Mark Rubenstein - Head of Strategic Investment Partners North America at HPS

Colbert Cannon: Welcome back to season nine of the HPScast. I’m your host, Colbert Cannon. If you’re new to the pod, HPS is a global investment firm. We manage approximately a hundred billion in assets for a broad range of institutional and retail investors. That capital’s invested across private credit and public credit strategies.

Each week I sit down with key relationships to, partners of, and friends of the firm to learn from their experience, ask how that experience shapes their current roles, and give insights into HPS and how we operate. So with that, let’s bring in our guest. Our guest this week is the head of HPS’s Strategic Investment Partners North American team.

After graduating from the Ivy Business School at Western University in Canada, he started his career on Wall Street and Citigroup’s leveraged finance business before moving over to Citi’s Special Situations group several years later. In early 2008, he joined up with Scott Kapnick and the governing partners of HPS to work on our nascent junior capital business.

He’s been with HPS ever since and over that 15-year period, he’s been instrumental in the growth and success of what initially was called the Mezz Fund and is now called Strategic Investment Partners, or SIP. His side of HPS invests in junior capital solutions to mid and large cap companies globally, including investments in mezzanine, sub debt, preferred equity, and common equity co-investments.

This gentleman is a fantastic investor and leader, but he’s also someone I quite like personally. So, without any further ado, I’m very excited to welcome in this week’s HPScast guest Mark Rubenstein, Head of HPS’s SIP North American team. Mark, welcome to the pod.

Mark Rubenstein: Thanks, Colbert. Thanks for having me.

Colbert Cannon: Alright, Mark, I like to start from the start. Where are you from originally? Where’d you grow up?

Mark Rubenstein: So, I grew up in Toronto, the youngest of three brothers. My father was an entrepreneur, and talk of business and markets were a cool dinner table topic. So, in the late ‘90s, coming out of high school, I was fascinated by what was happening with the dot com boom and bust, started reading a lot of books, including Ben Graham to Liar’s Poker, which had come out at the time, and decided that investing and markets was a career that I wanted to pursue.

Colbert Cannon: So, so you go to Ivy Business School. How did you shape your college career? What did you spend time studying undergrad?

Mark Rubenstein: So, the way it works is you do two years studying any subjects of your choice. I did two years of political science. And then you do the Ivy Business School for two years, which is a case study oriented curriculum similar to HPS.

Colbert Cannon: Great. So, you graduate in the early 2000s, and your first job was at Citigroup Leverage Finance. How did that opportunity come about?

Mark Rubenstein: Sure. Well, I actually ended up applying to Citigroup on their website just through the general Human Resources email, and it actually worked. And I got an interview opportunity.

And they said, “Okay, we’re going to do it over the phone.”

And I said, “No, I really want to come down and do it in person, because it was a big shot.”

And they said, “Well, we’re not going to pay for that.”

So, I said, “No, no, no. I’ll pay for it.”

So, I flew down to New York, and the person I interviewed with was an Analyst or Associate. He maybe gave me five or 10 minutes and walked out of the room. It wasn’t a good interview. I flew back, and I heard a couple of days later that I didn’t get the job.

So, I was upset. I had spent my own money to come down and didn’t feel like I’d gotten a fair shake. And I sent an email back to the HR email telling the whole story and why I felt I deserved another chance. And they said, actually, fine, and put me on the phone with someone who had been involved in the recruiting efforts, a Managing Director in the structured products group and scheduled a 30-minute phone call.

This time it was on the phone, and he and I ended up talking for over an hour about a broad range of topics, from markets to politics. And I think three or four days later, I had three different offers from three different groups within Capital Markets: Equity, Capital Markets, Structured Products, and Leveraged Finance.

Colbert Cannon: Alright, so you had some options. Why Leveraged Finance? What was the appeal of that group?

Mark Rubenstein: I thought, at that stage, the best thing to do would be just to learn as much as I could about different companies, different industries. That was about as detailed as the thought process was at that point.

Colbert Cannon: So, it’s mid 2000s, Citigroup, Leveraged Finance. What are you doing exactly? Tell us about your first job there.

Mark Rubenstein: Sure. So those were heady days in the LBO market as you know. 2004 – 2007 was a peak period in terms of LBO activity. We didn’t know any better in our Analyst class. We, in some ways, just assumed this is normal, but we’re working on very exciting transactions. Everything from Hertz to SunGard, very well-known, classic LBOs at the time,

Citi had very good market share within leveraged finance. So, it was really a tremendous learning experience at a pretty interesting moment in time. I would say a lot of very late nights and long weekends, pretty extreme in terms of how hard the effort was and how grueling the lifestyle was but well worth it.

Colbert Cannon: So Mark, I always think first jobs are formative on some level. Tell me any lessons or experiences from there that you take from your first full-time employment.

Mark Rubenstein: I would say the biggest thing is being indifferent and without emotion when it comes to making mistakes and having your ideas rejected. So really, speaking up, being part of the conversation, and making those early mistakes  and learning from them is critical.

Colbert Cannon: So, you wrap up your two-year Analyst gig, and you move internally within Citigroup to their Special Situations group. Tell us about that group and what was attractive about it at that point.

Mark Rubenstein: Sure. So, I started looking into buy-side opportunities around one year into my leveraged finance experience, and there was an internal posting for a role within the GSSG group, which was the Global Special Situations Group, which was managing a tremendous amount of capital with a very flexible global mandate. In 2005, a year earlier, Scot French had left Goldman Sachs to join the GSSG group within Citi to run the private side strategy. So, I interviewed with that group, and that went well. And I started working in that group mid-2006.

Colbert Cannon: Got it. Okay. So you did that and then eventually moved over, really at the early days, of what was then Highbridge Principle Strategies. You mentioned Scot French, now one of our Governing Partners and Head of SIP. Tell us about the process of leaving Citi and coming over to HPS.

Mark Rubenstein: So, it was an amazing experience within that group. It was really trial by fire, looking at tons of opportunities, everything from power plants in Central America to valuing entertainment libraries in the US and worked closely with Scot for a couple of years. It was a great experience overall. I was fortunate, I think, to begin my investing career sitting in that Special Situations role, really agnostic to geography, industry, structure, and really just learning to seek out the most attractive risk-adjusted returns. So, I’d been in the group about a year, and in 2007, Scot came to me one day and said, “Hey, I’m going to start this Highbridge Principle Strategies business with Scott Kapnick and scale a junior capital business.”

And I basically said, “Okay, that’s great. When can I join?”

And we let it sit for about a couple of months and then engaged in discussions about my coming over. And I began in mid-2008 at what we now call HPS.

Colbert Cannon: Now, what did you actually join? It was brand new. Like, how many people were there? What was the business when you stepped in the door for HPS?

Mark Rubenstein: Very few. The first fund was large, although not as large as we wanted it to be. So, the first mezzanine fund had around $2.5 billion of deployable capital. The strategy, from the beginning, was to focus on large cap.

So, if you looked at the market at the time in terms of junior capital, there was Goldman Sachs. Their mezzanine fund was focused on the large cap end of the market. And then there were a lot of players – Business Development Companies and other funds – that were focused on the middle market. So, our goal was to focus on the large cap end of the market, both because we saw less competition there, as well as the fact that we had a view that larger companies just perform better. And with larger companies, you could actually get paid about the same, if not incremental returns.

Colbert Cannon: So, from the early days, you know, you have that initial mezzanine fund. Just for people who are less familiar with it, talk to us about the strategy. What kind of deals were you doing? What was the focus for the Mezzanine Fund out of the blocks?

Mark Rubenstein: The strategy has always been to provide creative capital that sits in the middle of the capital structure, so, it could be sub debt. It could be unsecured debt. It could be preferred equity convertible or preferred equity. So, it comes in a lot of different forms, but at the end of the day, it’s creative capital in the middle of the capital structure.

So, in some ways, you can think about it in terms of what it’s not, which is, it’s not direct lending. It’s generally not First Lien, top of the capital structure, and it’s not control, private equity at the bottom of the capital structure.

Colbert Cannon: And as you said, a global business of scale where you’re lending to larger businesses, which makes sense. If you’re going to be more junior in the capital structure, there’s a barrier of safety for scaled businesses, and with creativity as to whether it’s structured as a junior debt security, preferred equity, and sort of everything in between.

Talk to me then, as the business has grown and expanded over time, it’s gotten obviously to significant scale. The most recent fund was announced several months ago, backed with $17 billion in investible capital. Tell us about the current mandate and what SIP has focused on strategically these days.

Mark Rubenstein: The strategy remains dynamic. So, when we go into a fund, we have no set metrics in terms of geography, LBO versus non-LBO, exact size of company. So, it’s dynamic. Over long periods of time, when you look at averages, we tend to be about two-thirds North America, one third rest of world, mostly Western Europe. And then LBO versus non-sponsored/non-LBO tends to be around 50/50, although that can move around depending on the market environment we’re in.

And then in terms of business profile, the companies have always been large companies, and our first fund average EBITDA was $200 to $250 million. Today, that number’s more like $500 to $600 million. So, the companies have gotten larger, but overall, the strategy is relatively similar.

I think the one thing that we’ve been able to do over time is really build out and develop that industry expertise. So, if you look at our top three industries, they comprise about 50% of our portfolio. The top four are around 60%. So, you’re going to find much more industry concentration than in a direct lending strategy where you’re going to see it mirroring GDP or the broader indices a little bit more. And I think, as we’ve developed those industry relationships and expertise, the phone rings more often, and I would say today around 40 to 50% of everything that we do touches a prior investment or relationship in some way.

Colbert Cannon: You guys have built up track records in these sectors. Speaking of evolution, over time, as I said, it was originally called the “Mezz Fund.” It’s now called Strategic Investment Partners. Why the switch, Mark?

Mark Rubenstein: So “Mezz” was confusing, and I think, for certain issuers, it had some baggage associated with it. Like, “I can’t raise capital, I need to turn to Mezz.”      So, at the end of the day, we’re a strategic partner to the companies that we work with, and I think this moniker in terms of “Strategic Investment Partners” better aligns with what we do day-to-day.

Colbert Cannon: Yeah, it matches the strategy. Alright, well let’s talk bigger picture about private credit. We’ll come to the current, more volatile credit markets, but in a normal credit market, why would a company turn to investments in the form of junior capital?

Mark Rubenstein: Complexity of the situation is one. Need for scale is two. Need for speed is three. Need for certainty of execution is four. And needing a partner with that industry expertise, I would say, is five.

And the ability to deliver a certain solution in a complex situation at that scale is quite difficult. So, there’s really only a handful of people that can do it globally. And I think, on top of that, our counterparties recognize that we’re not attached to an investment bank or a private equity firm. So, from a discretion standpoint, we’re viewed as a fairly friendly counterparty in the market as well.

Colbert Cannon: So, you know, one of the things I wanted to dive in on, just for a second, you mentioned one of the factors that would lead you to a private solution is complexity, right? But sometimes I worry that somebody hears complexity and thinks risk. Those are actually two different things. What is complexity from an HPS perspective when you look at saying, “Oh, this is an HPS kind of deal because we can understand this one.” What does that mean?

Mark Rubenstein: Sure. I think it’s easy to build a portfolio by saying, here are the industries or types of companies we’ve invested in historically, but you will miss out on the diamonds in the rough. And I think we’ve always embraced complexity from the founding days of the firm. And I think, when you do that deep-dive due diligence, you can come up with some pretty special transactions. To give you some historical examples, in 2010, in the early days, we financed an SPV that funded the conversion of most of the movie theaters in the United States from analog to digital equipment. And it was an extremely complicated transaction where you effectively had an SPV that was structuring take or pay style contracts with the entertainment companies. It was a transaction that took about a year to structure. So, it was very complex, but from a risk-adjusted return standpoint, you could wrap your head around making a very significant premium to the actual risk that you were taking.

Colbert Cannon: You and SIP generally have a reputation and a track record of financing entrepreneurs. You’ve always had great relationships with business builders, and it’s led to interesting opportunities for us that are distinct from, sort of, the more LBO type stuff that is bigger in the market. How, how do you do that? What makes an entrepreneur want to partner with you and with HPS?

Mark Rubenstein: It takes a very long time. Many of these relationships have been built over 10, 20, and in some cases, even 30 years. I don’t think it’s as simple as hiring and assigning a team and saying, “Okay, you’re the non-sponsor team.” I really think it requires the attention and focus of the most senior. investment professionals in the firm. And I think you need to have it embedded in the DNA of the firm and the Investment Committee in order to be successful. And I think we have an advantage in this area just because, from day one, this has been such a big focus. In our second fund, this was our 2012 vintage, LBO activity was something like 20% of the total. So, this has really been ingrained in the culture since day one.

Colbert Cannon: Okay. Well, let’s talk macro for a second, Mark. We’re recording and talking right now in the summer of 2023. At this exact moment, markets are feeling a little better versus the spring, but recession and inflationary concerns are ever present. Base rates remain high. What do you see as the most interesting themes for a junior capital business in this kind of market?

Mark Rubenstein: Sure. So, today’s opportunity set is driven more by repairing over-leveraged balance sheets.

While operating performance amongst companies and our portfolio companies has been relatively strong, companies are suffering in terms of liquidity due to the higher interest rate environment. And some companies are suffering from tight liquidity. Others have approaching maturities. And some companies are dealing with both. So, we see a lot of variability in the market in terms of who is impacted and by how much. I think you’ll see private credit play a very prominent role.

From an SIP standpoint. coming up with a creative capital solution in the middle of the structure can be quite value-add from an issuer perspective because it allows companies to not only reduce their cash interest expense, but also generate capital that they can use to reinvest in their business, either growth capital or capital for M&A to help the equity grow out of these capital structures that are over-levered today and can’t find other ways to do so.

Colbert Cannon: I mean, it’s interesting, right? You and I have both done this for a while. It’s been 15 years since refinancing risk was really a thing. Generally, over the last couple of decades, if you performed anywhere near plan, somebody will refinance you out. With the rate move and over-leverage in the capital structure, there’s an increased need for more complicated refinancing, senior and junior, which creates an interesting investing environment for what you guys do.

So Mark, how do you feel about the opportunity set by geography? You know, SIP invests across North America, Europe, Australia and New Zealand. Are there any areas that feel better or worse for you in the current market?

Mark Rubenstein: In the current market, we’ve been finding more interesting opportunities in North America. I would say, in this fund, we’ll probably be closer to 80% versus our historical average of closer to two-thirds, but that can change relatively quickly. We’re relatively agnostic to geography. We’re really trying to find those best of breed companies and looking across geographies. You mentioned Australia and New Zealand, where we’ve been active as well. So, outside of Western Europe, I think there have been a number of interesting transactions, including a few in the Middle East that we’ve been able to make over the last few years.

In today’s environment, we’re also able to invest in businesses at attractive loan-to-values while earning higher returns than we have over the past decade. So, if you look at the market in 2021, perhaps junior capital was detaching at a 65% loan-to-value, earning low teens. And today, perhaps on average, you’re detaching closer to 50%, earning mid-teens. So, it’s a pretty significant difference in terms of the risk you’re taking and what you’re getting paid for that risk.

Colbert Cannon: So, we talked about the forward pipeline being robust. There’s an awful lot of opportunity. What are the risks, Mark? What do you worry about in the current credit environment?

Mark Rubenstein: Everything today needs to withstand the impact of higher for longer interest rates as well as an economic recession, which is looking less likely. But those are really the factors that we consider when we’re coming up with our base and downside cases.

Colbert Cannon: Makes complete sense. Mark. Well listen, very interesting stuff. Always a pleasure to catch up. Thank you so much for sharing your thoughts on the business. With that, I want move to the last segment of the podcast, something we like to call “Best Ideas”, where we offer up something that’s added value in our lives recently. “Best ideas” because it’s our goal as investors to maximize exposure to those. Mark, you’re our guest. I’m going ask you to go first. What is your “Best Idea” idea this week?

Mark Rubenstein: I was going to recommend Sam Zell’s book, “Am I Being Too Subtle?” Sam was a friend of the firm who recently passed away. We partnered with Sam on a transaction about six years ago, and I was fortunate enough to have met him a couple of times, but it’s a tremendous story about investing through market cycles. And he was just an incredible, legendary investor and great human being. My favorite line in the book was, he says something along the lines of: “We suffer from knowing the numbers.” Meaning, we’re focused, we know the numbers, and while the party is ongoing, we suffer sitting on the sidelines. So that quote resonated with me.

Colbert Cannon: “Am I Being Too Subtle” by Sam Zell. I will second that. It’s a great read. I think he says, “If everyone’s going left, look right.” He’s sort of a legendary contrarian, and there’s a lot to learn from that. One great recommendation.

Alright, so for my “Best Idea” this week, I like to be inspired, as people know, by the guests of the week. As you heard earlier, Mark is from the Great White North, and so I started thinking about all things Canadian.

My “Best Idea” this week then is a travel destination in Canada, but in fairness, not particularly close to where Mark hails from. My “Best Idea” is the Magog area, a lake and mountainous resort town a little over an hour outside of Montreal. I love to travel and see new places, and an old friend invited me up last fall to his home in Magog, and I thought it was just remarkable. It’s centered around Lake Memphremagog, and while I went in September, it’s a great, sort of, four seasons kind of place. There are tons of charming bed and breakfast hotels, restaurants, and bars, and just stunning scenery. If you like to hike, Mount Orford is amazing in the fall and offers great skiing in the winter. You can go boating on the lake, and there’s also some incredible golf up there. If you’re lucky enough to get out at a course called Memphremagog, I can honestly say it’s as beautiful a golf course and as fun a challenge as I’ve ever played.

So, in honor of one of Canada’s favorite sons, let me recommend the stunningly beautiful Magog and the Lake Memphremagog area as a great travel getaway.

Well with that, it’s time to wrap up for the week, Mark. Truly a pleasure to have you on. Appreciate you taking the time today, and thanks for all the insights.

Mark Rubenstein: Thanks, Colbert.