Apollo Executive Declares Private Equity Valuations for Software Holdings Are Incorrect Amid Market Sell-off

Apollo Global Management’s co-president, John Zito, has issued a stark assessment of how private equity firms are currently valuing their software investments, stating that these valuations are fundamentally flawed. Speaking to clients of investment bank UBS last month, Zito, who also heads Apollo’s credit division, declared, "I literally think all the marks are wrong. I think private equity marks are wrong." These remarks were first reported by The Wall Street Journal and subsequently confirmed by CNBC.

The pronouncements from Zito come at a time of significant turmoil in the technology sector, particularly for public software companies. Investors have been aggressively selling off shares of these companies, driven by anxieties that the latest advancements in artificial intelligence, spearheaded by companies like Anthropic and OpenAI, could render existing software businesses obsolete. This fear has seeped into the private credit markets, raising concerns that lenders are holding onto outdated valuations for their software loans. Consequently, investors are increasingly seeking to withdraw funds from private credit vehicles, leading to a wave of redemptions.

Data from the Financial Times indicates that retail investors have pulled approximately $10 billion from private credit funds in the first quarter of the year. In response to this market exodus, prominent figures within the industry, including those at Blackstone, have attempted to reassure investors by emphasizing the continued strong performance of the underlying companies. However, sophisticated financial institutions such as JPMorgan Chase are beginning to take a more cautious stance. JPMorgan has started to rein in its lending to private credit players and is actively marking down the valuations of its software loans, signaling a tangible shift in market sentiment.

While industry observers like Jeffrey Gundlach and Mohamed El-Erian have previously highlighted the risks inherent in the private credit market, Zito’s candid acknowledgment of weakness from within the industry itself is noteworthy. An Apollo spokesperson declined to comment on Zito’s specific remarks. These comments emerge against a challenging backdrop for alternative asset managers, whose stock prices have experienced significant declines this year. Zito and other Apollo executives have, however, endeavored to differentiate Apollo’s operations from those of other market participants.

According to Apollo’s disclosures to analysts last month, the firm primarily extends loans to larger, more stable companies with investment-grade ratings. Software-related assets constitute less than 2% of Apollo’s total assets under management, and the firm has explicitly stated that it has no exposure to private equity stakes in software companies.

A Potentially "Bad Ending" for Exposed Software Companies

Zito’s commentary at the UBS event extended beyond just the valuation of software holdings in private equity portfolios. He pointed out the interconnectedness of private equity investments and private credit, noting that many companies acquired by private equity firms also utilize private credit loans. If these loans face difficulties, it directly impacts the health of the equity stakes.

He specifically identified software companies that were taken private between 2018 and 2022 as being particularly vulnerable. This period was characterized by high valuations and low interest rates, leading Zito to warn that many of these acquired entities were "lower quality" compared to their larger, publicly traded counterparts.

Furthermore, Zito suggested that private credit lenders and the investors who back these loans could face substantial losses in the coming years. His assessment is based on projected recovery rates for loans made to generic small-to-medium-sized software firms. In his view, if these companies are caught "in the wrong place" in the context of the evolving AI landscape, lenders might only be able to recoup "somewhere between 20 and 40 cents" on the dollar.

While Zito believes that lenders who have heavily concentrated their portfolios in the software sector are likely to encounter significant challenges, he maintains that the broader private credit asset class will ultimately weather the current storm. He cautioned that investors who engage in "stupid things," make "concentrated things," or operate outside the intended scope of their investment vehicles, are likely to experience a "bad ending."

The current market conditions have led to a surge in redemptions from private credit funds, with retail investors withdrawing billions of dollars. This has prompted major financial institutions to re-evaluate their exposure to the sector. JPMorgan Chase, for instance, has begun to reduce its lending to private credit firms and is marking down the value of its software loans. This move signifies a growing concern among sophisticated investors about the potential for overvaluation in certain segments of the private credit market, particularly within the technology sector.

Industry leaders are working to stabilize market sentiment, emphasizing the underlying strength of many companies within private credit portfolios. However, the candid remarks from a senior executive at a prominent firm like Apollo Global Management underscore the palpable unease and the potential for significant revaluations as the market grapples with the impact of technological disruption and shifting economic conditions. The period between 2018 and 2022, marked by easy money policies and a surge in private equity deals, is now being scrutinized as a potential source of future distress for certain investments.