The transcript from this week’s, MiB: Scott Sperling, Co-CEO of Thomas. H. Lee, is below.
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BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast I have an extra special guest, Scott Sperling co-CEO of T.H. Lee. He’s on the firm’s Management and Investment Committees.
T.H. Lee is one of the top private equity firms. They’ve been around since the 1970’s. They’ve done countless, countless deals, hundreds and hundreds of deals.
You might be familiar with some of their bigger deals. They did the Warner Music deal. That was a multibillion-dollar deal about 20 years ago. Dunkin’s is a group of franchisees from Dunkin’ Donuts. Perhaps the biggest deal they did or the most mindshare Cher was the Snapple deal. They bought Snapple. They took them public. They facilitated the sale to Quaker Oats.
That was really the first time I had private equity on my radar. It’s like really, someone just came along and said, “Here’s hundreds of millions of dollars for Snapple and let’s sell them for $1 billion, take them public.” Really fascinating, fascinating story.
Sperling is as knowledgeable about private equity and valuation, and how that sector and — and entire industry really is changing.
Oh, I forgot to mention, he ran alternative investments for the Harvard endowment for about a decade, really super unique perspective and just fascinating insights into the sector. If — if you were at all interested in — in private equity, in the nature of these transactions and how alternatives are changing, then you’re going to find this to be really a fascinating conversation.
So, with no further ado, my discussion with co-CEO of T.H. Lee, Scott Sperling.
VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My special guest this week is Scott Sperling. He is the co-Chief Executive Officer at Thomas H. Lee, a famed private equity firm. He’s also a member of the firm’s Management and Investing Committees from 1974 to 2006. THL raised over $22 billion in six institutional funds and completed more than 100 investments. Currently, their flagship funds has about $5 billion and the automation fund about 900 million in L.P. assets.
Scott Sperling, welcome to Bloomberg.
SCOTT SPERLING; CO-CEO; THOMAS H LEE: Well, thank you. It’s a pleasure to be here with you.
RITHOLTZ: So, let’s start a little bit with your background. You were at the Boston Consulting Group long before you were in asset management. Tell us about your years as a consultant and how did that lead into private equity.
SPERLING: Well, I joined BCG out of business school, and there was no great intent on my part. I was 23 years old and had lots of loans, and consulting was one of the higher-paying jobs you can get in those days. But it was a great experience because it really put somebody who is young and reasonably inexperienced in a place where you can apply the kind of analytics that you get used to in business school to the real-world working with C-suite executives at very large companies around the world. So, the experience there was, you know, really quite intensive, and for me it was about 3.5 years of — of just being fed with firehose of exposure to senior managers who were running some of the most interesting companies globally.
RITHOLTZ: And you eventually end up running Alternative Investments for the Harvard endowment fund. You were there for more than a decade. How did you find your way to the Harvard investment company?
SPERLING: So, it was one of those moments in life where you get a — a call out of the blue and you’re asked to consider something that you’d never considered before or even truly understood. And Walter Cabot who had started the Harvard Management Company is one of the first third-party managers of major endowment. It was wholly-owned by Harvard, but run completely separately under Walter’s leadership, had decided that rather than sticking with a typical 65-35 split of U.S. domestic equities and — and bonds, he wanted to expand into some new areas.
And he made the decision that rather than bringing somebody in with the typical investment management background, they want somebody with more of a business analytics background. And I went in, was incredibly impressed with Walter and his vision for where he wanted to take the management company and how he was looking for ways to really give the endowment an ability to participate in areas that he felt had higher risk-adjusted returns go-forward basis. And he convinced me that this would be a great thing for — for me to do.
And I started there and we opened up activities in what — in those days we thought of private equity, mostly as venture capital, but then moved into the buyout space investing largely in funds and then doing some co-investing.
There was some real estate holdings that Harvard already had, but that was an area that I was given, and then what we ended up calling commodities, which was largely oil and gas and timber in those days. And so, we started with almost nothing and grew to a little over 20 percent of the endowment by the time I left 11 years later.
RITHOLTZ: So that was more than a decade. When did you end up starting there? What was the date?
SPERLING: So, I started in ’84 and left in late ’94.
RITHOLTZ: We’re recording this not long after the — David Swenson who’s been running the Yale endowment for decades …
RITHOLTZ: … has passed away. This seems somewhat similar to the model that Yale was using under — under Swenson. How much competition was there amongst the Ivies for performance? And — and how much did each of the endowments that you were familiar with, how aware were each endowment of what the others were doing? Was it sort of collegial or was it, you know, competitive?
SPERLING: I would say it was more collegial. In — in those days as we pushed into some new areas, we would often not only cooperate, but there was some level of collaboration. So, we had pushed into again venture capital and — and early buyouts in that ‘84-’85 period.
David was starting at Yale, and he was similarly doing some of the same things. We worked together on a number of oil and gas opportunities. So, there was a level of cooperation that underlined a lot of what we did.
Now, I think Harvard accelerated to a little more quickly than some of the other Ivies did into these areas. We had the strong support of the Harvard Corporation to explore these kinds of activities. I would often do presentations to them about how it was going, and we had reasonable early success, which — which helps. And I think it is — as it became comfortable for Harvard to do it, others — others also jumped in. I think Yale about simultaneously and — and some of the other Ivy League endowments followed.
RITHOLTZ: Quite intriguing. So, the world of alternatives has certainly changed and your involvement dates back almost 40 years. What do you see as some of the biggest changes that have taken place in private equity?
SPERLING: Well, I think the — the — the nature of what we have to do to drive superior returns continues to get more labor-intensive requiring higher levels of value-add early on. I think there were lots of opportunities that did not require the level of intensity of either operational value-add or necessarily the ability to use acquisitions as platforms for consolidating industries.
The returns were often driven by the ability to enter at multiples are significantly lower than what we typically see today. The use of leverage was not all that well-known, particularly in the early part of the 80’s to mid-80’s. And so, in the — the — the — the buyout side of private equity, there was an opportunity that — that really doesn’t exist today to — to buy things so very cheaply relative to their intrinsic value. And then you were able to ride that to relatively strong returns.
I think today and, you know, really for the last decade, you know, pricing has been anywhere from fair to frothy. And in order to generate the kinds of returns that we expect and that our investors expect, you know, our organizations are dramatically larger, have much higher levels of expertise and much higher levels of specialization.
So, you know, it’s still a really good business to be in, something that I — I think has — brings together both investment skills and the ability to participate in growing really important enterprises. So, you know, as an individual, you know, it’s a — it’s — continues to be a fun and exciting place to be. But the nature of — and intensity of the work that we have to do to — because I mentioned sustain these high returns has certainly increased dramatically.
RITHOLTZ: So, I know you didn’t get to — to the Thomas H. Lee until the mid-90’s or so, but I have a vivid recollection of the Snapple deal that they did in ’92. And really that was my …
RITHOLTZ: … first recognition that, hey, private equity has some real firepower, and back then these were all called LBOs or buyouts or what have you.
RITHOLTZ: But — but that seems to be like a real turning point for P/E. What’s your recollection of the significance of that deal? Am I making too much of this or was that like a really big moment?
SPERLING: No, I think it was a really big moment. You know, I joined in ’94. The Snapple investment was made in ’92 and monetized in ’95. And the — the ability to buy a company and make your money on the growth of that enterprise as opposed to the traditional buyout up to that period of time, which was to buy large enterprises that might not be as efficient as they should be often had a aggregation of dissimilar businesses where there was value to disaggregating those businesses, you know, a — a model that applied to the great majority of — of — of buyouts that were done up through that period was something very different than the ability to identify a company that had the ability to significantly grow revenues where you can bring at least some strategic direction to the founders of that company that allowed for the growth to accelerate. And that’s one of the things that we saw on Snapple.
And that became a model for a lot of other things that happened in the industry. You know, in the mid 90’s, you know, my partner Tony DiNovi and I were involved in the — the buyout of the TRW business, the information services business that became Experian and similarly things like Fisher Scientific where we were identifying opportunities where the ability to significantly grow the enterprise was how you were making your money again not — not just on buying something that was inefficient and perhaps aggregated in ways that made less sense than disaggregating them.
RITHOLTZ: So — so to clarify, this isn’t just saying, “Hey, that’s a good company, but it’s inefficient and we can make it run better.” You’re really talking about strategically redeploying the assets of a company in order to generate a faster growth rate, a better return, et cetera.
SPERLING: I — I think that’s a fair characterization, yes.
RITHOLTZ: And before we get in some more details about private equity, I have to ask co-CEOs? How is that working out? Some firms I know find it really challenging to do that.
SPERLING: I’ve been doing it for over 20 years. It worked out extraordinarily well. I think we try to bring together talents that are complementary. And, you know, when you’re looking at the — the broad range of tasks at hand with the firm like ours, it’s always nice to have a partner to talk to.
RITHOLTZ: Divide and conquer. Makes — makes a lot of sense. So, mentioned earlier some of the valuation concerns that the market is certainly less cheap than it once was. Let’s talk about alpha in private equity in general and the idea that private equity had access to companies at lower multiples across the board lower than the public markets, lower than a lot of private market pricing. Is that just now a historical footnote and we’ll never see that again or is this one of those cyclical things that rises and falls like everything else?
SPERLING: Well, I’ve — I’ve long learned the hard way that I — I am not great at predicting the future in lots of different ways, so I can’t tell you that we’ll never see it again. What I will say is that there is an awareness on the part of sellers of the value of leverage that was something that was less well-known in the 1980’s and even in the early 1990’s. And the nature of what we do really is much more dependent upon picking industries, and sectors, and subsectors wisely and then having the ability to drive operational value improvements at these portfolio companies.
That is a skillset that requires a large number of expert individuals who have specialization both in domains, the subsectors or industries that we focus upon, and also a high degree of expertise in being able to improve the key business processes of companies in ways that allow that company to increase its competitive position such that we can drive higher rates of growth on the revenue side, make the company more efficient so that we can drive even higher rates of growth on the profit and cash flow side.
RITHOLTZ: So — so let’s stick with this topic because it’s really, you know, key issue underlying markets these days. There’s an observation — and I’m not sure if I’m paraphrasing or this is an exact quote, but quote, “It is problematic for asset valuations when company multiples are disproportionately high when compared to the company’s true growth rate,” unquote. Give us a little more flesh on that.
SPERLING: So, you know, generally we’re — we’re trying to buy companies reflective of what you might call the intrinsic or fair value of the company. And as we look back overtime the key drivers of that would be the return on invested capital characteristics of the specific company and more broadly, the industry. And secondly and perhaps, you know, over a broader range of calculated outcomes, it would be the sustainable growth rate of the company. So, we’re very focused on buying companies where the acquisition multiple is reflective of what we believe to be the sustainable growth rates of that enterprise might be.
And one of the things that we have learned over time is you can pay a reasonably high acquisition multiple if you believe that sustainable growth rate is about that same category as the acquisition multiple. So, for example, you know, you could pay 15 times for a company but you — you would like to believe that that’s growing at about a 15 percent CAGR on the EBITDA or cash flow side. What you don’t want to do is pay 15 times for something growing five or seven percent.
And so, you know, as we look at the world, there are enterprises out there that — that are in the sectors that we think have very significant growth opportunities going forward. And, you know, you’re going to pay a multiple that is reflective of that. Just try to stay away from paying multiples on the EBITDA of the company that is a much higher number than that sustainable growth rate.
RITHOLTZ: So — so capital these days is — is both plentiful and cheap. What does all this cheap availability of debt do to the playing field? How does it affect both the availability of deals, the attractiveness of deals and competition?
SPERLING: Well, the — you know, it’s a funny thing, people say what’s going to happen when interest rates go up? Is it going to make your business much tougher? And what we normally see when interest rates rise is the — obviously, the inverse on multiple side. And that’s because there’s a clear relationship between, you know, the cost of capital and the multiple you can afford to pay for a company. So, I think those things tend to self-correct if we move away from this relatively inexpensive debt — debt capital that we are currently seeing.
Clearly, the — the very low base rates that we have have allowed the markets to achieve overall multiples that are higher than on an absolute basis than we’ve seen it at many points in history. And I would expect that if the base rate increases that you’re going to see some contraction in market multiples, and that’ll flow through to — to what we see on the buyout side as well.
RITHOLTZ: Really, really quite interesting. So — so I mentioned the Snapple deal from ’92. You guys picked up for a song before bringing it public and then eventually having it taken over by Quaker Oats. I think the initial price was something like $300 million. Today we see deals in the billions of dollars all the time. How different is P/E deals in terms of size compared with a decade or two ago?
SPERLING: Well, a decade ago we were seeing some very large deals occur. You were seeing some $20 billion to $45 billion buyouts. A decade before that, you were orders of magnitude lower. So, you know, to your point, most deals were being done less than $1 billion of enterprise value. In the 1990’s, there were a handful of deals that were done that were significantly larger than that, but that was — those were more anomalous than the — than the norm.
Today, you’re seeing again a return to transactions that are in that $5 billion to $20 billion 0 enterprise value range. And there are a lot of things being talked about that are actually larger than that. So, you know, private equity will continue to look for transactions. Individual firms will look for transactions that are appropriate relative to the size of their funds.
Some of us are focused on what we would call middle market. We are focused on middle market growth companies. There are other firms that are spanning into, you know, what you would call very, very large enterprises. And again, that’s reflective of the fund sizes that some of them have raised or — or targeting.
RITHOLTZ: So, when the Warner Music deal was done, I think that was $2.6 billion. That was a pretty big deal for — for Thomas Lee back then. You were there.
RITHOLTZ: What do you recall of that — that deal, which many observers have said has — has been transformational for a lot of the music industry?
SPERLING: Well, we were looking at the opportunity to buy a iconic company that had been part — that clearly was — was a key part of the history of Time Warner, but where the parent had kind of moved beyond that particular sector. And we believe that the ability to see a transformation in the way music was distributed, presented broad set of opportunities that we could reasonably quickly take advantage of.
And so, we and our partners, particularly Edgar Bronfman who we brought in as the CEO of the business and who had a long and deep experience base in music and entertainment more broadly had a — a plan that we were able to implement very quickly that allowed us to see a significant growth in the cash flows of the company.
And, you know, it was one of the deals that was a — a precursor in many ways to the model we see today, which is be able to add significant operational value to a company in ways that — that allow it to — that allowed it to significantly increase its cash flows and sustain higher rates of growth in those cash flows than it otherwise might.
RITHOLTZ: Interesting. And — and one of the areas that DHL specializes in is financial services where you’ve had several exits in that space. Tell us a little bit about how you guys developed an expertise in that area. How do these deals take shape? Who were the buyers, et cetera?
SPERLING: We had long participated in different parts of the financial service world early on, looking at opportunities in balance sheet-driven businesses, banks, reinsurance companies, and had developed a successful track record there. And that migrated to looking at companies in more of the FinTech area and — but, you know, as I think it’s, you know, all publicly known, we were the — the key financial partner in the FIS transaction that was done with Bill Foley and Fidelity National, a couple of our partners, Tom Hagerty, Ganesh Rao, plus a number of others have been very involved in a broad range of transactions since then in that sector. And so, as you point out, it has been an area of specialization for us.
RITHOLTZ: Let’s talk a little bit about healthcare and some of your funds. I’m familiar with the flagship fund and the automation fund. Tell us a little bit about what their focuses are on and — and how they differ.
SPERLING: Our strategy has been to identify certain subsectors that we think have pretty extraordinary growth characteristics. And one of the ones that we have been involved in and have — have talked about a lot over the course of the last five or six years has been automation where we believe that there are very strong sustainable secular growth drivers that are going to be sustained for probably at least a decade.
And we are in a world where we know that there are significant labor shortages where there are strong secular trends like the move to e-commerce all well-known to everyone. And we’ve seen the ability of companies that have developed the capabilities and technologies to automate a whole series of processes, both industrial and on the distribution warehouse side that enable us to fill the gaps that can’t be filled because of the difficulty of finding employees to automate jobs that are more mundane and allow employees to be, you know, really focused on the higher value aspects of their — of — of the tasks at hand. And these companies continue to — to find new areas to expand into. So, we’re going to see much more automation in the office space, in financial services, in healthcare all again, things that will improve productivity, fill gaps in employment, and allow employees to see the benefit of that improved productivity through higher wages that can accrue to the existing employee base because of the improvements in productivity and profitability.
RITHOLTZ: So, we’ve been hearing, I don’t know, for a century, maybe longer, go back to Malthus that automation and technology is taking jobs away from people and pretty soon, half the society will be unemployed. That hasn’t really seemed to happen.
You — you mention the — the skilled service shortage and — and the difficulty in filling not just entry-level positions but, you know, high-level technical positions. Why is there such a skills gap? And what is automation going to do to — to fill that gap?
SPERLING: The — you know, the skills gap has been, as you point out, well-known for quite some time. And I think there’s a enormous and appropriate focus on making sure people get the education and the training to allow them to fully participate in the technologies of the future and the — the job sets that are opening up in those areas.
Automation again is going to be able to fill in for the jobs that, you know, people really don’t want to do and also allow for improvements in the productivity that will allow companies to sustain higher levels of compensation for their employees and still deliver the profitability that their shareholders and other stakeholders are looking for. And so, automation will play an increasingly important role in a broad range of industries as we go forward and allow for the retraining of employees into areas that again are higher value and are being sought after by employers both in this country and around …
SPERLING: … the world.
RITHOLTZ: So — so let’s talk a little bit about the health care space. Obviously, the vaccine changed the way — a lot of people think about the sector. What opportunities do you see in — in health care, including pharma and — and biotech?
SPERLING: Well, I think we — we have seen, you know, something pretty amazing over the course over the last 14 months, which was the ability from a standing start to rev into a pretty amazing product when you think about the — the — the — the number of effective vaccines that we now have.
I think the most interesting has been the development of the mRNA vaccines because that’s not just a single product, but that is a platform that has not produced therapeutics or vaccines before they can now be utilized to address a range of both vaccine opportunities, but also on the therapeutic side, yet one more tool against cancer and other rare diseases.
So I think the example of what we’ve seen over the course of the last year is not just a one-off, but is actually a microcosm of the opportunity set that exists in health care as the number of tools and technologies that we develop are allowing both a faster and more effective development of a broad range of therapeutics and diagnostics that go right to the heart of solving a — a number of difficult disease states across various cancers and cardiovascular diseases, as well as a number of other areas.
So, we’re going to see, I think, a continued explosion, if you will, of — of therapeutics and diagnostics. And there are entire industries that have been set-up to support the companies that have the innovative science that they will develop into those drugs. And the ability to provide services to the specific pharmas and biotechs who have the innovative science is — is something that, you know, we and many others have — have been focused on.
So, whether it’s the outsourcing of the clinical trials through CROs, it’s the ability to provide a broader range of products and services. It’s the ability to take some of the commercialization activity whether its Salesforce or the development of selling strategies more broadly and help these companies do all of that while allow them — allowing them to focus all their energy on the innovative science. You know, that I think is good for the world, as well as presents us a broad range of investment opportunities.
RITHOLTZ: Really interesting. You — you mentioned things that took place last year, obviously, a COVID-19 pandemic year. How did that change the way you think about investing? What was different for you whether it was working from home or just thinking about the impact of the pandemic? How did 2020 affect the way you think about healthcare investing?
SPERLING: I would say that the — the biggest impact was the recognition that, you know, there are a set of — of tools out there that allow you to operate in the virtual world incredibly effectively. And for us, those are tools that, you know, we had not used before and we’re finding that they’ll be incorporated in how we do business going forward.
In terms of the opportunity set in health care, I don’t know if there was any great realization of new opportunities coming out of the pandemic as much as there was a reinforcement that, you know, we are in a world where the, you know, as I said earlier, the ability to support companies that are able to provide a broad range of — of services to the — the pharma and biotech industry, you know, that is a — continues to be an enormous and expanding opportunity set. And the ability to support companies that are able to provide various forms of care at more effective prices so that we can reduce the total medical expense of the system is — is — is something that is worth focusing upon. So, you know, I think the — the pandemic in terms of health care investing reinforced a set of opportunities more than created any truly new opportunity sets.
RITHOLTZ: Huh, really interesting. I don’t know if you can answer this question, but — but I have to ask. Having observed this from a distance, as well as anything I’ve ever done in terms of medical services, why is the U.S. health care system so inefficient? There — there just doesn’t seem to be any universal standards for — for files or test results. You would think this would be perfect for technology to fix and yet here it is 2021 and it’s as much a mess as it’s ever been. Why can’t we fix this?
SPERLING: Yyou know, it’s a really interesting point. And I would say that, you know, first start with the question about whether the right metrics and why can’t we measure them uniformly across the system.
And one of the things that I found as I’ve been chair of the Mass General Brigham Health Care System for a number of years, and it’s a one of the country’s — in fact, the country’s leading high-end clinical and — or just research and teaching institution is the complexity of disease states, the — the nature of — of patient condition is so complicated that, at the very high end, which is where much of the cost is, it’s very hard to get apples-to-apples comparisons. And that is exacerbated by the fact that the most difficult cases will flow to the highest-end providers will flow into a Mass General hospital or Brigham Women’s Hospital or Mayo Clinic or Cleveland Clinic.
And so, you know, you might be looking at data that says people with a certain heart condition, you know, here — here are the outcomes, but it’s not as comparable as you would like to see it because the — the people with significant comorbidities and more complexity are going to flow into those highest-end providers. And even though the — the — the description may be similar, the nature of the condition and what you do to deal with that condition is very different.
So, let’s start with the fact that it’s hard to get true comparisons as you were referring to across the entirety of the health care system. But even with that, you know, there are — there are lots of ways that we can improve the efficiency and information flow to patients and reduce the total medical expense of the whole system.
And I think there’s a lot of work being done. I know at Mass General Brigham there’s enormous work being done to look for ways that we can make sure that a patient with a certain acuity or complexity to their condition is treated in the right place with the most effective, but cost effective as well care. And that requires an enormous amount of effort and changes to culture and changes to the structures that I think will be something that we see accelerating around the country in order to deal with this issue of — of high medical expense.
Now, I would also note that The United States benefits right now from having extraordinary health care. And, you know, one of the — the proof points of that would be the number of people who come from all — all over the world for care particularly at the very high end of the acuity level. People who are reasonably sick want to come and be treated here not as much people here going to other places.
RITHOLTZ: Other than so-called “medical tourism,” and that’s the strange paradoxes, the level of care here is so good and yet systemically the entire operation is — it seems to be just so chaotic. It’s really kind of fascinating that the — the more granular you get, the more specific you get, the better the treatment is, but step back and look at the entire system. It’s expensive and doesn’t always have great outcomes.
SPERLING: Well, you know, and again, I think it goes to this issue of are we measuring things correctly and do we have the tools, as I mentioned earlier, to actually measure things appropriately. And because of the — the incredible complexity and specific nature of — of patient’s conditions. It’s often hard to do that. And so, the proof points are — are more in the outcomes that we see for patients with extraordinarily difficult conditions.
The way that we provide care on, you know, the more primary and secondary side is something where it’s a lot easier to look on a comparable basis across systems to see what the most effective and yet cost-effective ways of providing, you know, primary and secondary care might be. The tertiary and quaternary side, it gets a lot harder for the reasons that I just mentioned.
RITHOLTZ: Let’s talk a little bit about how rapidly these markets came back and — and what that might mean for the alternative space. Were you surprised at how quickly the market collapsed and then snapped right back to what it was doing pre-COVID?
SPERLING: I was less surprised by the nature of the collapse given the fact that we have this unprecedented shutdown to our economy and much more surprised by the speed at which it came back. I think, you know, early on people were dismissing the possibility of a V-shaped recovery, particularly a sharp V. And those of us who were doing that were completely wrong. I think what we didn’t anticipate was the unprecedented level of both monetary and fiscal support that — that we saw occur here in the United States, as well as around the world.
RITHOLTZ: And — and did that create any unique opportunities for investing during — during COVID? Did — did anything bubble up more quickly than it might have otherwise?
SPERLING: I would say distressed opportunities were here and then gone in about a nanosecond. There were a few — few things that got done in the industry that I think, you know, was characteristic of distressed investing. But, you know, primarily, that — that disappeared as we saw that very sharp V shape recovery.
So much of what — what we were doing was again focusing on areas that we felt had that strong secular growth to it. And one of the benefits of strong secular growth is it tends to be less adversely affected by cyclical downturns, whether it’s caused by a normal economic cycle or, in this case, by the pandemic that again led to an unprecedented shutdown of the economy.
RITHOLTZ: So, some folks are describing the current era as — as late cycle or late business cycle. What sectors do you find attractive? If it’s late cycle, what — what businesses are you — kinds of businesses are you looking at?
SPERLING: You know, for us, it’s again the areas that we’ve — we’ve had very long base experience and that we think, you know, we’ll be able to — to ride through a more traditional economic cyclical downturn. And so, that would be things in the financial services, FinTech space. We talked about health care where we see again a — a broad set of opportunities that tend to be less — much less cyclically sensitive. And then the — the areas of technology and automation that will continue to be deployed almost regardless of the economic cycle.
And it’s not to say that these areas won’t see some adverse effect or economic cycle. I think they — they generally will, but it will be a much softer downturn than you’ll see in industrial — industries, process industries and, you know, other sectors that have tended to — to see a much sharper ups and downs as we go through the traditional economic cycles.
RITHOLTZ: So, you mentioned the financial sector, I have to ask you a little bit about DeFi and — and the potential challenge to centralize finance and fiat currencies. And — and let’s break that into things like financial apps and services versus, let’s call it, blockchain versus crypto. How do you look at that universe?
SPERLING: Well, so we have traditionally been focused on supporting companies that provide technologies to the more asset-based part of the financial services world. So, we were the sponsor of companies like Black Knight Financial, which is the largest provider of technology services to the mortgage world.
You mentioned FIS. We are very interested in companies that can help the various parts of the insurance value chain do their jobs better. Wealth management again is a — is a really interesting sector that we’ve participated in and where we think that there are ways of — of improving the ability to serve clients through the utilization of technology. So, in the financial services world, we’ve generally been focused on how to help the kinds of companies that directly serve consumers and businesses in their key business processes.
Blockchain is an interesting technology in that regard that I think we’re still in very early innings. I would separate blockchain from cryptocurrencies like bitcoin even though they’re often put in the same category. We have not really focused upon the — the cryptocurrency side. It’s not — it’s not an area that — that we have any traditional strength in. You know, obviously we’ve been fascinated to watch the — the explosion and evaluation of these cryptocurrencies, but don’t really have a strong view on it.
RITHOLTZ: Kind of — kind of interesting. And we’ve been — we’ve been talking about growth rate and valuations. When you look at spaces like blockchain, how do you come up with a valuation method for a particular company. Are you just guessing at future discounted cash flow? Are you trying to ball park where the market might go? When a technology is so young, it seems like it’s practically impossible to come up with a — a reasonable valuation.
SPERLING: Yeah, I — I think you’re — you’re pointing to something that — that probably is characteristic of the differences between the venture capital side …
SPERLING: … of private equity and the buyout side and — and growth equity side of private equity. So, I think on the venture side, when you’re investing in — in very young technologies, new technologies, you know, you are making a very broad-based bet without the ability to have any level of precision about what those numbers will look like in any given one, two, three, let alone five to 10-year period.
What we’re trying to do on our side is investing companies where we think we have enough data to have a reasonably high probability of achieving a — at least a three to five-year set of projections, obviously, a lot harder to go past that. And so, we spend an enormous amount of time trying to model out, particularly the first three years of growth of — of a given company looking at the broad range of market conditions that allow for that growth and where that specific company may be in the competitive set of — of companies trying to serve that market.
And so, you know, we’re — we’re making less of a — of a venture bet and more of a bet on something where there’s already at least sufficient data to be able to do the kind of detailed analytics that we like to do to have a reasonably high degree of comfort about at least what the next three years are going to look like.
RITHOLTZ: Quite interesting. And — and — and I know there’s that distinction and it’s really challenging to — to manage it. Do you look at the word “disruption” and think oh, not that cliché again, or is that a legitimate resonant description for — for some of the new technologies that are coming along?
SPERLING: Oh, I think it’s, you know, a crucial word in the investing universe because what we’re trying to do is look for companies that are on the right side of disruption and always be aware of the — the business models that could be disrupted by new technologies or new entrants to bring in a very different model to a given industry or sector. And so, we spend a lot of time trying to make sure that, you know, we are on the right side of that as I just said as opposed to being put in a position our entire business model can be undermined by new entrants who disrupt the traditional way that businesses done in that industry.
RITHOLTZ: So — so speaking about traditional ways of doing business, in my research I noted that when you guys did the Dunkin’ brands deal in 2005, they were one of the larger franchisers of Dunkin’ Donuts restaurants. You didn’t just do that by yourself. You — you had Bain Capital and the Carlyle Group as co-investors. Is that sort of transaction commented? It sounds more like a traditional V.C. investment with co-investors than private equity.
SPERLING: So, there was a period of time where the size of the transactions or the nature of the transactions in private equity in the buyout side of private equity were required more than one firm. And it was a point in time when the availability of capital was really from other GPs.
Today we’re in a world where we have just some phenomenal limited partners who are anxious to be co-investors in transactions. So, in today’s world, we rarely have another general partner in the deal, but back in the — the 2000’s and, in fact, even in the late 1990’s, it was more traditional given the size of transactions and the size of our funds to partner with another general partner or more than one general partner to acquire a company. So, you know, Bain Capital was a partner of ours in a number of different transactions, and Dunkin’ brands is one of them. And we partnered with Carlyle on a couple of things as well. And, you know, that — that has really evolved more in today’s world to a single G.P. buying a company with the support of their limited partners who co-invest in that deal.
Now, we’re also seeing some rather large transactions happen again, and then those transactions you might — you’re starting to see, you know, the so-called club deal come back because the — the ability to underwrite those transactions may require more than one general partner. So, you know, the world, you know, as — as you had mentioned earlier about cyclicality and the nature of valuations going up and down, you know, if you’re in this business long enough, you — you will often see trends that you thought might have disappeared come back. And I think we may be seeing the comeback of the so-called club deal where you club together two or more general partners to acquire a company.
RITHOLTZ: That’s really — that’s really interesting. It’s — it’s kind of fascinating. I had no idea that the structure — I knew there were calls on limited partnership who put money into a fund, but I never realized that when a big enough deal comes along they might be less limited than what we traditionally think of as limited partners. Is this the future of private equity? Is this going to be a — a big aspect?
And the reason I ask that is Vanguard and some other large public investor, non-accredited investor shops have been looking to access more private equity. This seems like a very different model.
SPERLING: Well, I think it’s something that’s been developing over, you know, the last decade. It’s something that we’ve been very focused on as the strategic partnership that you can have with your limited partners. I think a lot of firms in the industry have been thinking about it in a similar way. And it — it allows you — particularly in a world where it’s not clear what the pace of investing could be if one is trying to sustain, you know, the — the kind of high returns that our investors expect and that — that we want to be able to provide them.
It allows you to size your fund in ways that give a reasonably high level of assurance that you couldn’t maintain disciplines that you want in order to achieve those returns and allow you to scale-up on transactions that are on the larger side of what your target universe is. So, the — the strategic partnership there, I think, is important to the G.P.
And for the LPs, it’s a way of participating more broadly in private equity where you’re not necessarily paying the same kind of fees and profit participation to the G.P. that you would on the investments that you make directly into their funds.
RITHOLTZ: All right. I know I only have you for another 20 or so minutes, so before I get to my favorite question, I’m going to throw you a curve ball and …
RITHOLTZ: … that’s for — for two decades you sat on the board of the Dolans-controlled cable systems. And this year, first time in a long time, the Knicks are having a decent year. So, what’s it going to take to get the Dolans to finally sell the team. What do we have to do?
SPERLING: So I was on the board of MSG. I’m not sure it was for quite that long.
SPERLING: And the — you know, the — the — the teams certainly, as you point out, significant ups and downs and, you know, even more, I guess, significantly, you know, a long period of not getting anywhere near the success that fans had wanted. And …
SPERLING: … I’m no longer on the MSG board. But …
RITHOLTZ: Hey, anyone could have a bad decade, right?
SPERLING: … or — or two.
SPERLING: But, you know, the team, you know, I — I — I really think they’re on the right track now. You know, I think Leon Rose has done a very nice job of — of putting together a team that has a lot of upside to it with a coach that, you know, has finally returned the team to its roots of being a very tough defensive-minded squad. And so, I’m — I’m optimistic about the future. But as a longtime Knicks fan myself, you know, way before I joined the MSG board, I’m just very happy to see — see the success they’ve had this year.
RITHOLTZ: Let’s jump to our favorite questions we ask all our guests starting with what are you speaking of — of MSG in various channels? What are you streaming these days? Give us your favorite Netflix or Amazon Prime, whatever’s keeping you occupied and entertained during a lockdown.
SPERLING: Well, my wife and I have — have kind of gone through almost everything one can watch on either of those channels. I mean, I’d say our favorite were things like Queen’s Gambit, which I think lots of people have really enjoyed.
You know, there’s a wide range of — of other things that that go — that go across a number of just different genres from Bridgerton-type thing to the great on Hulu, you know. So, you know, we’re always looking. We — we probably stand 10 minutes trying to figure out what to watch almost every night so, you know, lots of different fun things.
RITHOLTZ: And tell us about some of your early mentors who helped to shape your career.
SPERLING: So, you know, I would say one really important mentor very early on was Walter Cabot who, as I mentioned earlier, is the CEO of Harvard Management Company, actually started Harvard Management Company for Harvard, and just a remarkable individual who I think had both great success in traditional money management and yet also had the foresight to push Harvard into areas that, at the time, you know, were not consistent at first thought with what they used to call the “reasonable man” rule, which was a general rule about how the nature of the risk one could take with endowment and foundation assets. And Walter was incredibly supportive of the — the efforts that he had me undertake to — to move Harvard into these alternative asset spaces well before almost any other endowment or foundation. And he, you know, was just an extraordinarily smart and supportive boss to have and really launched me into the career that — that I have now.
And, you know, there were people along the way who taught me lots of different things. I remember Floyd Kvamme at the Kleiner Perkins who we co-invested with when I was at Harvard. He was one of the general partners at Kleiner Perkins, and we served on a number of boards together of early Kleiner companies. And, you know, Floyd was a founder of National Semiconductor and a individual who had great operating and technology experience and really learned a lot about how young dynamic growth companies work from somebody like Floyd.
You know, Tom Lee, when we worked together, you know, Tom had — had this great ability to really like any deal. And what he was, you know, looking at was an ability to look for the opportunity set on things and learned — learned a lot of that from — from Tom. And, you know, as I go through the — the various relationships I’ve had over many, many years, you know, there have been extraordinary number of — of people who even though they were more on the pier side then the boss or older mentor side that I’ve been able to learn from.
And one of the great experiences that I had is working with John MacArthur who is the longtime dean of the Harvard Business School and who first got me involved in the — the — what’s now the Mass General Brigham Health System. And when he was the Chair of the Brigham and then became the founding co-chair of what was then called Partners Health Care, which is now morphed into the Mass General Brigham system.
And, you know, John was an iconic figure at Harvard Business School. He and I shared rugby in common, so I gotten to know him a little bit through that and then, you know, watched his ability to look at a situation in ways that were innovative and different than what almost anybody else was thinking and how he was able to turn a lot of that into new realities. And that’s been something that I’ve long valued both the — the personal relationship with John who passed away over the last couple of years and the — the learnings I got from his ability to take a step back, think out of the box, and then turn some out-of-the-box thinking into realities.
RITHOLTZ: So, let’s talk a little bit about books, what are some of your favorites and what are you reading right now?
SPERLING: So, you know, right — right now I have a — a few I’m reading kind of on a range of things. You know, I think the Jim Collins book “Built to Last” is pretty interesting right now. It’s kind of a — a survey, a wide range of different companies doing things differently and — and trying to understand, you know, how you make breakthroughs in — in places that have a — a long legacy of success.
I’ve had fun reading “The Dynasty,” the — the Krafts have done such a remarkable job at building a — a franchise that I think sets the standard for sports teams and other organizations like other types of organizations. You know, there are some interesting areas. I like the “A.I. Superpowers” as a — a way of really understanding China, and what they’re doing, and how they approach that incredibly important area.
I recently reread “The Best and the Brightest,” which was probably about my fifth time because I think that they’re — you know, there is continued lessons to be had about how we approach the world and the importance of — of avoiding hubris. So, you know, there’s a — there’s a range of things, I think, are really interesting.
RITHOLTZ: Huh, quite fascinating. What sort of advice would you give to a recent college grad who is interested in a career in private equity?
SPERLING: You know, it’s a great business, it’s a great business, it’s a great area, try to get involved in it if you really fundamentally love building businesses. There are probably easier jobs to have if one’s looking at it just from the financial aspects. I really do think our industry is about helping make companies better and being involved with management teams that can be true partners. So, if that’s what excites you, if you’re really interested in — in helping build enterprise, this is a great — a great industry to — to do that from.
RITHOLTZ: And our final question, what do you know about the world of private equity and investing today you wish you knew almost 40 years ago when you were first getting started?
SPERLING: So, it’s a really — and it’s a — it’s a fascinating thing because I’m not sure there’s — there — there — there is one thing. But, you know, I think understanding that there are points — there — there are various points where you think, you know, the downside is reasonably limited where it’s not things can always be dramatically worse than you might ever anticipate. But conversely, there — there are opportunity sets out there that one needs to — to imagine clearly with some analytical basis, but one needs to imagine as upsides that, you know, are not part of conventional thought.
And so, understanding that the range of outcomes can be much more extreme than you think is something that — that you’ve learned over time. And being unbound by often conventional thought is one of the more critical skills to acquire – short in our industry.
RITHOLTZ: Huh, really quite, quite fascinating. We have been speaking with Scott Sperling. He is the co-Chief Executive Officer of Thomas H. Lee.
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