Apollo's Kleinman on KDP Investment, PE Market and AI

Key Concepts

• Dr. Pepper/Keurig Deal: A transaction involving Dr. Pepper and Keurig, with KKR's involvement, aimed at reducing the company's leverage.
• Private Capital: Investment capital sourced from private equity firms, venture capital firms, and other non-public entities.
• Secondaries: The market for the trading of existing limited partner (LP) interests in private equity funds.
• Balance Sheet Capital: Capital held on a company's balance sheet, often from its own operations or investments.
• Hybrid Capital: Financial instruments that combine features of both debt and equity.
• "Pig through the Python" Analogy: A metaphor used to describe the slow and difficult process of the private equity industry adjusting to a higher interest rate environment after a prolonged period of low rates.
• Higher for Longer Rate Environment: A sustained period where interest rates remain at elevated levels.
• Valuation Environment: The prevailing market conditions and expectations that influence the valuation of assets and companies.
• Exits: The process by which private equity firms realize their investments, typically through sales or IPOs.
• Value-Oriented Investing: An investment strategy focused on acquiring assets at prices below their intrinsic value.
• Froth: Excessive enthusiasm and inflated valuations in a particular market segment.
• Pickaxes to Gold Miners Analogy: A strategy of providing services or financing to industries rather than directly participating in the potentially riskier core business.
• API (Application Programming Interface): A set of definitions and protocols for building and integrating application software.
• Volumetric Growth: An increase in the quantity or volume of goods or services produced or consumed.
• Value Story: The underlying profitability and sustainable earnings potential of a business.
• Labor Shortage: A situation where there are more job openings than available workers.
• Productivity Gains: Improvements in efficiency and output per unit of input.
• Circularity (in Tech Deals): A complex and potentially self-referential accounting or revenue recognition practice in some tech companies.

Dr. Pepper/Keurig Deal and KKR's Involvement

The discussion begins with the Dr. Pepper/Keurig deal, initially announced in August, with KKR's involvement becoming public recently. The genesis of KKR's participation stemmed from the need for the company to creatively reduce its leverage. KKR proposed "creative and thoughtful ways to make investments in the business" that are uniquely solvable by private capital.

Private Capital and Financing Strategies

Contrary to initial speculation in financial media about the role of secondaries in this deal, the financing primarily comes from KKR's own balance sheet capital and hybrid capital. This capital is seeking "interesting ways to make investments" in a "safer, more downside protected way." This highlights a shift in investment strategies within the industry, moving away from pure equity plays towards more structured and risk-mitigated approaches.

The "Pig through the Python" and the Rate Environment

A significant portion of the conversation revolves around the "pig through the python" analogy, originally used to describe the private equity industry's adjustment to a higher interest rate environment. The speaker acknowledges the aptness of the statement, suggesting the industry is still in the midst of this slow, arduous process.

• Past Environment (Low Rates): For a decade, low interest rates allowed private equity to acquire good companies at "pretty full prices."
• Current Environment (Higher Rates): The fundamental change in interest rates has made those previously acquired companies, while still good, overvalued at their purchase prices. Companies now need to "grow into those valuations longer than I think was underwritten."
• "Higher for Longer" Outlook: The belief is that the rate environment will remain "higher for longer," which will "keep the prevailing valuation environment, you know, intact." This suggests a slower pace of asset sales by private equity sponsors over the next few years.

Exits and Valuation Realities

The conversation touches upon the current exit environment. While some may perceive it as tough, the speaker clarifies that it's not necessarily difficult to exit, but rather difficult to exit at prices that justify the original purchase prices, especially for assets acquired during the 2021-2022 frenzy.

• Key Argument: "If you've paid reasonable prices for assets, you absolutely can get out now."
• Evidence: The speaker points to recent exits like Aspen Insurance and other deals, suggesting that windows for exits are reopening.
• Fundraising Impact: The speaker suggests that successful exits could lead to better fundraising for 2026.
• Apollo's Strategy: Apollo's ability to exit is attributed to their "value-oriented investing environment" where they acquired companies at "lower prices," making them less dependent on "expected high valuations" for profitable exits.

Market Enthusiasm and Potential Froth

There's a recognition of building enthusiasm in the market, particularly for tech-oriented businesses. However, the speaker expresses caution about potential "froth" and "over momentum" in certain tech segments, noting that the current rate environment still limits how far the buyout side can go.

Apollo's Approach to Tech Deals: Financing vs. Equity

Apollo has been deliberate in its approach to tech deals, focusing on the financing side rather than taking equity stakes.

• Analogy: "We'd rather be selling pickaxes to the gold miners than doing the gold mining ourselves."
• Rationale: Apollo has "enormous pools of capital" seeking "safer, downside protected" investments. At current valuations, the equity story can be difficult to justify, whereas financing or structured investments offer a more comfortable risk-return balance.

API Growth and the Value vs. Volume Disconnect

The speaker expresses a strong belief in the future growth of APIs, seeing them "seeping into more and more parts of the economy." However, a crucial distinction is made between volumetric growth (increase in usage) and the value story (profitability).

• The Disconnect: Just because API usage is increasing doesn't guarantee current profit levels, which were influenced by early-stage supply shortages. These will eventually correct.
• Historical Parallel: This pattern is compared to the PC and Internet revolutions, where initial supply constraints eventually eased.
• Investment Approach: Apollo takes a "more thoughtful, downside protected approach" due to this uncertainty in the timing of value realization.

Labor Market Dynamics and Productivity

The labor market is described as a complex and critical question.

• Dual Nature: In some sectors, there's still a labor shortage and not full employment. In others, particularly where automation or efficiency gains are possible, "the lowest hanging fruits" of productivity gains are being realized.
• Evidence: The speaker points to recent announcements from large companies and anticipates this becoming a more common discussion on quarterly earnings calls as investments in productivity start to yield results.
• Apollo's Focus: Within Apollo, a significant focus is on driving productivity, improving credit spreads, and enhancing decision-making, including risk assessment. This involves "all of the above" strategies.

Circularity in Tech Deals and Concerns

The concept of "circularity" in some tech deals, where revenue is generated through complex or non-traditional means, is raised. While the speaker doesn't opine directly as it's "not my area," they acknowledge that "a lot of folks are creating a lot of value on paper, you know, right now."

• Potential Outcome: Such practices often lead to "one side outcomes," where some benefit greatly, but others may be left "holding the bag" when the market corrects.
• Current Opportunity: Despite the risks, the speaker reiterates that "there's a lot of money to be made along the way" in the current environment, particularly with the value versus volume disconnect.

Conclusion

The discussion highlights a private equity industry navigating a challenging but evolving landscape. The shift to a "higher for longer" rate environment necessitates a more cautious and value-oriented approach to investing and exiting. While enthusiasm is building, particularly in tech, a degree of skepticism regarding inflated valuations and the sustainability of certain revenue models is evident. Apollo's strategy of focusing on financing and driving productivity within portfolio companies reflects a pragmatic approach to generating returns in this new paradigm. The labor market presents a mixed picture of shortages and emerging productivity gains, while the long-term value realization of API growth remains a key area of focus, albeit with a cautious outlook on the timing of profitability.