Here's why private equity is putting ‘buckets of money’ into IT companies
- 21 October, 2019 14:30
In the past two months, private equity firms have ramped up their efforts to stake claims on territory occupied by the world’s biggest technology and channel players.
According to CrunchBase, 40 per cent of acquisitions in the United States valued at more than US$100 million were made by private equities in 2018.
And this, according to Gartner research vice president Neil McMurchy, comes down to one major thing: private equity companies have “bucket loads” of money in their hands and any company will always sell to the highest bidder.
“There is just so much money: estimate last year that there is well in excess of a trillion dollars in private equity funding,” he explained. “If you look at the business model, it’s about a combination of equity and debt. To that trillion, you can probably add two or three trillion more in extremely low-interest-rate debt. So they are outbidding other buyers.”
Although it is not a new phenomenon for private equity players to chase tech purchases -- global leader Thoma Bravo first acquired a software company Embarcadero Technologies as far back as 2007 -- there is little doubt that activity has accelerated in this space.
As a snapshot, this year saw Thoma Bravo stake claim over Connectwise, Australian cloud and managed services provider Nexon Asia Pacific get acquired by Swedish firm EQT Partners and Vocus fight off a $3.2-billion buyout from EQT Infrastructure.
Meanwhile, Australian private equity investment firm Future Now Ventures launched a $100 million-fund from external investors specifically targeted at Microsoft independent software vendors (ISV).
According to McMurchy, a lot of the appetite from private equity firms for technology companies comes down to the level of maturity within the market.
“There is a much bigger supply of big enough companies at a more mature stage for these firms to buy than there was 10 years ago,” he explained. “They are at a point where there is a reasonable level of profitability as well as good growth, plus the opportunity to drive even greater profitability.”
Illustrating the growth rate at play within the tech sphere, McMurchy noted even large tech companies, including Google, Amazon and Netflix, are still growing at a faster rate than the majority of those in the Fortune500, of which 60 per cent grew by less than six per cent.
Drilling down to specifics, distributor giants like Ingram Micro and Tech Data have a key selling point, according to McMurchy, in that by relying on volume deals, these are businesses more likely to have lower margins and overheads and therefore be “fairly efficiently run”.
On the other hand, he argues, software-as-service companies’ margins are traditionally higher and, while bringing some maturity and some profitability, there would be a “lot more efficiency to be wrung out of them” by potential buyers.
From a vertical standpoint, security unsurprisingly has taken centre stage as cyber attacks become an increasingly malevolent global threat. Thoma Bravo, now one of the most active players in the security market, now has Barracuda, Imperva, Veracode, LogRhythm, Centrify and McAfee within its portfolio, and now is just US$3.9-billion away from Sohos.
Meanwhile, closer to home in Australia, BGH Capital rolled together 12 independent brands into a unified cyber security powerhouse CyberX in a move that will still generate the profit and scale benefits as big one-off purchases, said McMurchy.
But while profitability is an obvious necessity for any private equity firm looking to deliver a return to its investors, there are drawbacks. One, in particular, is the risk of slowing down the technological advancements that made the company attractive in the first place.
“Generally private equity firms don’t spur innovation,” admitted McMurchy. “It’s about efficiencies, synergies and amalgamating businesses together.
“If I’m driven by growth, like in a venture capital firm, there is a higher comfort level in investing in innovation. On the other hand, if I’m a private equity business, I’m measured not just by growth but by profitability - so if you sacrifice growth for profitability, you have to be prepared that there is a potential that the attitude to innovation could become more conservative.”
Nevertheless, McMurchy believes there are no signs of activity slowing down in this space any time soon given the current abundance of cash and the lacklustre offerings across other industries.
“I can only predict [private equities’] presence will get stronger because their other investment options are so unattractive and they’re in a position compete very aggressively," he added.