Apollo exec John Zito questions private equity software valuations

Apollo’s John Zito had a blunt assessment of how private equity firms are valuing their software holdings as shares of comparable public tech companies have plunged: They’re not, he said.

Zito, co-president of the firm’s giant asset management division and its head of credit, spoke to clients of investment bank UBS last month in remarks first published by the Wall Street Journal. CNBC confirmed Zito’s comments.

“I literally think all the marks are wrong,” Zito told the clients. “I think private equity marks are wrong.”

For weeks, investors have punished the shares of public software companies on fears that the latest tools from Anthropic and OpenAI will make these companies obsolete. That has fed concerns that private credit lenders are sitting on stale valuations of their software loans, igniting a wave of redemptions as investors ask to withdraw funds from private credit vehicles.

Retail investors have pulled about $10 billion from private credit funds in the first quarter, according to analysis by the Financial Times. Amid the stampede, an array of industry leaders have sought to calm markets by explaining that the underlying companies are still performing well.

But sophisticated players including JPMorgan Chase are starting to act, reining in lending to private credit players by marking down the value of software loans.

While Wall Street figures including Jeffrey Gundlach and Mohamed El-Erian have flagged risks in private credit, Zito is among the first from within the industry to candidly acknowledge weakness in the market.

An Apollo spokesman declined to comment on Zito’s remarks. They come amid a tough backdrop for alternative asset managers, who’ve seen their shares battered this year. Zito and other Apollo executives have sought to draw a distinction between Apollo and other players in private credit.

Most of Apollo’s loans are to larger, more stable companies rated investment grade, and software makes up less than 2% of the firm’s total assets under management, Apollo told analysts last month. The firm has zero exposure to private equity stakes in software firms, it said.

While Zito’s comments at the UBS event were about valuations in private equity, many of the companies bought by the industry also took out private credit loans. If the loans are in trouble, that means the equity is also in worse shape, he pointed out.

Zito singled out software companies taken private between 2018 and 2022 — a period of high valuations and low interest rates — as particularly exposed, warning that many were “lower quality” than larger public competitors.

Zito also said that private credit lenders, and by extension the investors backing the loans, could see deep losses in the coming years. That’s based on what he said could be the eventual recovery rates on loans to a generic small-to-medium sized software firm.

Lenders could recoup “somewhere between 20 and 40 cents” in those companies if they are “in the wrong place” in terms of the new AI-led regime, he said.

While lenders who focused heavily on the software sector are heading for trouble, in Zito’s view, the broad asset class will endure the current upheaval.

“If you do stupid things and you do concentrated things, and you do things that you’re not supposed to do in your vehicle,” Zito said, “you probably will have a bad ending.”