Private Equity Storms into Tech Buyouts
Art by Tim Peacock
For private equity firms, technology has long been suspect as a good place to invest. But that’s starting to change: The PE shops, which preferred more traditional targets like manufacturing and consumer goods, are increasingly attracted to info-tech investments.
Since 2007, when mergers last were in vogue, right before the Great Recession, PE acquisitions of tech outfits have more than doubled in number, to a record 823 last year, according to data from Preqin, the alternative asset research organization. Tech’s share of aggregate private equity deal value climbed to 19% in 2017, from 15% in 2015. Thus far in 2018, it has risen to a robust 23%.
With mergers and acquisitions roaring again, more and more PE firms are dedicated exclusively to tech. And these tech-focused funds are raising huge amounts, Preqin reported. The16 largest secured a combined $40 billion last year, the biggest amount ever in the tech space. Preqin’s head of PE products, Christopher Elvin, said that “2017 in particular marked a banner year for buyout funds focusing on IT.”
The heightened tech interest in recent years from the PE crowd stems from several factors:
Tech in where the growth is. These days, tech accounts for 35% of the S&P 500’s value, a full 20 percentage points more than a decade ago. Among S&P sectors, tech has the largest profit margins, a nice 22%, reported thus far for the year’s first quarter.
PE managers are more comfortable with tech investments. A standard PE deal was the 2015 combination of food giants Kraft and Heinz, put together by 3G Capital and Berkshire Hathaway. Traditionally, both 3G and Berkshire have shied away from tech deals.
Until recently, “most buyout chiefs didn’t understand technology companies,” said Chip Schorr, senior managing director at One Equity Partners, a PE firm heavily into tech investing. “They knew how to evaluate frozen vegetables, but couldn’t tell you what [a] capacitor was if their lives depended on it.”
That hidebound view has eroded as the importance of tech in people’s lives has expanded, with the enormous computing power of smartphones now ubiquitous among everyone, young and old. The upshot: “The level of sophistication has gone up” about tech investing among private equity types, said Barak Ravid, co-leader of technology for EY-Parthenon, a PE consultancy.
The taint of the dot-com bust has faded. The last time tech rose to more than a quarter of the S&P 500 was in the late 1990s. Back in those days, many startups pulled in investors excited about the new web era. Private equity didn’t have much to do with that gold rush, and when everything went south in 2000 with scores of web tyros going out of business, PE kept its distance in the new century’s first decade.
The big players of dot-com era, who survived even though their stock suffered in the bust, were concentrated on business customers: Microsoft, Intel, and Cisco. Today, consumer-centric tech companies are the most salient, with Facebook, Apple, Amazon, Netflix, and Alphabet’s Google dominating the stock market. And after all, consumers drive two-thirds of the US economy, a shift PE firms can’t ignore.
Plus, compared to the dot-com time, when valuations were astronomical, tech stocks today are more affordable. “What’s different now is that no one feels they are overpaying,” said Eddie Hebert, managing director of money manager PPM America.
Thus, a lot of money is available to spend on tech acquisitions. One of the leading lights in tech M&A, Silver Lake Partners ($39 billion under management), last year closed its fifth fund at $15 billion, one of the biggest capital raises ever.
The firm’s fourth fund has annual returns of 37% in its most recent year, Pitchbook research showed. In March, Silver Lake invested $500 million in Credit Karma, the personal finance technology company. Last week, the PE group announced it was buying ZPG, one of Britain’s largest property-search companies, for almost $3 billion.
Other top names in tech PE are Vista Equity Partners, which tilts toward software makers, like EagleView and Aptean; Francisco Partners, whose portfolio includes cybersecurity provider SonicWall and API Healthcare, which furnishes hospitals with IT support; and Bain Capital Private Equity, which is active in many areas but has a strong tech presence with holdings such as Vertafore, the software purveyor for insurers, and WorldPay, an electronic payment processing business.
The champ in this field is the $100 billion Vision Fund, which Japan’s SoftBank has set up to make technology-oriented deals. Among its assets are stakes in chipmakers Arm Holdings and Nvidia. Vision is in negotiations to sell its investment in Indian online retailer Flipkart to Walmart—the fund bought 22% of Flipkart for $2.5 billion just a year ago, and now prices it at $4 billion.
A virtue of having funds devoted to tech is that they bring more operational savvy to their acquisitions, said EY-Parthenon’s Ravid. “They know how,” he added, “to put together an engineering team, for instance.”
Small wonder that private equity buyouts of tech lately have gotten richer and richer. The peak year in dollar terms for PE buyouts of tech was 2015, amounting to $140 billion in total, by Preqin’s reckoning.
That aggregate number is skewed by one monster transaction in 2015, the $67 billion purchase of data storage provider EMC—a deal that Dell Technologies engineered, with the help of Silver Lake. Previously, Silver Lake helped Dell founder Michael Dell take his company private.
Funding for tech traditionally came from venture capital, whose funds invest smaller amounts than PE firms, and get in at companies’ startup phase. Consider Sequoia Capital, which put money into the likes of Google and PayPal early on. Private equity, on the other hand, invests later, when a company has established itself. That fresh capital gives IT companies a vital second wind.
“Private equity wants a record of proven growth,” said Preqin’s Elvin. And nowadays, there’s no shortage of that in the tech world.