Dave Waters from Alluvial Capital on $PX (podcast #125)

Dave Waters from Alluvial Capital returns to the podcast to discuss his thesis on PX. You can find Dave’s first appearance (back in the absolute depths of the pandemic when my hair had truly gone out of control!) here.

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Transcript begins below

Andrew Walker: All right. Hello and welcome to the Yet Another Value Podcast. I'm your host Andrew Walker. If you like this podcast, it would mean a lot if you could rate, subscribe, review it wherever you are. With me today, I'm happy to have on for the second time one of the original guests on this podcast my friend, Dave Waters. Dave is the founder and CIO of Alluvial Capital Dave, how's it going?

Dave Waters: Great, man. How are you? Great to be back.

Andrew: I'm doing good, man. Let me start this podcast the way I do every podcast. First, with a disclaimer to remind everyone, nothing on this podcast is investing advice. Knowing you normally I'd say that, and then I'd have to give the added disclaimer, Dave traffics in some really quirky off-the-radar securities. We're actually going to be talking about one of your larger ones today, but everybody should just remember, not investing advice, please do your own work, consult a financial advisor.

Second, a pitch for you, my guest. I mean, you were one of my original 10 guests. You were top of my list when I launched this podcast, I love chatting with you. I love following you and am just super excited to have you on for a second episode. So all that out the way, let's go to the idea we're going to talk about. The company is P10 Holdings. The ticker is PX. I believe this is your largest holding based on your letters, which I read pretty aggressively. So people know the conviction that you've gotten the work you've got on this. I wanted to talk about it because I got so many inbounds people saying oh, what do you think about the PX? And I was like, well, I know the guy who kind of is on it. So I'll pause all that. What is PX and why is it so interesting?

Dave: Great, big story here, lots of developments happening. I've owned it for years and it's so different than what I got going but the story gets better and better. So P10 is an owner of management fee streams from alternative asset investment vehicles. So all the way from traditional private equity funds to funds the private credit through venture and through impact/ESG investing and now getting into venture debt in their latest purchase. They are pure management fee receivers. They have no exposure to carry and I like the vertical there.

I mean, I think alternative investments will continue to grow and their share of the dollars of the investable universe and there'll be some ups and downs along the way but the P10 will grow based on that. I mean, the returns on capital are insane. They also have a huge NOL that they've successfully begun using unlike a lot of LOL shell companies. So yeah, lots to say about the management team, lots to say about the strategy but that's the very basic because we're talking alternative assets management fee streams.

Andrew: Perfect. That's great. I think one thing if people haven't done any work on the alternative asset fee streams, I think one of the big pieces of your thesis people should understand is the alternative asset fee streams, this is the old private equity, they charge 2 and 20. The 20 part is an incentive fee, which we make a big profit, and we keep 20% of the profits. The 2 is a management fee stream and that management fee stream because it's so stable, it comes in hell or high water, people give it a much bigger multiple, because it's so steady, it's locked in all that.

The big thing with PX and you can correct me if I'm wrong. You mentioned in the opening, they only buy that management fee stream. So what you're seeing is they buy the management fee stream and you're saying, hey, I get this, I get great visibility. People can and will slap a big multiple on this and that's one of the really attractive things about PS.

Dave: Absolutely. I mean, I can hardly think of any other companies out there that know almost of the dollar, what their revenue will be three, four or five years out based on their current asset base. And I should say in this case that yeah, 2 and 20 might be the standard but in the case of P10, they're mostly running funds of funds. And their average fee rate is right around 100 basis points and that's been pretty consistent over time. So essentially, they're pooling capital and other investors, getting a big pot of capital, and then dispersing that amongst various, all managers that they think are attractive and can get them into the best funds that way with their larger pool of capital. And for their time, for their service, they get about 100 basis points a year.

Andrew: That's great. So let's start there because their funds are almost exclusively funds of funds. I think one or two of them got a GP fund, which is really interesting. But most of their funds, the vast majority of their AUM are funds of funds. I do think that's interesting because funds of funds have been around for a long time. I think a lot of people look at a fund to funds and say, hey, a fund of funds I invested in Dave, Dave takes one in 10 off the top and then he goes finds 10 private equity managed to invest in, probably going to take 2 and 20. And a lot of the pushback I've heard on this idea and a lot of pushback I personally have is its fund to fund and like at some point, it's a fee stream on a fee stream. You have the risk that as your GPS gets bigger, maybe they go directly to the LPS. As the LPS get bigger, maybe they go directly to GPS. So I just want to ask you about that fund of funds structure like what gives you confidence in the fund of funds that they're investing because again, it seems like fees on top of fees to me?

Dave: Yeah, it is, in a way. But as in any fee, the question is, am I getting more value than what I'm paying? And I think for a lot of cases, what you have is, the typical example I gave is, let's say you're a small college or university. You have maybe an endowment of, I don't know, 80 or 100 million. So small, and you want to put, say, 6 or 7 million into private equity. Well, you might have an investment committee of two or three people, and then maybe a board of directors if they have to sign off. But do these people really have the ability to fly around the country and due diligence on 50 different private equity funds, and then decide on five to invest in?

And the answer is, they absolutely don't have that time or that expertise. But what you can do is you can go to somebody like RCP Advisors, which is P10's sort of traditional private equity manager. You can just say, okay, they're raising whatever fund and you put in 6 million, and they'll get equal checks from another 100 people in your circumstance. They'll do the diligence, because they have that massive history and experience and Investment staff, and they'll put you in the best funds they can find. You get diversification and you get well, frankly, liability reduction, because of your tiny little investment staff of a small university. If you pick a good fund, everyone says congratulations, you did your job, you pick a bad guy, and you're out the door because the buck stops with you. So really, it's sort of like an outsourced Investment staff in some cases, and that's where the value of B comes in.

Andrew: Yep, I don't think I've ever had someone pitch KKR on this podcast. But there has been a longtime pitch for KKR, Blackstone, all these really big guys like, hey, if you're at a college endowment, and you go to take a risk on a startup on and they do great, awesome, you get a pat on the door. They go up 100, you get a pat on the back. If they do awful, you get fired. Whereas if you as a Blackstone, they do great, pat on the back, they get fired. They say, well, everybody else investing in Blackstone can't hold that against you.

Fund of funds, let me just ask one more question on that. So what about disintermediation risks? The example you gave was a small college endowment that goes to RCP to get advice on private equity. And I could see just your intermediation coming in two forms. One, you always hear about the KKR, the Blackstone, they're trying to suck up every dollar they possibly can, right? Like they've talked about, hey, how can we get into individual investors' IRAs? They're trying to get $500 tickets from individual investors, if they're trying to do that, I'm sure they're trying to think of ways to make it a lot easier for every small college or the country to write them a $6 million check

Then the other way I could see it would be like someone like JPMorgan or the giant banks. They do have advisors, and it does seem like they could almost undercut RCP on fees just in the way that they've got these great relationships with the GPs, and they can make money on all sides of the transaction, right? Like if they took their fund-to-fund fees to zero, but they got the college endowments banking business, and they got the GP. If they got all the advisory fees for all the transactions, they make so much more money on that. So what do you think about the disintermediation on both sides of that coin?

Dave: Yeah, I think that RCP in particular has tried to address that risk a little bit. But number one, by focusing on focusing on a niche that sort of add a little bit out of reach of KKR, and Blackstone, they're focused on the lower middle market private equity. So their funds are smaller there, but looking at opportunities that just might be a little bit too small for your 10-5 billion private equity fund that's out there. So there's sort of like I am kind of competing in a niche that is just inaccessible to the really large pools of capital, but at the same time, it means that the competition is stiff in this industry. I mean, there's a lot of people out there competing for the dollars because it's so attractive economics are amazing for the sponsors in the GPs a lot of cases.

That also comes down to the fact that RCP has delivered really excellent returns over time. I mean, I think that there's a lot higher risk of being distributed intermediated if you're more mediocre or kind of lower quartile provider, but RCPS returns have been fantastic and you can look they publish them right there their investor deck it's not private it's not secret stuff. But they have a 20-year track record of really delivering for their LPs and that creates a lot of loyalty and momentum in these LPs are just likely to re up the next time they come around for a new fund and that kind of so the risk is definitely there. It could definitely happen but I know they're thinking about it just as hard as JPMorgan in the bigger ones and they have the niche focus and the track record to defend their franchise.

Andrew: Yeah, one of the classic things maybe not so much in 2022 when all tech groceries have been killed, but in 2020 want to do the 20 was like, hey, when the large comes to the big or when the largest for the small, the small generally wins because it's all they think about, they're much more nimble, they're going to make a much better product. And I think something similar could be applied to RCP versus JPMorgan, where it's like, hey, RCP, all we're doing is focusing on the small guys who can't reach it, who can't write a big enough check to get into the giant PE like we're going to hold their hands. These are very much relationship businesses that can't be underestimated, hold their hands, and all that sort of stuff.

I was so excited to talk to you, I jumped straight into funds of funds. I didn't even start with my traditional open questions. So we're going to talk about a lot of stuff. We already talked about a lot of stuff, but just want to back up a bit and just high level say, look, the market is a super competitive place. PX is on the smaller side, but certainly not unknown. It's a finch-wit darling. So I just want to ask, what is the market missing that you are seeing that makes this a compelling investment that's going to generate, hopefully, risk-adjusted alpha if all goes right?

Dave: Yeah, well, first, I have to say that even though P10 is like a one-and-a-half-billion market cap... So, a solid small cap. In other words, it doesn't trade that way because the share structure is nothing like that. There's only about 20 million trades that were listed they sold and a combination of capital raise and some insider selling and their IPO in 2021. And that amount, probably less than half is free floating. So even though this thing has a one-and-a-half billion dollar market cap, it's less than 100 million in the free float. So honestly, it trades like a micro-cap. I mean, it's well off the radar of the really large pools of capital out there. It's not included in any kind of passive index. So it doesn't see the flows that go into and out of the market. It doesn't go that way.

So it's still, I think, just kind of little known under research. I mean, as far as most people are concerned, P10 sprung into existence in late 2021 in the IPO. So not even a full year of reporting. The story is just not really out there yet. I mean, even though they traded over the counter for years before that, and I very enthusiastically own them. There's just not much of a track record here. They only resumed SEC reporting a couple of quarters ago. So it just takes time to get the story out.

I also think a lot of people look at it and think, okay, as a small kind of subscale provider, like why wouldn't I just buy one of the blue chips that are out there that had this immense brand recognition, and just hire the best people all the time? And like you kind of mentioned, like the IDM solutions for institutional investors. And I get that, and that comes down to sort of like, what's management? Like, are they capable? Are they incentivized? And I happen to think the world of the two guys who established the company, Clark Webb and Robert Alpert. These guys put four and a half million dollars into a bankrupt shell about four years ago. Now they've turned it into hundreds and hundreds of millions in equity value for themselves. It's one of the best deals of this century, I think, and few people know about that. So I think the world of these guys, I think they're super bright, super motivated and they want to keep on building this.

I mean, 59% of P10 shares are owned by insiders and that's meant to be a long-term thing. I mean, you don't see people trickling shares out in the market, they believe in this, and a lot of them are locked up for the longer term. So I love it when I see a case where a business is owned by people who have done well, and they're pretty comfortable. But if they can get the shares to double, triple or more, they're talking about incredible wealth, and they have every incentive to do that.

Andrew: That's great. So there are two threads that I want to pull on what you just said. The first was, you said, no one knew about this into the 2021 IPO. And I just want to note days first podcast appearance, in late 2015 was PIOE at the time. It was the focus there. I just want to say we were focused on it.

Dave: That was true.

Andrew: But the other thing you said, people asked about why not invest in one of the larger ALTs? I mentioned KKR, Apollo Blackstone, all these guys are public. That actually really segues nicely into my next question, which was all of investing is opportunity costs. Obviously, like, we can say, why buy PX versus any number of other stocks, right? But I think the opportunity costs directly here, when you think about it, hey, let's compare PX to the best peer, and that's probably the other listed gun. So maybe we can start by just talking a little bit about PX's valuation, and then we can dive into talking about comparing them to some of the bigger other guys.

Dave: Yeah, totally. So right now on my numbers, I think that with the latest acquisition of western technology investors, I think P10. can do about 90 cents in run-rate free cash flow per year. A couple of things that go into that is P10 is s not a cash taxpayer. They have a massive NOL shield and they also have some intangible assets. They amortize and you get the deduction there as well. So there won't be a cash taxpayer for quite a long time, probably later this decade. if not sooner, if not later than that, I mean. There's a tax shield so the earnings are not directly comparable.

Andrew: If they're a taxpayer before later than this decade, I think you would be pretty happy because I don't know it might be acquisition shut off but it also means that earnings just skyrocketed so much. So if they start paying taxes two years from now, it's like, oh, they're making so much money. It's a good problem to have.

Dave: Correct, or some crazy legislation came out that wiped away, nothing's impossible. But yeah, I'll be thrilled if they burned through that NOL faster than I think they can. So generally, the run now they're running it around, just around 18 and a half billion in s&p paying assets under management. On that, they get about a 1% fee rate, so call it 180 million in revenue. After that, the margins are incredible. They're guiding from between 55 and 60% EBITDA margins. So I mean, you're converting well over half of each revenue dollar into pre-tax, pre-interest cash flow. They have a little bit of debt that they've taken on to just go from acquisitions and for liquidity purposes, but it's low cost, it's well structured, it's long term.

So essentially, after you get to the EBITA, and after you deduct the interest cost, that's free cash flow. There's zero CAPEX. They have no physical assets whatsoever, which is a pro and con in some ways. It's entire people based, so they have to take care of the people but the cash flow profile is so immensely cash generative. I think it deserves a really high multiple but here we are trading at around 13 times what I think is the current run rate cash flow and with the AUM growth they've gotten to over the next couple of years, I think we're below 10 times free cash flow looking just a couple years out.

Andrew: People can see me nodding along because I'm really interested in the idea, so I built a model. And it doesn't have to be a complex model, because everything they've said, they give you on the calls they talked about all the time on the Q2 calls. But you can basically just plug in, hey, here's what their assets are at, 1% of revenue, 55% EBITDA margin is the low end. I think they're a little bit above that already but it can fluctuate. You do that, and that's your current earnings. and then you've just got to figure out what the essence of management is. So you had everything in my model right off the bat.

So trading at... let's call it low to mid-teens run rate, free cash flow right now, obviously growing... I'm going to talk acquisition of seconds but right now they're actually growing really nicely organically too. Some of that's a good performance. Some of that's a little bit of committed capital coming in, all that type of stuff. But let's compare that to the best ALTs. I only build a model out for KKR for this podcast, but I think what happens for KKR applies to most of the other ones.

So KKR is trading for about $50 per share a little above that right now. Of that, about half of it is book value per share. And KKR is unique among the ALTs in that they keep a lot of their book invested in their funds, right? So that 25 $26 per share. That's hey, KKR flagship private equity fund, we've got $2 billion in there, all that type stuff, right? So if you just value that book, which some people do it above, some people do it below, I think the book is fine. They trade for $25 per share. That would put them at about 15 to 16 times the run rate, kind of management fees, which is directly comparable there. And that's not even giving them credit for they get the incentive fees because they own the full GP, unlike PX, which owns only the management fee.

So I look at it and say okay, I get a little bit of a discount with PX, but that's assuming zero value to the KKR incentive fees. And I think we talked fund of funds versus GPs already. But I would probably lean a little bit more towards earning owning like a direct GP versus this. Now the counter, which I'm sure you will say his PX is growing really quickly. They got acquisitions, and we're going to talk acquisitions in a second. But just when I lay out that opportunity costs like, why is PX the way to go versus KKR or something else when they're kind of at the similar thing, even if you just zeroed in the centerpiece, which is a bold zero out?

Dave: Yeah, well, first of all, I gotta say don't take it hard but I do think it's cheap. I wouldn't call anyone dumb or anything for buying KKR because I think it's an incredible business. And it does trade at a pretty reasonable price if you ask me. A couple of things I liked about P10 though is like you said, I like the pure management fee focus. It's very easy to analyze. It's really like, like a growing annuity.

So I think you should get that premium. I mean, other private equity sponsors, the earnings are going to bounce around a lot more just because in the long run, they'll do very, very well with their incentive in their carry, but in a particular year, it can be up 50%, down 50% flat, we just never really know. So it's just that predictability is a nice feature and you touched on it as well. It's just a growth opportunity. I mean, your KKR, your Blackstone, your Brookfield, whatever, they're giants. I mean, P10 is kind of where they were 20 years ago or maybe more. And so I mean, yeah, obviously they're going to continue to grow. But at some point, there is a limit where they just will have difficulty maintaining a high single-digit, low teens rate of AUM because just isn't that much anyone out there to talk in.

So at some point, I'm not saying it's this year or even soon, but at some point, growth will slow down because they can really like take assets from each other and a handful of other competitors at that point, I think P10 has a lot more blue sky in that nature in that respect, and they can do things that move the needle a lot more easily than KKR. I mean, with this latest acquisition of western technology, they're increasing their AUM by about 10%. It's going to be about 12% accreted for free cash flow. Think of the size of the acquisition that is necessary for Blackstone or KKR at 10% AUM. Then in most cases, they're a lot more focused on driving AUM growth internally, which makes a lot of sense. For now, I mean, P10 is doing a great job increasing AUM internally, but they're also very, very much engaged in acquisitions. But it's more than a pure financial engineering sort of thing and we can get more to that, how we can think about acquisitions later, but it's such a much larger opportunity for them versus their mega-cap years.

Andrew: Let's talk acquisition now because that's actually the piece I was most interested in. That's such a great segue aside from the fund of funds part, that's the piece I was most interested in. So we've talked about PX as an investing in fund of funds, what they do all that sort of stuff. But a big piece is they're doing acquisitions, right? And what they're really doing is they're going and especially buying into new verticals, just two weeks ago, you mentioned that it was WTI. Right. So they bought a venture debt fund, basically, a technology debt fund. So they're getting into that, and I'll talk cross in a second. But you know, one of these tough things I have with acquisition stories, which PX is they're going to go out and they're going to buy fund to funds. And you would think a fund to fund should be a reasonably sophisticated buyer and seller, right, their whole thing to college endowments is, hey, we're sophisticated in evaluating these private equity firms, I would hope they're sophisticated in evaluating what their own business worth, right?

So PX can go buy from these sophisticated sellers and they're going to somehow create value from these acquisitions. Generally, when I think of acquisition stories, you create values in two ways. You can do it through synergies or you can only do it through synergies. Here, PX does have the tack shell, which gives them some benefit but I don't see huge synergies to PX just going in buying WTI as management. So I do worry, like, hey, they're buying from sophisticated sellers without synergies, how are they really going to create value going forward from doing this?

Dave: Right, and you're exactly correct. It's not the case where they can go, and they can run this more efficiently than the previous owners. And they'll wring out savings from that it's not that at all, a couple of things is the one they want. They want to round out their product offering. Because the more different types of alternative strategies they have in their stable, the more value they provide to their LPs to maybe come to P10. And looking for private equity. And people say, well, why don't you complement that with some private debt or things like that?

Andrew: Can I just pause there? So this was going to be one of my next questions, but so when the LPs come in, they're looking for things that PX can go and this is cross-selling, right? But I was curious because RCP has the relationship, right? They bought RCP and RCP has got all the college endowment relationships, just px owning RCP and then going and buying WTI like, can they really cross-sell like that? Right? Because the college domine went to RCP for the private equity firm. It seems like a tough thing for RCP to say, Hey, sister company over here, we'll help you with venture debt. Does that make sense?

Dave: They really can and they really had success doing that. And one reason that it's economically attractive for the RCP principles is the RCP principles are big PX stockholders. And that's one reason they kind of insist on the companies they buy taking a lot of stock because they want them aligned for the longer term. I mean, they don't want the silo effect where oh, if I send them over there, that's less revenue for RCE. But it all comes back in a way if they're all big owners of the mothership in a sort of way. So yeah, running out of the product set is a big thing.

Additionally, like I said, they want to be involved in some of the fast-growing sorts of more innovative niches within ALTs. That for example was the motivation behind buying Bon Accord which they lifted out of Aberdeen, which is kind of a circular thing that buys minority stakes in GPS in private equity sponsors. So they kind of have that part of the value chain which can grow as well. And also Hark sits under the debt silo but they provide financing based on asset value to private equity funds, not assets specific financing, but to the entire fund which can accelerate returns to LPs, which can they can provide to portfolio companies that they want to, but it's an innovative thing. They're first funded really well and they're going to raise another one here.

But yeah, I mean, you're exactly right. It's not that they buy this and they just make sense on a spreadsheet and have to make strategic sense in the context of the greater PX P10 structure. And they've emphasized a lot of times and calls and in shareholder meetings that I've gone to that, they don't view themselves as, as a dealer, and alternative assets, managers. They're not going to buy something and gas it all up, make it look great, and sell it five years down the line if they consider it a permanent relationship, which is a reason for insisting on a high percentage of stock. I mean, in some cases, they can make a greater return on equity on their investment by using all cash or using more debt. But that's the reason for insisting on a large amount of stock in a transaction is to align the incentives there.

Andrew: Well, that hit my next question, because I was going to ask about using stock because the other thing with acquisition stories is itself when you say, hey, we're going to create a lot of value through acquisitions. But if you're issuing a lot of stock for it, it kind of does come back to that. One more question. So you kind of this was more when we were comparing them to kind of KKR but you talked about the blue sky opportunity and how much there is. And I do wonder how many verticals are there for them to buy funds to fund advisors, or do you think they eventually go exit the fund-to-fund? Because if they've already got a probably a lower mid-market, private equity, they've got a few different debts, they've got the tech VC, like there are that many categories for the fund to fund. It's not like you're going to have a fund to fund that's specifically focused on New York real estate and private market lenders. So are there a lot more fun to funds that they can do or do you think the blue sky is just eventually they exit fund of funds, and they're doing P directly or they're buying LP management featuring directly or something like that?

Dave: Yeah, well, they basically move past the focus on the fund to fund. So RCP is still, of course, the largest manager that they own. I kind of consider it that was their blue chip acquisition. Very, very strong brand, long operating history, large asset base, and having that in their stable, that brand name, that cash flow, enable them to go out and buy a couple more, more entrepreneurial, more innovative offerings. So the most recent acquisitions have been in direct funds outside the fund of strategy. I do like that for the longer term And I think they'll continue to focus their efforts there.

Andrew: Let me just go a little bit more on the acquisition strategy. I don't fully believe it but some people say, hey, the best businesses that you want to buy, a lot of times they're not publicly traded. So especially people business, and I think the example of this would be consulting, right? Like the big three consultants, Bain, BCG, and McKinsey. All of those are private. If you saw their financials, I think a lot of people even if they scoff at consultants, I think a lot of people would be really interested in buying their consulting businesses if they could, but they're not public so they can't. There are public consultancies, but those tend to be a much lower market, much less brand, not as good businesses, basically. The same could probably apply to accounting firms and a lot of other businesses.

So I do think you will say, okay, yes, there are management fee streams for sale, but they're not management fee streams from the best businesses. You can't go get KKR as a management fee stream, you can buy KKR stock, but you can't get direct access to the management fees. That's because the best people at this, they're betting on themselves, they think there's a lot of growth to come. They're just not going to sell basically. So some people say PX is buying average company management fee streams, and eventually, that's going to come back to haunt them in some way. I think you've already addressed seller bias, but I do think there are other ways to come back. So how would you respond to someone who said, hey, they just can't get access, that you're kind of buying from the second-tier management fee streams here?

Dave: Excuse me. Yeah, absolutely. So at first, I would say there is probably something to that. I mean, yes, they're probably not going out and buying the very pinnacle have the most incredible management teams and sponsors in each field. Because like you said, either they're not for sale, or if they are they're so incredibly pricey that it just won't make any sense. What I do think they are doing is identifying good streams in good managers with the potential to be great that just need a long-term home and could use a bit more exposure. It could use a greater amount of marketing expertise and, and more resources dedicated to bringing assets to them.

A good example is Trubridge, their venture provider which is successful in its own right but had never done any fundraising in Europe before they bought them. It just didn't have the personnel, didn't have the connections. And that was one of the first things that P10 did when it bought Trubridge is start talking to their LPs in Europe and introducing the strategy. It was a great way and was very successful, they almost immediately raised several hundred million in additional capital from institutional investors in the Netherlands, and other places for that.

So a lot of these businesses are successful businesses doing a lot of great things, but they don't have the overarching infrastructure to do everything they want to do. In some cases, they've been more focused on building relationships with their existing LPs and building their investment expertise, but being a part of a structure like P10 can sort of taking them to the next level. So like I guess, like Good to Great is the goal here, take a good fee stream... I've never read the book. I don't know anything about it. I just know it's a phrase. But that's the goal here is to take a good asset and improve it with the relationships they have. That's the plan.

Andrew: What I liked about that answer is it also went back to the synergies discussion we had earlier because honestly, one of the big things, when I was researching this, was I was really skeptical about the synergies. And I know they talked multiple times about actually exactly what you were saying on their calls, where they said, hey, we're really good at getting people to access to Europe, maybe we're not so good at North America. But that's great when we bind North American businesses and get them to Europe. And you just gave a very tangible example that proves out, hey, this is actually synergies in action. This is actually cross sales and action. They recently announced this might have been it was either right before or right after the WTI deal. I think right before, I can't remember specifically, but they announced what they call the holy grail of all alternative capital is getting permanent capital. Everybody wants to do it. All the private equity guys have been going out and buying insurance companies because an insurance company gives you captive permanent capital.

Dave: It's gone terribly, but right.

Andrew: Yes. In general, it has gone terribly. Some of them have actually done really well because the argument would be if you go by an insurance company and the insurance company is investing in generic AAA fixed income that's making 3% If you're really good at fixed income, and you can take that and do like private market lending at 7%. And you can charge fees on it because you can fee stream out from the insurance captive upstream with the 1%, you can create so, so much value from that. Now the devil is in the details in that execution. Permanent capital, you say hasn't gone well for some people. PS just did their first permanent capital deal, right? And this is with CRSS which is a correctly traded OTC company people should go look at it if they want. OTC, even people should keep that in mind carries a lot of extra risks. But it was a really interesting deal obviously talked about a lot. I'm not 100% sure what they're doing, or what their fee stream from it is so I wanted to interview you, what's going on with the PX CRSS deal, and do you think this is like the first in the stream? Is this going to create a lot of long-term value for them?

Dave: Yeah, so this deal is incredibly intriguing, and it made almost no market impact for either company when they announced it. So just to back up a quick second. So the principal is the guy who found that P10. Again, Clark Webb and Robert Alford, this is not their only horse in the race. They also control a couple of other public vehicles but P10 has done the best and it's for this longest development. But another one is at CRSS. Crossroads is a Texas-based sort of alternative lender with a focus on community development, their CDFI, maybe not legally but at least in their approach. Historically they've focused on--

Andrew: Can you just describe that just so people know what that is?

Dave: Yeah, so actually, their goal is to lend and provide capital, they're historically disadvantaged, and that sort of under-invested in people and in regions and municipalities, things of that nature. So to this point, they focused on providing sort of non-standard mortgage loans, especially to the state to Hispanic buyers. They buy and develop homes, they sell them to buyers and then they finance through non-standard mortgages, which have a really high pay rate their delinquencies are very, very low so it's working. They also became a big PPP lender during those programs but that's behind us now.

Andrew: I remember some people realize that and that they were going to make a lot of money. I think you might have been one and I think the stock did not respond until they made a massive dividend but probably neither here nor there.

Dave: Yeah, I wasn't logged a little bit there. So that actually ended up using up the entire NLL that Crossroads had. So Crossroads is kind of looking for a second to act and what they've decided to do essentially, is to just sort of scale up and become like a socially conscious impact lender, lending for renewables infrastructure. And like I said, continuing the mortgage business and working with minority and women-owned businesses on lending and stuff like that. And with the goal of essentially, like I said, scaling up and becoming a sort of a socially conscious VDC or something that's listed on an exchange. But to do that, they needed some scale because they were small. So along comes one of the P10s. Managers along with another company conversing capital. And it's really interesting how they agreed to do this.

So first of all, one of Enhanced's capitals, that's one of the P10's lines of business. One of their funds invested in a private placement from Crossroads where Crossroads issued a bunch of equity in the fund purchased it, as well as conversely, which is their third party together. They sort of capitalized on Crossroads with the idea that they would do some more of this down the road and Crossroads also got a line of credit essentially doubled or tripled its capital base doing so. And following that, now that Crossroads has all of its capital, they'll go out and start making loans.

However, Enhanced will manage the loans, originate them, manage them and receive a fee stream for their trouble. And it's a permanent thing. It's not like it's a fund where they have to distribute capital and then you're up again and get a bunch of new LPS because Crossroads is a regular old C-Corp. It's a permanent entity that they never have to distribute any capita. They'll pay the dividend at some point but for now, it's just scaling up. So essentially Enhanced now gets management fees and origination fees on those loans from now to eternity. And that's the first permanent capital they've produced.

Andrew: I think PX participated in this directly as well alongside Enhanced. Am I remembering that correctly?

Dave: I don't believe they did. No, I think it was just Enhanced.

Andrew: So Enhanced made an investment into Crossroads.

Dave: Cross-fund managed by Enhanced.

Andrew: So Enhanced fund makes investment to Crossroads. Crossroads is going to go out and originate loans.

Dave: Well, Enhanced does that for Crossroads. Crossroads is very passive in all of this.

Andrew: So what is Crossroads doing all of this?

Dave: Owning the loans and holding them.

Andrew: So Crossroads is basically a closed-end BDC at this point, right?

Dave: Correct. Exactly.

Andrew: So Enhanced we'll go make the loans and then Crossroads basically just buys them and Enhanced gets origination fees, management fees, all that sort of stuff. It's kind of circular though because Enhanced gave all the capital across roads. I guess it's permanent capital, but same as on balance sheet capital kind of I don't know. Yeah,

Dave: I mean, again, it's not Enhanced the manager itself, it was a fund to Enhanced managers. So it's not even Enhanced capital, it's LP capital from other places.

Andrew: So supposedly permanent, I guess the LPS is permanent because Crossroads is a publicly traded company. The LPS will need an exit at some point but the exit could be as simple as just handing them Crossroads shares. Now they might not calculate that, I'm sure there's going to be other end games involved in mind.

Dave: I'm sure that at some point Crossroads will be offering NYSC or something and that could be the exit for that fund that Enhanced had purchased the shares through or something. But yeah, the idea is to scale that company out, make it larger increase, increase the liquidity and have like you said a closed NDDC essentially.

Andrew: I think I understand it a little bit more now. How much of Crossroads is in Enhanced now, did they disclose that?

Dave: They did. Off the top of my head, I don't remember but yeah, they do disclose the amount of capital invested and at what price so they became a large holder.

Andrew: Okay. Yeah. Maybe it's because I only read the P10 side of it, but it's a big deal. I mean, it was 180 million with the option to do another 310. So half a billion dollars and this is right now I think post-WTI. They mentioned a little bit more, but it's about a $20 billion AUM company, all MPX. So half a billion dollars, it's not nothing.

Dave: No, it's not and I think this is just the start. I mean, I think they'll do repeated offerings. I mean, if Crossroads can get its balance sheet to 1 billion to 5 billion someday and Enhanced is the manager originating a billion dollars of loans a year, that is substantial amounts of origination fees and ongoing management fees. So that's definitely the goal to keep that going.

Andrew: Cool. Let me ask you about one of my favorite things and that is share buybacks. So PX, I believe they started paying a very tiny dividend, but I was restricted they do have a share buyback purchase and a share buyback program outstanding. Obviously, insiders own a ton and this is a very liquid stock, but there was a line in their Q2 call that shocked me, right? This stock went from 14 to about 11 inches or quarter q2, something along there. I can't remember exactly. And somebody came on and said, hey, you guys have a share buyback program in place, the stock came down. Why weren't you buying? And they said a couple of things. They said, oh, we were blacked out for a lot of the quarter. Our stocks are really liquid so we do have to think, hey, do we want to take the liquidity out?

But there was one thing that they said, that really jumped out to me. I'm going to do a quote. We had an order, and it just wasn't filled. that strikes me because it sounds like they had a limit order to buy shares at a price that they thought was attractive, and it wasn't hit. So the first thing that jumps to me is, hey, Dave, why are we buying when the management team said, hey, we had a limit order at a price we think we would be attracted to buy and it wasn't hit? So they're saying today's price, which is higher than the price it was in Q2 when the limit, wasn't it, maybe, I mean, it could be cheap, but it's not cheap enough for them to deploy their capital into the company.

Dave: Well, I mean, they've been really clear about their capital allocation priorities. And they've said that the hurdle for them to do anything really, except go out and drive asset management as AUM growth is really, really high. I mean, with a margin profile they have, with the tax shield they have, it's more valuable, the faster you use it just through math. The number one focus for them is to go out and get more AUM because like I said, the economics are so fantastic. So they view the share buyback as not really a thing, not just a generic thing to support the stock, nothing like that. It's really there in case of a large holder wanting some liquidity or real dislocation in the share price.

I mean, at the time, like earlier this year, I mean, they went below two, and they were into the high nines, and maybe it was 950, or something where they were looking to buy some stock. They were the only ones and all the old threw down as well. So I mean, I liked that they have a price where they think, okay, it's time to flip a little bit from focusing on acquisitions because our own sock is the cheapest thing out there. But I also appreciate how they know they need scale, they know they'll never get the multiple they really deserve until they're larger, and until the shares are more liquid.

I mean, I've seen this time and time again, where you have a little company and everyone knows it's cheap, the float is low. And you have investors saying buyback stock, buyback stock, and I think that won't help at all. Exactly what this company does not need is to go from trading 50,000 shares a day to 15,000. That just exacerbates the problem. And so I do think that especially for low flow companies, there is a higher hurdle to hit before it makes a lot of sense to buy back a lot of shares. But if you look internally in the statements, they actually are buying back. They repurchased 1 million in options from insiders at a slight discount to fair market value. They've done some opportunistic buybacks, but I mean, they're not the kind of thing, they're not going to programmatically buy that 1-2% of the shares. Maybe this is just because they view it as opportunistic.

Andrew: The line you had in there where you said, the hurdle for illiquid stocks to repurchase shares is higher, I feel like every illiquid company I talked to you, their CFO should just listen to this podcast and play them back. Because buybacks and shares and all of them, and probably if they say, hey, look, if insiders own two-thirds if we go buy back shares, like, why are we even a public company because we're going to take all the liquidity out? And then I'll normally say, yeah, why are you a company?

One other interesting thing you mentioned, we've talked about acquisitions, and how they're doing with stock, and I'm doing it off the top of my head, but the WTI acquisition, if I remember correctly, is 90 million in cash about 45 or 50 million in stock. But the other thing is, they also gave 4 million stock options to all the employees inside to align them, and 4 million stock options at current prices, that's $48 billion of stock or something along those lines. Eventually, their stock options are going to pass a lot of them will get forfeited to cover taxes. But I guess I'm just saying over time, the stock will get more liquid because they're going to do stock deals. Also, they're going to give all of the employees stock options. And eventually, those do trickle into the market. So until the insider sells a big chunk, it's never going to be the most liquid stock, but it will get more and more liquidity and get bigger. I don't know if you want to add anything to that I'm rambling a little bit on it.

Dave: I mean, it's definitely the process that's happening. And as part of the IPO, they actually reclassified shares into A shares and B shares since I ended up with a bunch of B shares that were the original ones and the ones they offered shares. The Bs don't trade, they're super voting, but on any transfer or sale, they're automatically converting the A. So over time, there will be fewer B shares and more A shares and they'll become much closer to qualifying for index inclusion. They do probably want to be in the Russell 2000 at some point, but it's just going to take time. And like you said, it is a process. It could take a couple of years for those employee shares and original long-term holders like me to sell some, maybe. But it will happen at some point. This will not always be an illiquid stock. I mean, you and I, I know you got your start, I know what I'm doing today, I have a lot of stuff that will always be illiquid until it gets a buyout or something happens. But that's not the case here. This is a stock that will steadily get more liquid over time.

Andrew: Anything else we should be talking about on PX?

Dave: Yeah, I mean, I would just recommend for people to take a look at the bio of the people in charge here. I mean, they have an incredible track record. Look at a couple of other deals they've done especially look at Global Scape. Global Scape was this kind of underperforming software company that I looked at and thought like what on earth like old school like PDF conversion technology, but they had like the army and stuff as customers and that was probably like a long-term project. Good luck changing that. The CEO was kind of strange and but they came in and they worked wonders with it. I was just amazed and kind of mad that never bought it with how well they did.

So they've kind of cracked the code in terms of taking NOL shells, and it actually makes them into something. I know we both watched a lot of NOL shells over the years and the track record is really disappointing for most of them. They either failed to do an acquisition, or they do a bad acquisition. They buy way too much. It's not a great business, they use way too much debt. But these guys kind of come in and realize that we can do a transaction where we sell 49% more shares, and they have outstanding, which is not an ownership change. Then we can do it again, which is still not an ownership change. And we don't actually have to get a lot of debt capital these the first, we can just increase the number of shares outstanding as long as nobody goes over the ownership change. We can kind of have a business as big as we want it to be and still maintain the NOL. I hadn't seen that before at least in public markets and they've just had a runaway success with it. So yeah, I just kind of think the world of these guys and anything you can read about them, check it out.

Andrew: Do they own any other public shows right now?

Dave: Yes, there is another one called ELA Holdings, which I have to say is super tiny and illiquid, so due diligence all day.

Andrew: What's the ticker? I'm going to throw it on the watch list.

Dave: E-L-A-H. It's an interesting one. This is the former real industry, which was a failed attempt at running an NOL shell but they came in and recapitalize. And I have to say that this is a bit disappointing. They got a big debt commitment from Goldman Sachs, I think like 600 million or something supportive acquisition. But it's been years now and nothing's happened. And I realized market conditions, everything was so bubbly, it was kind of tough to find something but yeah, it's just kind of disappointing that they haven't found something yet. But big NOL, big resources available to them.

Andrew: Interesting. I'm going to throw it on the watch list and maybe do some work on it. NOLs are interesting but one thing I have learned from watching them is as, with everything, they can take a lot longer than they want. Because one thing within it always is they need to deal right and m&a, especially at the size that a real NOL shell needs to do to kind of have it work with their tech shell. It takes time, it takes effort, it takes all the stars aligning. So it's tough but it's been an interesting one for NOLs. Did you see a couple of weeks ago, RBCN, which was always a little NOL show out there? They got a really interesting deal done that was a very interesting one. There have been all sorts of ones.

Dave: Steel Partners, there's a lot with NOL stuff. Yes, there are some specialists working out there. They're more or less shareholder-friendly depending on the entity you look at.

Andrew: Steel Partners and shareholder-friendly, I'm not sure if I've heard those two terms thrown out together.

Dave: That was the last part of the shareholder-friendly but yeah, they are doing deals.

Andrew: Quick question. I know you've been spending a lot of time over I believe Italy and Poland recently. I don't believe you've actually been there, maybe you have been there but just to kind of look into the finance there, how's that been going?

Dave: I mean, nobody or I did not know that Russia was planning to roll across the border or tanks and missiles at Ukraine. That definitely hurt things in the short term. Also, the Polish economy is kind of struggling with, of course, energy and high inflation. But I gotta tell you that the values are absolutely unreal. I mean, I'm buying quality stuff that you know, three, four, or five times operating income when that debt and with net skewed net cash on the balance sheet. And like if you're willing to look out past the next six months pass next year, you're going to be fine. I think this is a tremendous entry point for a lot of really high-quality companies, especially ones that export to them. Whereas in the European Union or export to the US, especially, it's a tremendous time to be a European exporter if you don't depend a lot on energy.

Andrew: Yes, if you depend on energy, it's not a very good time.

Dave: No, but yeah, I am so enthusiastic about those markets.

Andrew: It's so funny. So I heard a lot of pitches for especially Polish, like Polish us a lot of really small gaming companies out there. I've got one friend who's pitched them and they're all very interesting, or [inaudible] has come on here and pitched a couple of European names. You look at him, you're like, oh, my God, like, you compare the values over to American companies kind of similar quality and size, everything. You're these are so much cheaper, but it's almost like, oh, they just keep going down and it's hard to use like a step in front of them. The one other thing is, it is tough, because like, if an American company keeps going down, at some point, generally an activist steps in and kind of forces something. And I just haven't seen a lot of activism over especially in the really small companies in Europe.

Dave: There's just not nearly as much. I mean, just culturally. Again, there are sometimes laws and things that make it more difficult to be an activist there. So yeah, you can't depend as much on an activist stepping in if the stock really struggles, so you just have to be a bit more patient. And frankly, European markets have been so awful over the past decade, and it scares a lot of people away. And I get that. I mean, there are a lot of reasons that people want to invest in the United States. We're pretty great in terms of investor friendliness.

So I mean, I totally get it but I just think that European valuations have been crushed so hard. And people take a look at an economy like this happens in Italy. People think, oh, Italy, like slow growth, like high government debt, like bureaucracy everywhere, France too. And yeah, like, I'm not excited about large-cap companies, or even mid-caps for the most part in France, Italy, and Germany. There's just low growth. It's a problem, low innovation. But under the surface, there's a ton of really tiny, hugely innovative, hungry, fast-growing really profitable companies led by smart people who want to make it big. I think it's a great time to look at those because they're getting targeted that with the general macro issues in general, like cultural malaise, investors think it applies to the entire continent.

Andrew: And you were the one who turned me on to this, like one of the issues in the US is at this point, if you're not 500 million or 1 billion dollars, it doesn't really make sense for you to be public because the public company costs just too much. And especially to go public, like I was just talking about to go public. Absolutely, forget about it. But you're the one who took me around where like in Italy, you can have a $50 million company or $20 million company IPO in like $200,000 worth of stock, because the costs are very low, which obviously comes with a lot of increased risks. But it also comes with a lot of increased potential opportunities and gives you access to really quirky, unique stuff, which for someone looking to find alpha and unique values, that's the dream.

Dave: Yeah, I mean, it's not a place to look if you really, really care about your performance versus your benchmark go for 6, 12, 18 months. But if you want to do well over three or five-year periods, I think you owe it to yourself to look in markets like that, because yeah, there's some wild stuff that is not priced correctly.

Andrew: Cool. Anything else you want to talk about?

Dave: Not too much. Just open your well. When I get to New York, we'll play a board game or something together sometimes.

Andrew: I'm organizing eventuate board game night, and I had somebody from Pittsburgh who said they're going to drive up for it. Hey, stop slacking and drive up here.

Dave: That's incredible.

Andrew: That'd be great. Well, anytime you come up here, let me know and I'm going to have to do some work on some small Italian names.

Dave: Well, just a couple of tickers.

Andrew: Dave's one of my favorite people to follow. I'll include a link to... he's got a Substack. I'll include his link to Substack and his Twitter so give him a follow there. Dave Waters, thank you so much for coming on. Looking forward to having you on for the third time.

Dave: Appreciate it.

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