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Rolling with the punches

The tech buyout market has watched deal activity take a downward trend through Q1 2023. But there are signs a new valuation environment is turning back in its favour.

This article first appeared in the May 2023 Tech Buyouts Insights Report

The tech buyout market has watched deal activity take a downward trend through Q1 2023. But there are signs a new valuation environment is turning back in its favour. 

All bank crises and sour macroeconomic conditions considered, the absence of the uptick in deal activity that buyers and sellers were hoping for at the start of 2023 is – according to some commentors – justifiable.

Why? Hunter Lewis, co-founder and former chief executive of Cambridge Associates, tells Private Equity Wire that the current buyout model has “ruffled some feathers” and possibly “spooked some LPs”.

Lewis is reflecting on his recent opinion piece in The FT, titled, Why I am not investing in a buyout for a long time to come, where he indicated that buyouts are currently guilty of “inflated returns, denial of volatility, high prices and fees, excessive leverage, and absence of covenants on buyout debt.”

“GPs and the LPs that are heavily invested in buyout strategies in the current economic climate could spook LPs about large tech buyouts,” he adds.

Indeed, tech buyouts have been hit harder than most. In Q1 2023, large global tech buyouts in the US, UK, EU, and Asia accounted for $79.4bn across 597 deals. This marked a drop of 50% in deal value and 35% in volume on Q1 2022. A new survey of investors and deal advisers conducted by Private Equity Wire found high asset prices were the number one challenge when considering tech firms.

However, despite the dive in deal flow and questions around value, wider Private Equity Research suggests transactions are starting to pick up in Q2 of 2023 – they’re just taking longer to negotiate and complete.

“Deals are getting done, all you have to do is look to the take-privates to see that,” says Ryan Lanpher, a partner in Permira’s Technology Team. “It’s a classic case of mismatch between buyer and seller expectations,” says Lanpher who is a non-executive director at companies including Genesys, Informatica, Seismic, Synamedia, Mimecast, and Zendesk.

“On the take private side, the premiums are much higher than they have been in historical periods,” Lanpher continues. “Private investors have so far been willing to pay a large premium to the classic 20 to 30%. In some cases, premiums on public market trading are being negotiated at 50 to 100% even if perhaps they shouldn’t. It’s a sign the public markets are partially disconnected from fundamental value.”

In March, Permira made a final close of its latest flagship buyout fund, Permira VIII with total capital commitments of €16.7bn. The Fund closed above its target size of €15bn – an increase of over a third compared to its predecessor, P7, which closed at €11bn in 2019.

Salim Nathoo, a Partner in Apax’s Tech team in London, expects more take-privates to be added to deal tally in 2023. That’s because “boards are now becoming more reasonable as the new valuation environment sets in.”

“The last 12 months’ highs of stock prices are dropping, and equity fund managers are pressuring companies to accept bids at reasonable premiums,” he says. Adding, “More broadly, 2021 was the anomaly with valuations in extremely high territory.  While valuations have come down, it is hard to argue they are particularly cheap by historical standards, especially when you factor in the premia needed for a take private.”

Compelling opportunities 

Nathoo believes it is hard to say that any sub-sector in tech is undervalued given the rise in interest rates and the macro-outlook. “However, tech valuations have come down from very high levels in 2021 for both high growth and mid-growth businesses,” he adds.

Apax has a number of interesting opportunities in the pipeline across its three core tech subsectors of software, tech services and telecoms, Nathoo says.

Swedish investment firm EQT is seeing opportunities in the US and Europe, says Arvindh Kumar, Partner and Co-Head of the firm’s Technology Sector Team, while noting that the underlying financials are very different.

“The US has more unprofitable software companies trading at a lower revenue multiple than in Europe, presenting a number of compelling buyout candidates,” he says.

The US tech buyout market invested $47.3bn across 249 deals in Q1 2023. This was in stark contrast to Q1 2022 which saw 424 large buyout deals close worth $93.6bn.

Take-privates in the US have accounted for all but one of the top ten largest tech buyouts closed in the past year. The odd one out was a corporate divestiture, Emerson Electric.

The top tech buyout deal over the past year has been Elon Musk’s Twitter bid, which closed at $44bn and included a Who’s Who of investors from private equity, family offices and sovereign wealth investors.

Only one US mega buyout closed so far in 2023 comes close to rubbing shoulders with the 2022 top 10 deals and that is Qualtrics, which was taken private in March of this year in an all-cash deal worth $12.5bn by CPP Investments and Silver Lake (see fig. 1.4). The take-private deal has since run into troubled waters. Kaskela Law announced that it is investigating Qualtrics International Inc. on behalf of the company’s shareholders (since March 2022, the value of Qualtrics’ shares have fallen 38% and the investigation seeks to determine whether the decline is attributable to the prior issuance of false and/or misleading statements and/or the failure to disclose material information to Qualtrics investors, in violation of the securities laws).

In Europe, five of the top 10 deals are from 2023, with the ranking topped by Saudi Arabia’s Public Investment Fund’s $17.3bn buyout of German telecoms business Vantage Towers from March.

EMEA Private Capital Pitchbook Analyst Nalin Patel says deal count in Europe has “remained fairly resilient” despite challenging trading conditions in large tech caused by factors such as weaker corporate spending on cloud services and digital ad spend.

That’s because sponsors have “avoided larger deals in favour of smaller transactions,” says Patel.
EQT’s Kumar calls the opportunities in Europe “compelling,” highlighting strong products with a need for new owners that bring strong operations, a different perspective and a profitable growth mindset.

In Asia, meanwhile, China is again the one to watch. Over the next five years Greater China’s buyout deals are expected to outgrow other asset classes, according to Bain & Company (see boxout).

The next cycle 

“The rise in interest rates has set the stage to separate the men from the boys in private equity,” Emmanuel Daniel, fintech commentator and founder of TABInsights, tells Private Equity Wire.

Daniel is of the opinion that buyout funds that have been too reliant on leverage to boost valuations in recent years, rather than inherent value, could be weeded out in the next fundraising cycle.

Those funds that nurture portfolio companies are most likely to survive this period, especially in the fintech sector’s buy-now-pay-later segment, he says, which companies have found out is “not a technology innovation, but rather a balance sheet-defined innovation.”

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