A new wave of funds thinks it can win with aggressive investments in tech businesses.
When the private equity industry was in its infancy in the 1980s, the tech sector was barely on its radar. Gradually, this changed. First hardware assets became tolerable for debt providers. Then came the realisation that software, although lacking hard assets to lend against, could offer reliable recurring revenues.
“The lenders originally were sceptical of the sector because the assets walk out the door every night and there was nothing that they felt they could lend against,” says an asset manager who invests in Thoma Bravo’s funds. “What has been proven is the stickiness of the sales in software. The renewal rates in the best businesses are well above 98 per cent.”
Tech is now attracting all types of private equity firms, with the sector representing almost 40.1 per cent of US buyouts last year, according to Dealogic data. That is the highest proportion on record and up from around 10 per cent in 2010. Established generalists such as KKR and Carlyle have been joined by tech-focused firms such as Golden Gate Capital and the newer Siris Capital.
The old guard has had a mixed record in the sector. In 2006, Freescale Semiconductor was taken private by a consortium of Blackstone, Carlyle, Permira and Texas Pacific Group for $17.6bn, just before its orders plummeted. Stephen Schwarzman, Blackstone chief executive, described it as a deal “where literally everything goes wrong”. More recently, Carlyle ended up cutting from $8bn to $7.4bn the price paid to Symantec for Veritas, a data storage provider, after banks struggled to finance the deal. Avaya, a networking company, bought for $8.3bn in 2007 by Silver Lake and TPG, filed for bankruptcy in January. In a sign of its changeable approach to the sector, Carlyle has opened, closed and reopened a Silicon Valley operation all within the past 10 years.
Perhaps their experience plays a part, but the larger firms are raising eyebrows at the prices and aggression of the younger pretenders such as Vista and Thoma Bravo. “They are prepared to pay an ebitda multiple that is almost ridiculous,” says a partner at a rival firm, referring to the standard valuation that considers the price paid as a multiple of earnings before interest, tax, depreciation and amortisation.
But Mr Smith is critical of some of the other funds for failing to understand the software market. “The world is awash with capital and ambition which has led more PE tourists to invest in the highly specialised area of software,” he says. “Many have already lost money in the space. I expect to see a few more lose money in their software investments in years to come.”