BY MARIA ARMENTAL | UPDATED DEC 27, 2022 08:00 AM EST
Technology investors say market challenges are unlikely to deter corporate spending on software
The rout in public technology stocks in 2022 has put pressure on private technology company valuations, which had soared during the previous two years and drove the value of US private-equity tech deals in 2021 to a record of more than $400 billion, according to data provider Dealogic.
Private-equity backers of tech companies say they have intensified their focus on controlling costs in the face of higher interest rates and an uncertain macroeconomic outlook, industry advisers say. Still, executives at tech-focused private-equity firms say there’s much to like about the sector, particularly software, largely seen as one of the most inflation-protected assets because it helps companies cut costs and increase productivity.
WSJ Pro Private Equity spoke to several senior private-equity executives about the challenges and opportunities they see ahead for these deals. They include: DJ Deb, co-founder and chief executive of Francisco Partners; Monti Saroya, senior managing director and co-head of the main buyout funds at Vista Equity Partners; AJ Rohde, a senior partner at Thoma Bravo who co-leads a team focused on midmarket tech deals; and Sri Rao, general partner at growth investment firm Silversmith Capital Partners. Responses have been edited for length and clarity.
WSJ Pro: Where do you see the biggest investment opportunities for technology in 2023?
mr. Rohde: Our big theme for next year would be the resilience of software in terms of corporate spending [and] corporate priorities [and the] ways that companies are getting smarter and more efficient about how they can use technology to accelerate some of the streamlining of their business. We think we’ll continue to see an acceleration of digital adoption. When things get rough, you have to look at every cost. And so, 2023 will be a priority year. And in a priority year, people usually invest more in software.
mr. Range: It’s just getting back to basics, frankly, and finding those teams, many of whom we’ve met three, four or five years ago and we built a relationship with. There wasn’t an opportunity to invest last year or the year before [with these teams]. But now they look around at the overall market and say maybe now’s a good time to diversify their personal risk and bring on a partner that can help them navigate more uncertain economic times. Or, maybe they actually see that now, when other folks are kind of retrenching, this is an opportunity to be a bit more aggressive and capital can help there.
WSJ Pro: What do you see as the biggest challenge in 2023?
mr. Rohde: Finding willing sellers at a reasonable premium. When there’s this much dislocation, this fast, people often say, “Well, I don’t know if we’re ready to go private.” This is true in every industry, but tech had a significant pullback. And so for [public company] boards to engage in a transaction, they have to be willing to accept the fact that being private is a better answer for that company. And not everyone is there yet.
mr. Sarah: Fear, uncertainty and doubt. All three will contribute to delays in decision making and strategic planning for businesses as the macroeconomic picture remains cloudy.
Still, we believe companies will rely on software tools to drive efficiency and enhance their operations despite this uncertainty—especially in mission-critical functions such as cybersecurity, business continuity, IT infrastructure and resource management.
mr. Deb: First, things are going to get worse before they get better, so when making an investment, you need to factor in that we are entering a recession. Second, interest rates are expected to increase, so companies will need to pay more interest, which will result in reduced cash flow. Finally, we are concerned about the level of long-term rates being higher than we have seen in the “free money, no interest rate” decade that we just all lived through. Higher interest rates are likely to have a concomitant negative impact on terminal multiples and exit values.
WSJ Pro: What surprised you the most this year?
mr. Sarah: The lack of underwriting discipline. The high valuation environment over the past two years created a dynamic where we saw capital deployed with far less selectivity, as many investors underwrote returns that were predicated on continued multiple expansion, rather than a company’s underlying fundamentals.
mr. Deb: In 2021, we thought the markets were frothy when growth stocks were [valued at] over 30-times revenue. As a firm, we decided to sell as many companies as we could, only made new investments that were recession resilient and pulled in fundraising by nine months. While we were expecting a market downturn, the rate of decline was higher than we forecast. We also expected a wave of companies to go private in 2022, but that has not yet happened as public company boards continue to focus on 52-week highs as a benchmark. However, we expect more [go-privates] in the upcoming year as the stock market continues to languish.
WSJ Pro: How do you see the technology investment landscape evolving?
mr. Rohde: There’s going to be a shakeout of the haves and the have-nots, as you always see in a market dislocation or recession. In many cases there are just too many companies. And I think that will be weeded out over the next 12 to 24 months. Whereas public companies are the vast majority of [opportunities in] the pipeline now, [a year ago] they would have been the minority.
mr. Sarah: The proliferation of cloud-native technologies has dramatically reduced the technical barriers to launching a software business. The ability of a founding team to swipe a credit card and rent infinitely scalable computing power means that new entrants can grow quickly to tackle new problems or challenge legacy incumbents who may not be as nimble. As an investor, this accelerated pace of change means being a specialist in this market and having a true appreciation for “where the puck is going” has never been more important.
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