5 Takeaways from the ACG Technology & Business Services Conference - Successfully Navigating this Frothy Market for Technology Assets
In September, we attended ACG New York’s Technology and Business Services Conference. For those who weren’t able to be there, we wanted to share five key takeaways from the first panel held at the event, which focused on “Successfully Navigating this Frothy Market for Technology Assets: Finding and Closing on Technology Assets that Warrant These Nose-Bleed Multiples.”
The Current State of Tech Investing
The surge of private equity interest in tech investing, driven by big growth opportunities, has made the field much more competitive in recent years, according to Umang Kajaria, Principal at Apax Partners. That leads to situations where PE firms and strategic buyers try to pre-empt processes with market-clearing prices, added Cole Bader, Head of Technology Investment Banking at Stifel. In that environment, having the right team, processes, and capital helps—but it’s just as important to get out ahead, according to Brendan Scollans of Stockholm’s EQT Partners. Tracking businesses for years before a transaction is a common practice in Europe due to the smaller size of the market, Scollans said, but it is becoming imperative in the US as well. Successful buyers will be forward-thinking in terms of identifying the tech sectors where they want to play and spending time with owners and management teams in anticipation of a future process.
Finding Value, Creating Alpha in This Frothy Market
Service providers report that tech-driven investment opportunities often feature as many as five or six buyers willing to pay high multiples – and PE investors are frequently willing to pay more than strategic buyers. In such situations, according to Abilash Jaikumar, Co-Founder and Managing Director at TresVista, a successful buyer must create not just value but also alpha on the investment. That means not only having an angle on the investment that other potential acquirors may not see (to justify the higher multiple) but also an ability to work harder. In that regard, he said, some investors are turning to data analytics as a means of identifying areas to improve operational efficiency and to determine the best places to spend capex and make investments. Another potential source of alpha comes from well-executed add-on strategies, he said.
Are We Talking Platform?
Yes. 'Platform' is one of the latest buzzwords in the private equity space, especially on the tech side. Thinking of portfolio investments as a synergistic part of a ‘platform’ helps justify higher multiples on certain investments allowing PE firms to pay similar multiples to strategics. The investors on the panel, Kajaria and Scollans, agreed that a smart platform strategy can play a role in justifying a higher multiple on the initial acquisition, which can then be ‘bought down’ and the dollar-cost averaged out in subsequent roll-ups. In this case, however – as Jim Rosener, Partner at Pepper Hamilton noted - identifying talented management teams who can integrate add-ons is just as important as putting up the cash. This is where buyer diligence becomes essential for the success of both buyers and sellers.
The Benefits of Due Diligence
That sort of heavy-duty upfront due diligence was another trend broadly identified by the panel. Really digging deep can help uncover interesting angles that might amplify a buyer’s conviction about the platform potential of the acquisition. It also can send the seller an important signal about your determination to close that is valued by sellers and bankers. The only real way to mitigate buyer risk in a frothy market is to get as much insider knowledge as possible prior to closing—and for this to happen, business, legal, and operational attention is key. Another argument in favor of heavier due diligence is the trend of large-cap sponsors coming down-market to acquire smaller businesses, underwriting all the equity as well as the debt and taking the debt risk off the seller. Legal diligence also helps sellers and service providers insert protections against acquisition price adjustments post-purchase, especially against buyers who have acquired a reputation for it.
Other Notes from the Field
Looking forward, panelists expect the sector to undergo some amount of stress in the medium term, given that the U.S. economy is currently nine years into an expansion. The focus is then on businesses of a non-cyclical nature with recurring revenues. Avoiding cyclical end-markets may also be another factor for consideration. Another perspective would be to identify businesses that have the potential to go from ‘good to great’ —in other words, decent businesses that can be transformed in time to add a margin of safety to the valuation. Separately, panelists also discussed the potential evolving role of VCs in the tech industry. Jaikumar noted that VCs are increasingly saving a portion of their capital to invest in later rounds—potentially mitigating the need for so-called “unicorns” to go public. IPO trends vary across industries and will always be an evolutionary stage for certain sectors. But with nearly $1 trillion of capital on the sidelines and earmarked for alternative investments, together with recent moves by large institutional investors such as CalPERS and other pension funds to allocate a portion of their capital to alternative investments, this trend of staying private might only become more compelling down the line.