go back and do a kind of rebranding for the type of weather we're experiencing here in the Northeast. And maybe just to start, Marc, can you tell us a little bit how your summer is going? And any highlights to share with us?

Yes. Well, since we'll have -- summer is going well. So first of all, thank you for having me here today, and it is a privilege to be with S&P on this platform to have this conversation. So thank you for that. And in and of itself, therefore a current highlight of the summer. Summer is good. Business is very good, and we'll come back, of course, to that and [indiscernible] kind of the business answer aside. But on the personal front, off to a good start. I have all my kids back here in town, and they're all working this summer, and it's nice to have the family together.

Great. And you mentioned something about a concert.

Oh, yes. Well, so the nonbusiness highlighted [indiscernible] aside, of course, from having the family together. I did go with a group of friends out to see Dead & Co at the Sphere, and that was spectacular. I'm a longtime Dead ad. I'm sure it looks that way and love the grateful Dead -- and now Dead and Co, and the experience at the Sphere is incredible. So for anyone that has the opportunity to go for any show, personally biased toward Dead, but it's really quite incredible. So that's been a lot of fun. That was a highlight so far. And now this is the highlight.

Thank you. Thank you for being so clear on that. And I'd love to see a picture of you a different type of car, but at some point -- we'll get to that at some point...

And that will be after the poolside chat.

All right. But maybe just to start our discussion for our audience. Can you tell us a little bit about Blue Owl and its history in the private credit markets?

Sure. So Blue Owl, as a platform in total today, pro forma, we manage about $200 billion in assets. Roughly 50% of that is in private credit. It is the [ progenitor ] business here because Owl Rock, which is the predecessor, ultimately renamed Blue Owl, is our credit business, which coming up on a decade old since Doug Ostrover, and I and our third Co-Founder, Craig Packer, started that business. And so our business overall, as I said, therefore, has 3 components. It has $100 billion roughly in private credit. And then the other $100 billion is split. A little more than half of that is in our so-called GP Strategic Capital or the stakes business, more commonly known. And then we have a real estate business, a fairly particular real estate business, where we do triple net lease, that is to say we do really financings against real estate or investment grade rated or strong rated companies. So actually, we and S&P interact very actively there as well, another area where we really focus on the kind of ratings and credit quality of those counter parties. So that's the total picture. And the legacy, if I go back over that rough decade, has followed the sort of evolution of what I would argue are the private markets, and we can we can go back decades before that, too, if and when you wish, I started at KKR 1995, and private credit was not an -- didn't exist as a thing, and certainly direct lending didn't exist and definitely not in this format. The last 10 years, which we've been fortunate to be a part of and I don't say we're the ones that did it, but I think we've been a part of driving this evolution of direct lending from a lender of last resort model, if you go back more than a decade to lender first choice, and we've seen that evolution over the course of these many years now. And if you look over the last several years, private credit has played a fairly significant role in really the majority of large cap private equity transactions.

Yes, I want to get to that specific point about the relationship on the private equity and private credit side and how that's evolved and how that will evolve over time. Let me just -- I heard you speak at a conference -- a few conferences this year, the BofA conference earlier this year in January, it's when that struck me where you talked about what I consider the 3 Ps, predictability, privacy and partnership as key differentiators in the private credit market for -- particularly for certain providers. Can you elaborate a bit more on that and tell us what you think some of the key drivers of success for private credit managers will be in the future?

Absolutely. Well, so first of all, thank you for listening to those remarks at the BofA conference or elsewhere. So what I've tried to do for myself and I, in general, try to do is sort of keep things simple, try to find where the core is because there's a lot of complexity, obviously, in the back end of everything we do, and I'm sure the same you would suggest at the end of the day, there's a -- the singular output, and that's what the users care about, right, whether that's that specific rating that you provide or in our case, like, look, at the end of the day, what we produce are principal protected, lower volatility, alternative solutions that are yield-oriented and inflation protected. And at the end of the day, that risk return is the experience the investor has and that's the experience that matters. But how do we achieve that? Why does it work? And then there's -- well, I'm sure we'll get into it. There's a lot of complicated mechanic, so to speak, at work, and lots of people that go into selecting the loans that we make. But what about this, where is the alpha? Where is the return? And why is it durable? And actually, I think you put your finger on it, it comes down to the 3 Ps, the predictability, privacy and partnership are the value that Blue Owl or our peers offer to a user of private capital, a user of direct lending solutions. And that's really been at the foundation of this evolution of direct lending from lender of last resort to lender of first choice. There has to be a value proposition. And the durable value proposition is the explanation for why the risk return works and I think is very compelling, and I always find that if you can't -- if something seems too good to be true, then either you have to be able to explain it or it's just too good to be true and maybe it's not. So the explanation lies in the 3 Ps. And what I mean by that is we do charge a premium in direct lending. And this has been a proposition from day 1. We charge a higher rate. Our documents, and I would argue more importantly, our documents are much more restrictive. So what a borrower is allowed to do is much more limiting in a manner of protecting, of course, the lender. And we do that all in a way where the diligence component is much more invasive. We'll spend weeks or months crawling through a company to make a decision to commit capital. So all of those things -- those are burdens. So why does someone pay those burdens? Why is someone willing to pay us more and restrict themselves more and subject themselves to that type of deeper dive because of the predictability, privacy and partnership we offer in the capital solutions we provide.

Marc, in that forum and other forums, you talked about situations, particularly over the last, I would say, 18 months or so where that partnership aspect really played out to benefit certain perhaps companies more so than it would have been in the public markets. Can you talk a little bit about that as well?

Absolutely. The most -- and you're hitting on, again, exactly right. The one that we ultimately think is what most both differentiates private credit. And frankly, it's also where Blue Owl itself can most differentiate itself even relative to the handful of other large-cap providers that we end up competing with is in this role of partnership. And that is this ability to have a call much like you and I are having right now when times change for better or worse. We obviously prefer the calls for better, but we obsess about what the calls are as what a user of the capital for worse. When times change in unexpected ways, how do we address those problems in ways that protect the credit, that's what's critical to us. But to the borrower, allow them to carry forward, having invested large amounts of capital, how do they remain in a position to continue to achieve their long-term goals. And that partnership, that dialogue, literally like this one-on-one, is kind of worth its weight in gold when that conversation is either required or desired. So I'll start with a more affirmative case, something let's move toward the negative case because, again, we all worry about downside. That's where this focus comes to. But the affirmative case that people have experienced very frequently over the last couple of years, think about 2022, 2023, there was no liquid debt market for leveraged lending debt market to speak of, right? It was nonfunctional. And the result of that is during a time when people had strategic ambitions to acquire businesses, those who have private solutions, those who were partners of Blue Owl or other direct lending peers have ready access to capital. They had a partnership with us and could call up in the middle of what amounted to a more of a debt market and say, listen, we have an opportunity. We're #2 in our market. We have an opportunity to buy #3 in our market. This is a great opportunity for our company, therefore, for our credit and our equity. Well, can we do this? Even if it's not wired into the document, we obviously don't have the capital. We need you to -- we'll provide equity, but we need some corresponding debt. And all of a sudden, they did that in a world where very few other people had access to capital. So it was an enormous competitive advantage to have access, and we have this regularly with companies of ours, say, we'd like to actually expand our credit facilities along with more equity, do something strategic, and we did that very regular in '22, '23. So I view that as kind of, let's say, that is the affirmative case of when times change, and you want to pick up the phone and make that call, how that can create value for the lenders and the equity holders. And so that's the affirmative case. The negative case, of course, is the one that we obsess about and largely all of us would think about is, well, what about when things change for the worse? How do you address that problem? And here, one of the catalytic elements, catalytic moments for private credit turned out to be the pandemic because the pandemic is obviously a perfect study in the absolute unexpected occurring, the overused black swan. We can all agree that nobody had built a capital structure or a business plan around, okay, well, here's my global pandemic case, right? Here's my case where my revenues are 0. But we had a lot of companies, of course, in the world that went through that. And within our portfolio, we have some companies that went through that. And I think roughly about 10 companies ultimately in our portfolio that literally were in this doing fine to -- we have 0 business, right? They had consumer interactions. They have factories that were literally shut down by the government. And so in that moment, the ability to call up and say, hey, we need to talk about what's happening here and what the path forward is, again, became worth more -- probably more than is waiting goals. One thing to capture an opportunity, it's another to deal with an existential moment. And again, we could have a conversation that said, none of us know the path of this pandemic. But we do all know that company -- I'll give you an example, we had a company that does the -- the largest provider of dental implants. They do all the lab work that's outsourced for dentists. And you can imagine, of course, the number of people that were having visits to the dentist in April, May of 2020, who all got 0. So number of people getting implants was about 0. But the number of people that were still going to need those implants and still have dental issues someday was exactly the same. And so we all could agree there'd be a day, and that would be a perfectly good business again. And the question becomes, okay, how do you get from here to there? And so those are examples of businesses. We have software business for the supported fitness centers, no business in fitness centers, but of course, people are going to return to working out outside the home someday. So all of those are examples of where we can engage and work to an answer that was protective for the credit and in 9 out of 10 cases, allowed the equity to carry forward in a way that worked out well for them.

Again, thanks for that, Marc. One of the things that we observed coming out of the pandemic, and I think particularly over the last couple of years, has been this real drive to around formation of more private credit firms or more private credit vehicles or investment arms of existing companies. And I recall someone mentioning that in a conversation that when you have so many new entrants, so to speak, or you've always seen later on transactions that people said, well, this is my first deal that I've done. And the first deal in many cases for many firms is not the best deal that they've done. They go back and kind of regret that. Are you at all concerned about the -- just a high degree of interest and investment in private credit from firms that are maybe or entities that don't have the history of a Blue Owl and Owl Rock before entering the marketplace.

Yes. I am concerned about certain behavior by certain firms on certain credits. However, not a small, however, I'm not concerned about the health of the private debt market writ large. And look, I'm using the word a little bit lucid because my job is to be concerned, right. I spent all day thinking about because we're in the downside protection business, well, what could go wrong in any given company, what could go wrong in a portfolio. But trying to address your question when it's useful to the people who are kind enough to join this morning, I'm genuinely not concerned about the health of the sector and the health certainly of our portfolio. And by the way, again, I don't know if you overly parochial, it's not unique to Blue Owl. I should say the market is pyramid-shaped. So I want to do one thing to calibrate my comments today. I tried it over time. What I find over the decades, is I realized how little I know. It is the more you realize the complexity of the world, the more one hopefully appreciates how little you know. But there are certain parts I have knowledge of, and I'd like to make sure I'm clear about what I'm speaking to. Think about the market, like any market, it's pyramid-shaped in direct lending. And at the base of the pyramid is this ever-increasing number of participants who can do small cap to mid-cap loans. $25 million, $50 million, which is not small dollars in the real world, but they are small in the world of what we would consider this pyramid of lending. And then you go up that and of course, each tier, it gets fewer people that can write the bigger checks. And at the top of the pyramid, where we are strategically positioned and we're -- we consider ourselves fortunate to be there, but it was always our strategic ambition for reasons we can get into if you want to be in the very largest end of the market. Now the largest end of the market 10 years ago was doing $100 million, $150 million loan. Today, we do $1 billion or $1.5 billion loan. So everything has gotten bigger. The whole pyramid has grown out of the sand, so to speak. But the top actually looks very much the same. There's a handful of people that populate this top of the pyramid, and we are the go-to providers for the largest credit solutions for the largest backers and their largest companies. And there's a reason for that, and we like it. But my comments are going to be more particular to the behavior of that small group. By definition, when I have 30 or 40 people running around, and I don't even have visibility into what they're all doing in the smaller end of the market, I'm sure we'll have by a number more challenges, and I'm sure even a manager here or there that tips themselves a bit over. But in the large end of the market and certainly by some extension out of that, generally speaking, the credit quality has been and remains extremely high. Will there be individual credits that don't work? Of course. Nobody can generate the kinds of returns we generate with no risk. That would be a ridiculous statement for any of us to make. It's a risk-bearing asset. But we're built to sustain having, hopefully, a very small number of problems. And when we have a small number of problems, get a good recovery. And when we do that, the math works. And today, when I sit here, I feel very confident that's where we are, and I feel quite confident, actually, that's where the industry, again, at the large end, is today as well.

Maybe switching over a bit to the sponsor side. Any observations there on how that relationship is changing and continues to change as sponsors grapple with exits and secondaries as different ways to essentially achieve the returns?

So the PE market, which is, by the way, is my origin side. In '95, when I started, I did LBOs. They were called LBOs then, as you know. Many on this call will not particularly have used that term because we changed it in the late '90s to private equity to sound better. And so now it's private equity. And back then, there were 2 large LBO firms in the world, KKR [indiscernible], and I was fortunate to be a KKR. And at that time, we had 20 total professionals, front, mid and back office include, contemplate that world for a minute. And our large-cap mega fund was $3 billion. I mean today, that's like right in the big middle of middle market. So the world has changed. But I say that, again, only to inform our friends on the call here can judge the value of my comments. From a PE point of view, I've been around that market for 30 years. And so if I anchor back to '95 to today, so that 30-year arc, there have been a tremendous number of changes. But looking now there through that lens and sitting here today, there's 2 changes of very substantial. One, of course, has been the tremendous growth and institutionalization and proliferation of private equity from 2 firms of scale to thousands of private equity firm, literally thousands today, right? From a $3 billion mega fund and [indiscernible] had something similar. So think about like single-digit billions plus TPG was a start-up. Blackstone had a $1 billion fund. You can add it all up, it would be measured in a couple of hands of billions to, of course, $4 trillion or $5 trillion of assets in the hands of private equity firms. So that's been one dynamic. The other dynamic more recently, though, with that evolution, has been a rigidity in the buying and selling, right? We've certainly seen a meaningful slowdown in probably what was this hyper speed by sell motion of 2021 being the peak of it. I think when we look back, we'll all remember 2021 is fairly euphoric moment, particularly wasn't unique to private equity. But within private equity for the purpose of this conversation, the result of all that is people bought a lot, LP has made a lot of commitments. And now just to cut to the chase, people are overcommitted, and it's not so easy to sell things. So the whole market is a little bit sluggish. And I think that is informing like through that lens, when you look at private equity, I think it helps us see a bit more about some of the pressures and opportunities, right? The pressures are certainly on, hey, how do I drive exits? How do I drive liquidity? It is creating new structures like NAV loans, right? That's a bit of a new -- it's a brand-new phenomenon in the U.S. It's a new-ish phenomenon worldwide. Europe started doing it a little earlier. But NAV loans are a new phenomenon. GP-led continuation I think, is going to be a very big phenomenon for people trying to bridge this world of I have a great asset. It's not really a great time to be a seller, but I need to be a seller because I have LPs and need capital, and I've got to print IRRs if I want to raise my next fund. So I think you're going to see a very meaningful development of this GP-led secondary market, right, where a firm keeps a prized asset, a trophy asset. You're going to see this question rise, and I'll let you guide me if I want to talk about it, the so-called maturity wall is going to be a very different animal in the world of private credit with private equity firms now with their scale being stuck with assets sounds too negative. Like, it's not like they're stuck with. They're not bad assets. It's just that it's not a very good market to try to sell them. And so it's going to bring kind of a new definition to the question of what do maturities look like and mean if the private equity firm either is in no hurry or just isn't in a place to optimally sell an asset and you have lenders that have lent capital to it. So I think there's a bunch of things that are going to change on the PE landscape. It's going to be -- the returns are going to be lower, right? Like that's just a reality, as math. I mean if you look at where people's expectations got to in PE, they got very high and they were partly generated by very rapid turnover. And if you take the same math and just stretch it out by 2 years, you know what that does to IRRs. The IRRs are going to change radically. And frankly, the cost of debt has gone up. I mean we're generating unlevered double-digit returns. And that itself, number one, they have to pay those bills before they realize their equity value, but also for investors, like what realistically you're expecting to make in an equity. And if people like ourselves could generate 10%, 11%, 12% returns, you got to have something meaningful above that to make it worth taking a whole lot more risk. So the world is evolving. It's not a bear science. It's an evolution or maturation of the market.

And does that -- in your view, does that make private credit a more attractive "asset class" relative to some of the other areas where planned sponsors, wealth funds and the others may be looking to allocate funds?

It does. At the end of the day, it's -- and by the way, it's not the solution for all problems, and it's not every dollar of every portfolio, and it's about risk return. And to be clear, the way we describe what we do from an investor point of view, we're in the sort of the stay rich business as well as to the get rich business. You don't come into private credit trying to make triple your capital like that, no, we can debate the viability of making triple your capital and where you're going to make it, what risks you're going to take. But that's kind of a conversation for another day. But our place in a portfolio, private credit, yes, I think at the end of the day, most investors, if they could say, look, I am pretty comfortably -- I don't want to overstate it. These not government bonds, but I can pretty comfortably make a 10% return that is floating rate, so I'm not having to take a view on, do I win or lose in the face of rate changes, that's going to be durable through recessions, they were going to have one. I think most investors for a portion of their portfolio would say, that works pretty darn well for me. And I think that's what we're seeing happening. Again, that doesn't mean we are the answer for every problem. We're not. But yes, I think institutions and increasingly individuals are realizing there is a distinct role as long as I can tolerate some illiquidity. To be clear, on purely liquid assets, this isn't your answer. But if I tell it's an illiquidity, this is an awfully good answer, and I think we are seeing many people say, you know what, to be on the top, we on average lend about 40% of the value of an enterprise we buy. So to be in the top 40% of the capital structure and earn, again, roughly double-digit return versus go to the bottom of the capital structure and be overly simplistic, like 2.5x the risk, like I got to get to 100 from 40 I appreciate that's a crude statement to earn what? I mean, I don't know, like are you going to earn at 12. I mean I don't know what realistic expectations people have or how much they want risk to get more. So I think -- and I don't want to make it sound like a commercial because again, as I said there's lots of reasons for lots of strategies. Yes, I think we have found that people are moving part of their PE allocation toward private credit moving from liquid credit to private credit in part, just like they did with liquid equity to private equity, and it's become a very helpful part of a well-thought-out portfolio.

I mean over time, one of our colleagues here, Ruth Yang, was absolutely terrific and leads our private markets effort, has talked about the kind of the growth of the private markets in general, whether it's private equity, private credit, and the more limited role of the public markets over time. Do you have any perspective on that you can share with us?

That observation, that work has been tremendous. By the way, I fully echo the sentiment. And so risks of these are directionally repetitive. There's little doubt the evolution over these same decades has been from more public to more private. And I think there's every reason to believe that's going to continue, not added to an item and not -- again, there tends to be these hyperbolic and maybe stories are more interested when they're written to the drama of this market, taking over that market, right? So private credit taking over from the syndicated market. That's not going to happen, and it shouldn't happen, or the private market taking over from the public market. That's not going to happen, shouldn't happen. There's a role for both markets. However, there is no doubt that the progression of time has led to an increasing scale and will continue directionally, in my view, to lead to an increasing scale in the private markets over the public markets and for one simple reason because it works. I mean, at the end of the day, back to like this -- again, I always like to come back to this [indiscernible] we'll keep it simple, which is the only reason that's true is it's not mysterious. It's because we are able to generate in certain applications for a certain portion of the market, a superior risk return experience for the investor. And that itself is back to, in our case, to bring it back to our world, the 3 Ps. This public market cannot -- there's no way for the public market to offer the predictability, privacy and partnership we offer. So where that is valuable. Again, it's not valuable in every case. It's not valuable to every user. We don't want to finance every credit. So it's not a singular solution, but where it's valued and where someone is willing to pay for it and investor is the beneficiary. So there's a durable explanation for private markets because at the end of the day, just bringing it back to private equity and private credit, that ecosystem. What is it we can do? We can take long-dated capital and provide long-dated solutions. We can plan for 5 years out and make fundamental credit decision, will we get paid back? And the equity holders could say, will this company fundamentally be worth more? And for those who want to, and I think there's a lot of value in being able to do that, that means there's a role for the private marketplace, and it's going to continue to grow. It's not going to wipe out the public market, but it's going to continue to grow as an application.

I want to come back to this point, particularly around some of the areas where I think we've done some work as an organization around transparency and so on. But there's another area where we've gotten a fair amount of questions. And I encourage our -- those who are listening into our webinar, too, if you like to put your questions into the chat and we will make sure we pose those questions to Marc. But in terms of the channels that support growth of private credit generally, so you've seen the tapping of the institutional markets. Clearly, there have been some linkages with large long-duration pools of capital, for example, insurance companies. And some interesting developments on the wealth channel. That's relatively new. And I wonder if -- my own personal view is it's a little untested, but that may be proven over time. Any thoughts about how that will unfold as we go into the next 3 to 5 years?