Spotting the Downturn Early and Coming Out Ahead w/ Gryphon's David Andrews

[MUSIC] In August, I wrote an email to our LPs that we believe were about to enter one of the harshest cycles of private equity history. >> That's David Andrews, founder and co-CEO of Griffin Investors, and an industry veteran who truly understands the cyclical nature of our industry. Since August of 22, David was arguing that this cycle was unlike any in the industry's history. It was time for a hard reset. >> We'd like to have an advisory board meeting to discuss this openly and why we should not plan on a normal fundraise next year. About half the LPs push back in writing to me, what are you talking about? >> Today on Dry Powder, I'll ask David what he saw that enabled Griffin to get ahead of the curve. He'll take us inside of the hard conversations and course corrections that are defined the past year. David is strikingly candid about what he got right and what he wishes he'd done differently. And when he thinks this unprecedented cycle may finally break. I'm Hugh McArthur, chairman of Baines Global Private Equity Practice, and this is Dry Powder. [MUSIC] >> David, it's a pleasure to have you on the show today. Thanks for stopping by. I think you'll agree with me that we've been living through some extraordinary times here really for the last five years since the pandemic started. But in particular, in the post-2021 era when we had that huge spike of buyouts of a trillion dollars of TeVee in 2021, things started to change in 2022 pretty drastically. When did you first sense that there was a shift in this cycle and that we were going to be moving into a new phase here? >> Well, these things sort of evolved, but then there's these key inflection points that you have, you say, yep, this is going to be different. And I'll go back first to 2014 where we were aware, competitive pressures, low interest rates were driving up purchase prices. And we actually determined that we are going to focus on recession resistant businesses. And top three leadership positions by those companies measured by market share and marginal pricing power and that we would underwrite against exit multiple contractions. Okay? >> Yes. >> So now you move forward. And in 2018, this industry is cyclical as you know. And it was getting pretty frothy. And in January of '19, I made a point of presenting the notion that the biggest problem out there everybody right now is not the valuation multiple you're thinking of, the price. The E and the E is pro forma EBITDA madness is what I labeled it. And that has continued on to today and that is a reason for the low DPI's. This is when your June podcast, speaking of the extraordinary nature of it, was one like, okay, here's a person come from the same place. Now we wrote a letter in August of '22 to get back to your 22 dates where markets are becoming choppy, the Ukrainian war erupts, debt deals are getting hung. And we are in the spring talking about launching our next fun, Griffin 7, the following spring. And in August, I wrote an email to our LPs that we believe we're about to enter one of the harshest cycles in private equity history. And we'd like to have an advisory board meeting to discuss this openly and why we should not plan on a normal fun race next year. About half the LPs push back and writing to me, what are you talking about? And by the time we got to the end of October, folks that had finished diligence a year earlier on a different six fund or March, it's like they'd seen a ghost. And we then rotated to making a statement in February of '23 that this was going to be extraordinary. And then I got another level I'll push back and bickering with some. And we saw it coming. It doesn't make it any easier. Right. And it had elongated our value of curfews. And while we've had a zero percent loss ratio and all investments since 2008, we're going to probably have our first year soon. Sure. I mean, it's put the industry under tremendous pressure. That sounds like everyone is driving into this perfect storm of unrealistic eventile projections which drive very high prices. And then you hit this unprecedented cycle of Fed interest rate hikes. And you say this math doesn't work. I've now got a problem. What are some of the things that you did to protect the portfolio during this period of time where you're in the middle of it? And most people are throwing every bit of cash on the balance sheet that they can. That's step one. Let's survive. But what are steps two, three and four? Well, first would be keep our team focused on the portfolio companies. And that is why, unfortunately, we had over a year of discussions, if you will, her advisory board as to what to do. Because the notion of going out and raising a full fund for middle market fund is so dilutives a time most big institutional investors can't understand it. You know, I can't understand what it's like to deliver a baby. And if they haven't raised a middle market private, I think they don't know. So first, we allow the team to focus. Second, was tripling down with each of our companies on their sectors and what the revenue and margin dynamics were going to be like. And we were extra vigilant on our debt agreements. However, I will tell you our biggest mistake, you as also our greatest strength in some ways, is that in addition to the EBDA madness dynamic that was out there for the first time, you also had covenant light, middle market, finance needs. Right. So you had no yellow lights flashing for the credit markets to pick up and to talk about problems. You have equity cures that can punt the thing down the road. And you had no requirement like early in my career to have your debt hedged. And we were on that, but then we got cut up on our own perfectionisms of how we're going to go about it or execution to that. And we only started doing it six months later and we lost a lot of value. So that's a mistake we made. But fortunately, it seems like 90% of everybody else did too. So those are the big ones. And then you get really focused on ad on acquisitions as well, where attractive targets that fit can be bought at lower prices. But the complete contraction in an extraordinary manner for three years and the type of companies the flagship buys also enabled more time with the portfolio. Now that makes a lot of sense. And would be interesting to hear your thoughts, David, on how the last three years have really affected the deal flow and exits at Griffin. Yeah, every one of our funds is top quartile, according to Cambridge and DPI all of our recent funds last four, where the tallest short person and private equity if you will with DPI. The issue though is you have unrealized returns being justified by this pro forma EBITDA madness still. It's very hard to track middle market data as you know. But we're pretty sure we get 98% of all books that come to market from 100 million to 1 billion enterprise value. And it is astounding that for each of the last three years, 56 to 58% of companies that came to market did not sell. Really? I've been doing this since 1989. I would guess an average would be 10%. Right. And it's all because of the disconnect between what P firms have at their mark and their expectations and what the marketplace will actually provide. So what that leads to though is if you have a really good company, a top three leader, like we really do want, you're not going to sell that baby at a value that you don't feel good about. And so there's just been a dearth of those types of opportunities. We've been able to do them selectively, but those are kind of one-offs here and there. So what have you done specifically that's helped you maintain your DPI leadership, such as it is obviously that DPI is stressed for the entire industry, but you seem like you're outperforming the typical middle market fund. What are the kinds of things you've been doing and what kind of exits have you been generating that have really helped you continue to do that through this period? We have in the last two and a half years tried to sell 11 companies. We've sold 10. Okay. Good batting average. We've sold them consistent with our last 21 exits at about 75% higher valuations than six quarters earlier. To get to your most recent powerful example is a company called Schirmco. We saw the opportunity in helping maintain the grid, the infrastructure of our country, and we bought it. And then we went through some of the very extraordinary dynamics of COVID there, including the War for Talent, Management Challenges, Wrong CEO, blah, blah, blah. And then we had a three-year turnaround here. And we just sold it at 4.3X and we had it marked in Q1 at 2.3X. But it was a combination to your point of finally getting the management equation correct. [BLANK_AUDIO] sector normalize more on the demand side. Yeah. And then the valuation will be in higher than the averages that exist, because it's a scarce asset. And that's kind of a winning formula for us. Yeah, and that sounds like a winning formula. And are you bullish that we're on a path toward more exits and deals in the future, say, the next six to 12 months, absent events that you and I can't predict? Yes, although it can be a lot more confident, kind of in 26 than the next few months, I think fundamentally it's interest rates stupid, right? Right. And the Fred, finally, hopefully feeling that their main mandate's being achieved on the inflation side will continue to give our industry relief. Secondly, this is big LPs. And I've heard you talk about this before enough. We need cash back. We don't care if we've been your partner for decades. We don't care what your brand name is. Right. And so the pressure to sell good assets, even if you have a mark too high, I think is coming. So we'll have quality companies coming next year, I believe. We also have very specific plans at the beginning of each year of companies that we believe we could sell and how we position up front to go evaluate that market with management and then bankers and then do it. So as the market comes back, we think we'll be having our fair share of even more assets. But right now, we've been doing it very selectively, but 10 and 2 and a half years, which some of our LPs are just absolutely abilit about. Now, that's quite a few. And the fact that you're saying that, you know, 2026, we're thinking is going to be a pretty good year for deal making, again, absent macro events that we can't predict and in better year for exits, which I think is a very positive message for the entire industry. Totally agreed. Is that what do you see? What are you thinking? I think the same. You know, I just think that something you said earlier, David, we've had three years of well below the types of liquidity that the industry is used to seeing. And that's really unprecedented. Even during the GFC, we only had two years of really low liquidity in the buyout markets. This is three. And 2025 looks like it could be close to four. We've just not seen that kind of a cash flow cycle. It's an eight to nine year cash flow cycle, not the four year cash flow cycle that most LPs build their spreadsheets and their plans off of we just can't keep doing this. There are always seems like there's something that comes up every year. You know, well, it's a pandemic. It's inflation we haven't seen. It's interest rates. It's a great policy. Yeah. It's all crazy. Supply chain problems in our ports are unimaginable. I mean, there has to be a solution. Totally totally. You know, I just tell you, I really have a lot of compassion for LPs right now. Yeah. There's always been a tough business for them trying to suss out truth from fiction and unrealize numbers, looking at rearview mirrors to predict the future. It is extremely hard right now with the low DPI. So fund raises, except for maybe, you know, some 10% of the firms out there are ones where it takes a lot of communication, a lot of work, a lot of transparency. And we've been trying to do that to a fault by me, frankly, maybe too much information at times. But we think it's going to serve us well as we launch next year, Griffin 7. It makes sense. I mean, things can always go sideways. They certainly had been. I was thinking 2025 in January was going to be a very big year for deal making, but that fizzled in about the first month when the tariff word started to come up in February. So we were right there with you. Yep. So you never really can tell, but you just keep wondering how long can this keep going on? And what will happen if we do that? We'll see how Griffin has developed the operational capabilities of a mega fund on a middle-market budget. We have an opt script that now has 40 employees in it, and we have 160 plus employees for a 10 billion, 11 billion AUM firm. I'm Hugh McArthur. Thank you for listening. [MUSIC]