In a stark and candid assessment that sent ripples through the private markets, John Zito, co-president of Apollo Global Management’s formidable asset management division and head of credit, declared that private equity firms are fundamentally misvaluing their software holdings. Speaking to clients of investment bank UBS last month, Zito’s unvarnished remarks, first reported by the Wall Street Journal and subsequently confirmed by CNBC, underscored a growing anxiety within the opaque world of private capital. "I literally think all the marks are wrong," Zito asserted, leaving little room for ambiguity. "I think private equity marks are wrong." His comments illuminate a critical fault line emerging in a sector that has long enjoyed a period of unprecedented growth and often operates with less transparency than public markets.
The Genesis of Discontent: Public Market Tremors Meet Private Illiquidity
Zito’s blunt pronouncement comes at a particularly volatile juncture for the technology sector. For weeks, public software companies have experienced significant share price depreciation, fueled by a potent cocktail of macroeconomic headwinds and existential fears surrounding the rapid advancements in artificial intelligence. Investors are grappling with the potential for generative AI tools from companies like Anthropic and OpenAI to disrupt established software models, rendering some existing solutions obsolete or significantly diminishing their value proposition. This speculative uncertainty in the public domain has inevitably spilled over into private markets, raising questions about the fairness and accuracy of valuations for privately held software firms.
The fundamental challenge for private equity and private credit firms lies in their valuation methodologies. Unlike public companies, whose market capitalization is updated instantaneously with every trade, private assets are typically valued periodically, often quarterly, using a "mark-to-model" approach. This involves a complex interplay of internal projections, comparable public company multiples, and recent transaction data. When public market comparables experience steep declines, the integrity of these private valuations comes under intense scrutiny. Zito’s statement suggests that many private market participants have been slow, or perhaps reluctant, to adjust their internal marks to reflect the new economic realities and technological shifts.
A Golden Era Fades: The Context of Peak Valuations (2018-2022)
To fully grasp the significance of Zito’s warnings, it is essential to understand the preceding "golden era" for software investments in private markets. The period between 2018 and 2022 was characterized by several converging factors that propelled software valuations to dizzying heights:
- Historically Low Interest Rates: A decade of near-zero interest rates made capital cheap and abundant, encouraging aggressive leveraged buyouts and growth equity investments.
- Tech Boom and Digital Transformation: The accelerating pace of digital transformation, further intensified by the COVID-19 pandemic, drove insatiable demand for software solutions across all industries.
- High Multiples: Public software companies traded at elevated revenue and earnings multiples, providing a robust benchmark for private market valuations. Private equity firms frequently acquired software companies at multiples exceeding 10x revenue, sometimes reaching 20x or even higher for high-growth SaaS (Software as a Service) businesses.
- Rise of Private Credit: As traditional banks retreated from certain types of leveraged lending post-financial crisis, private credit funds emerged as powerful alternative lenders, providing flexible, bespoke financing solutions, often at higher yields. This influx of capital further fueled deal activity and valuation inflation.
During this period, global private equity deal value soared. According to Preqin data, private equity-backed software deals alone reached a peak of over $150 billion in 2021, representing a substantial portion of overall private market activity. The sheer volume and size of these transactions meant that many private equity firms, and by extension, private credit lenders, amassed significant exposure to software assets acquired at these elevated valuations. Zito specifically highlighted software companies taken private during this 2018-2022 window as "particularly exposed," warning that many were "lower quality" than their larger, publicly traded counterparts. These firms, often burdened with substantial debt, now face a triple threat: higher interest rates on their floating-rate loans, a slowdown in customer spending, and the disruptive potential of AI.
The AI Tsunami: A New Layer of Complexity
The fear of AI disruption has added an unprecedented layer of complexity to software valuations. Companies like Anthropic and OpenAI, through their advanced large language models (LLMs) and generative AI capabilities, are not merely incremental improvements; they represent a paradigm shift. Investors are grappling with scenarios where entire categories of existing software applications—from customer service tools to content creation platforms and even basic coding functions—could be fundamentally altered or replaced by AI-native solutions.
This existential threat has directly impacted public market sentiment. The Nasdaq Composite, heavily weighted towards technology stocks, saw significant volatility, and while it has recovered some ground, many individual software companies, particularly those perceived as vulnerable to AI disruption, have experienced substantial declines from their 2021-2022 peaks. This divergence between public and private market valuations has created a "valuation gap," where privately held software companies are still marked at levels that public markets no longer support. The reluctance to adjust these private marks is a key concern for Zito and others, as it can mask underlying stress and impede transparent capital allocation decisions.
Private Credit’s Awakening: Redemptions and Re-evaluations
The valuation concerns in private equity have direct implications for private credit. Many of the software companies acquired by private equity firms relied heavily on private credit for their financing. If the equity value of these companies is overstated, the underlying loans, though senior in the capital structure, also face increased risk.
Indeed, the private credit market has begun to feel the tremors. Retail investors, often through semi-liquid structures like Business Development Companies (BDCs) or Non-Traded REITs that invest in private credit, have pulled approximately $10 billion from private credit funds in the first quarter alone, according to analysis by the Financial Times. This wave of redemptions signals a loss of confidence among a segment of investors, many of whom were drawn to private credit for its higher yields and perceived stability compared to public bonds.
In response to these outflows and mounting concerns, several prominent industry leaders have sought to reassure markets. Firms like Blackstone, a major player in private credit, have publicly stated that the underlying performance of their portfolio companies remains strong and that the redemptions are manageable. However, the actions of sophisticated players like JPMorgan Chase suggest a more cautious approach is warranted. JPMorgan has reportedly begun to rein in lending to certain private credit players and, critically, has marked down the value of some of its software loans, indicating a tangible recognition of the increased risk. This move by a major global bank adds significant weight to Zito’s observations and underscores the growing divergence between some internal private market valuations and external financial realities.
Zito’s Specific Warnings and Recovery Rate Projections
Zito’s comments at the UBS event extended beyond general valuation critiques to specific warnings about potential losses. He noted that while his remarks focused on private equity valuations, the fate of the equity is inextricably linked to the health of the private credit loans financing these companies. If the loans are in trouble, the equity is in an even more precarious position.
His most striking prognostication involved potential recovery rates for private credit lenders. Zito projected that lenders to a "generic small-to-medium sized software firm" that finds itself "in the wrong place" in terms of the new AI-led regime could recoup "somewhere between 20 and 40 cents" on the dollar. Such low recovery rates, typical of distressed situations, would represent significant losses for lenders and their investors, far exceeding the typical expectations for senior secured private credit. This warning is particularly salient for funds that heavily concentrated their portfolios in the software sector during the boom years. Zito cautioned that while the broad private credit asset class will likely endure the current upheaval, those who "do stupid things and you do concentrated things, and you do things that you’re not supposed to do in your vehicle," would "probably will have a bad ending."
Apollo’s Differentiated Stance and Broader Industry Scrutiny
Amidst this backdrop of heightened scrutiny, Apollo Global Management has actively sought to differentiate its private credit strategy. Apollo executives, including Zito, have emphasized that the vast majority of their loans are extended to larger, more stable companies, many of which are rated investment grade. Furthermore, Apollo disclosed to analysts that software makes up less than 2% of the firm’s total assets under management, and it has "zero exposure to private equity stakes in software firms." This strategic positioning aims to insulate Apollo from the specific risks Zito articulated and reassure its investors that its portfolio is more resilient to current market pressures.
However, Zito’s candidness stands in contrast to the generally more guarded public statements from other private market participants. While figures like Jeffrey Gundlach and Mohamed El-Erian have long flagged risks within the rapidly expanding private credit market, Zito’s voice is one of the first from a senior executive within the industry to openly acknowledge such a widespread weakness. His remarks are particularly noteworthy given the tough environment for alternative asset managers, who have seen their shares battered this year, partly due to concerns over valuation and fundraising prospects.
Implications and the Path Forward
The implications of Zito’s assessment are far-reaching, touching various stakeholders across the financial ecosystem:
- For Private Equity Firms: Those with significant exposure to 2018-2022 vintage software assets face difficult choices. They may need to accept lower valuations, potentially leading to reduced carried interest for fund managers and capital losses for their limited partners (LPs). Exits via IPOs or M&A could be challenging, forcing longer hold periods or distressed sales. Fundraising for new funds could also become more difficult if LPs perceive a lack of transparency or impaired returns.
- For Private Credit Lenders: Funds heavily concentrated in vulnerable software sectors could face loan defaults, restructurings, and the deep losses Zito projected. This might necessitate further markdowns of their loan portfolios, impacting reported net asset values and potentially triggering more redemption requests. The sector may see a flight to quality, with investors favoring larger, more diversified lenders with stronger underwriting standards.
- For Portfolio Companies: The software companies themselves, particularly those with high leverage and business models susceptible to AI disruption, face intense pressure to innovate, reduce costs, and demonstrate clear paths to profitability. Some may struggle to service their debt, leading to covenant breaches and potential insolvencies.
- For Limited Partners (LPs): Institutional investors such as pension funds, endowments, and sovereign wealth funds, which allocate significant capital to private equity and private credit, will be closely scrutinizing their fund managers’ valuations. Increased demands for transparency and more frequent, conservative markdowns are likely.
- Regulatory Scrutiny: Persistent valuation discrepancies and significant losses could attract increased attention from financial regulators, who may push for greater standardization and transparency in private market valuation practices.
The current environment represents a critical test for the private markets. While the asset class has grown exponentially over the past two decades, its resilience in the face of rapidly rising interest rates and disruptive technological shifts is now being challenged. Zito’s candid observations serve as a stark reminder that even in the less transparent world of private capital, fundamental economic realities and technological progress cannot be ignored indefinitely. The coming months will likely reveal whether his "bad ending" prediction for certain segments of the market becomes a widespread reality or if private market participants can adapt quickly enough to navigate these turbulent waters. The ongoing debate over private market valuations underscores the critical need for robust, transparent, and timely assessments to ensure capital is allocated efficiently and risks are appropriately managed.
