Concerns about an impending software crisis in the age of generative AI have put private credit efforts in the headlines.
But while everyone is focused on the rush to redeem private credit, Blue Owl said on its first-quarter earnings call that the real concern is with its equity portfolio.
“Today, by and large, the issue at hand is not really a debt issue, it’s an equity issue,” said Mark Lipschultz, co-CEO of Blue Owl. Although Blue Owl does not have a private equity arm that invests heavily in software, it is a major lender to software companies.
Lipschultz said this is by design and means the company’s job is to focus on due diligence and underwriting. It also means that if some companies inevitably fail as AI shakes up the economy, they have a better chance of achieving better results than equity investors.
Bond investors are the first to be repaid in the event of a default, while equity investors are less likely to be repaid. Lenders may even take the keys away from troubled companies and give them another chance to squeeze profits out of them.
Blue Owl’s retail-oriented investment vehicle has been inundated with investors seeking refunds, with a record $5.4 billion in requests in the first quarter. The company has become a symbol of broader private credit concerns, with its stock price down more than 50% from a year ago as of yesterday’s close.
Blue Owl’s stock price rose nearly 10% today following the company’s earnings report, which saw inflows of $6.1 billion in the quarter, highlighting continued strength in institutional funding and a credit portfolio that is not experiencing high default rates.
“The headlines are quite different from the underlying facts,” Lipschultz said, noting that the firm’s internal metrics for its portfolio companies suggest continued success in the near term.
“You can’t just go from a healthy company and have some crazy problems,” Lipschultz said. “We have great prospects for that.”
Lipschultz predicts there will be winners and losers across the economy, especially in software, because of AI.
That said, the company is trying to scale back its bets on software.
“Given the level of uncertainty, it’s fair to say that we are now reducing our exposure to software,” Lipschultz said. “We’ll probably know a lot more in a few years.”
Rent or own?
Lipschultz mentioned the difference between financing and owning on a call with analysts.
Stockholders benefit from the company’s growth and profitability. On the debt side, companies will run into “more serious problems” such as defaults, Lipschultz said.
“Trust is not intended and is never expected to be a perfect exercise,” Lipschultz said. “There have been defaults in the past, and there will be defaults in the future.”
He said the “key” was to minimize defaults and maximize recoveries, noting that the company’s principal recoveries averaged 80 cents on the dollar, but when factoring in interest payments on the company’s loans, recoveries could total 110 or 120 cents on the dollar.
Things could get worse, he said, and software defaults could occur in the future. But with equity investors writing big checks, they will likely inject additional capital into companies rather than handing it over to lenders.
Blue Owl and similar lenders will need to work with their private equity counterparts to decide how to deal with “more contentious” companies, Lipschultz said. This will result in some losses, but these losses are not limited to private credit. Public credit, high yields and equities will also be affected, he said.
While software stocks are on a “downtrend,” loan-to-value, a measure of how much debt a company owes compared to the value of its equity, has risen to “the low 40s” in Blue Owl’s portfolio.
But that’s still a lot of “cushion,” he said, and for now the company’s job is “to be ready and ready.”