Private Equity’s Tech Bonanza?
The technology and software sector continues to be a goldmine for the world’s biggest and best performing private equity firms. Add KKR & Co., cofounded by billionaires Henry Kravis and George Roberts, to the list of mega-firms set to mine one of its great dealmaking coups in the tech sector.
AppLovin, a pioneering maker of software for mobile gaming application developers, is poised to go public at a valuation of about $30 billion, according to a report from Reuters. AppLovin has set its IPO range at between $75 a share and $85 a share, and is looking to raise $2 billion by selling 25 million shares.
For KKR, which invested $400 million into Applovin in July 2018 out of its flagship KKR Americas XII Fund, the looming IPO will yield a home run investment.
According to AppLovin’s S-1 filing, KKR’s funds hold over 110 million AppLovin shares. An IPO at the midpoint of AppLovin’s range would create an investment worth over $8 billion. That should yield an astronomical investment rate of return for KKR, which harkens back to the glory days of the buyout industry.
Investors are absorbing the initial public offerings of software companies at sky high multiples of about thirty-times revenues. Public shareholders, even mutual fund firms that invest in growth stocks at a reasonable price, have seen successes like DocuSign or Salesforce and are willing to underwrite years of future growth. That’s because opportunity for software businesses abounds. Industries across the economy are moving their internal infrastructure, marketing, and product development onto software platforms. And new digital-first industries like mobile gaming and app-based e-commerce infrastructure are among the fastest growing subsections in today’s economy.
The technological changes are leading to companies with financials like Applovin, which saw revenues surge 46% to $1.45 billion in pandemic-plagued 2020. Total debt prior to AppLovin’s IPO stands at $2.1 billion, however, the company plans to repay about $400 million in debt through the offering. Adjusted earnings before interest taxes, depreciation and amortization was $345 million in 2020. Investors appear to be prepared to pay over 20-times sales and about 100-times trailing EBITDA to hitch their fortunes to AppLovin’s growth prospects.
For KKR, a firm renowned in the 1980s for leveraging and breaking up companies trading at massive discounts to their assets, software deals mark an evolution. The firm’s Menlo Park-offices now house dealmakers chasing fast-growing technology companies and raising funds targeting growth-equity investments. That an investment in an app developer sits inside KKR’s flagship private equity fund speaks volumes to the changes afoot in private equity.
KKR isn’t alone in finding the surging sector to be an area of enormous opportunity. Software-focused private equity firms like Thoma Bravo have made billions on software deals in recent years, monetizing enormous profits for limited partners even during the Covid-19 economic disruption. Forbes recently analyzed how Blackstone Group’s push into software and technology-enabled investments was yielding strong returns.
Founded in 2011, AppLovin started as a company helping mobile game developers find and monetize users. In recent years, it has pivoted into a fast-growing software platform for the industry. It recently struck a deal to acquire German analytics company Adjust for $1 billion, comprised of nearly $600 million in cash and the remainder in convertible securities. It’s also spent recent years organically building Lion Studios, a soup-t0-nuts platform for developers to market their games and find new users.
For cofounder Adam Foroughi, the IPO will mark a major success. AppLovin’s S-1 filing attributes 27 million Class B shares to Foroughi, which could be worth over $2 billion at the midpoint of its IPO range. Herald Chen, the former KKR dealmaker who led the firm’s wildly successful AppLovin investment, left to join the company as its president and CFO in November 2019. Some 4.6 million AppLovin shares are attributed to to Chen in its S-1 filing.
While public stockholders may now clamor for his shares, Foroughi had a hard time finding startup capital on Sand Hill Road a decade ago when creating the business. Ultimately, the lack of capital was a blessing in disguise. It forced AppLovin to focus on cash flow early on and eventually led the startup into the buyout portfolio of KKR.
Says Foroughi in AppLovin’s S-1:When we founded AppLovin in 2011, we thought our vision for solving the mobile app discovery problem was exactly the kind of big idea that every venture capitalist would love. Maybe it just wasn’t the right timing, but not a single VC chose to invest with us after countless meetings. At AppLovin, we love a challenge, and rather than being discouraged, we were motivated. We knew that mobile apps were changing the world, and that the importance of the app ecosystem would only increase. We believed that if we could help developers get their apps discovered by the right end users, we would build a meaningful business that would simultaneously better the lives of consumers around the world.Without venture capital, we committed to profitable growth from Day 1. We remained intensely focused on the things that mattered most—our people, our products, and our technology. Every dollar and every resource were allocated with care. Looking back, we have had positive cash flows from operating activities each year since 2013 and we still treat every dollar like it is our own.Our lean, entrepreneurial approach means that we can make fast decisions, be flexible and creative, and deliver more value for our customers. We keep our technology at the core of everything we do and are always thinking about what comes next. While we have grown significantly over the years, we have maintained this hungry, smart, and focused culture—a culture that is embedded in our DNA. This approach has fueled our success to date and will continue to carry us into the future.
Sounds like KKR is about to hit a grand slam (not a home run) with this AppLovin deal and its investors in its flagship KKR Americas XII Fund are going to reap some great gains too.
There's an important shift going on in private equity, the focus is increasingly on funding growth equity.
In fact, Myrian Balezou of Bloomberg reports that private equity’s taste for tech spurs $80 billion deal spree:
Private equity firms are barreling through the records as they place bets on technological revolutions in sectors ranging from finance to health care.
Firms have spent $80 billion acquiring companies in the global technology sector this year, according to data compiled by Bloomberg. That’s an all-time high for a quarter and already up 141% on this point in 2020, which went on to be a record year for such deals.
This month alone has seen Thoma Bravo ink a $3.7 billion acquisition of fintech outfit Calypso Technology Inc. and Ontario Teachers’ Pension Plan agree to take a majority stake in Mitratech, a provider of legal and compliance software, in a $1.5 billion deal.
In Europe, TA Associates said it would take over Dutch enterprise software firm Unit4 NV in a $2 billion-plus transaction, while one of Insight Partners’s portfolio companies bought data management group Dotmatics Ltd. for as much as 500 million pounds ($690 million). Earlier this year, Montagu Private Equity agreed to acquire U.K. software developer ITRS Group Ltd. for about $700 million.
Buyout firms are flush with investor cash and are being drawn to startups helping companies to reinforce their businesses following the impact of the Covid-19 pandemic, according to Chris Sahota, chief executive officer at tech-focused advisory boutique Ciesco.
“2021 will be a time of reinvention for many companies and digital technology is driving that, so the private tech market is booming,” he said. “After last year’s turbulence, businesses want to be agile and they have started to future-proof their operations.”
Competition for tech assets among buyout firms has been fierce. The sale of Dotmatics was completed in just three weeks, according to people familiar with the matter, while Montagu moved quickly with a high bid to beat out rivals and secure its purchase of ITRS, another person said, asking not to be identified discussing confidential information.
In the public markets, Bain Capital and Silver Lake Management were behind competing offers in the near $7 billion tussle for U.S.-listed laser maker Coherent Inc. Bain has pledged financial support to winning bidder II-VI Inc., while Silver Lake had backed Lumentum Holdings Inc.
Adding another element of competition for private equity firms chasing deals in the sector is the proliferation of special purpose acquisition companies. SPACs raise equity to fund takeovers of private companies and have been drawing in record amounts of investor capital. Backed by financiers and moguls from across industries, many are targeting tech deals.
SPACs are showing up in PE technology auctions as a real alternative bidder, although the SPAC market correction of the past few weeks could bring more realistic valuations, said Madhu Namburi, global head of technology investment banking at JPMorgan Chase & Co.
“Sometimes in bidding, private equity firms are struggling to match on valuation,” Namburi said about auctions involving SPACs. “SPACs are being aggressive but I haven’t seen PE firms have a lack of discipline.”
Among the most sought after assets are software firms, which account for $49 billion of companies acquired by private equity groups in the tech sector this year, the Bloomberg data show. Those like Calypso that offer a so-called subscription-as-a-service model are proving particularly popular, said Nandan Shinkre, managing director and European head of technology at Jefferies Financial Group Inc.
“It makes it easy to predict what the year is going to look like for these companies, hence buyers being comfortable paying forward multiples,” said Shinkre, whose bank worked on the Calypso, Dotmatics and ITRS transactions.
Elsewhere, growth capital continues to flow into tech startups, driving valuations. This month the payments processing group Stripe Inc. became the most valuable U.S. startup at $95 billion, following fresh funding from the likes of Sequoia Capital. Cybersecurity platform Snyk Ltd. has seen its valuation quadruple to $4.7 billion since the start of 2020.
“What’s becoming clear is that the returns from that investment opportunity is looking really attractive as a lot of tech companies are going public and creating a lot of value,” JPMorgan’s Namburi added.
Dizzying prices of tech companies in the public markets, meanwhile, have made take-privates harder to pull off and led to fears of a new sector bubble two decades after the dot-com crash. But Shinkre doesn’t see an immediate shift in momentum.
“I don’t anticipate a correction in equity valuation for good quality assets,” he said. “We now have more international interest than ever before in European tech companies, which shows how global the pool is. I believe this trend is here to stay.”
Jefferies is the top adviser to private equity firms on tech acquisitions by value this year, according to Bloomberg data, followed by Evercore Inc. and Barclays Plc.
What is going on? On one hand, we are repeatedly being warned that valuations in growth companies are off the charts.
Indeed, as the Visual Capitalist shows here, Private Equity's appetite for growth deals has ballooned the valuations on all their deals:
On the other hand, Private Equity is increasingly focused on growth because of structural factors:
- We live in a low growth/ low rate world, you need to pay a premium for growth.
- The pandemic has accelerated the digitization of the economy. Companies have no choice but to spend to money on their digital platform and adapt or they will not survive.
That's why the focus is on software companies.
By the way, the same thing is going on in public markets where software shares (IGV) have rallied well above their pre-pandemic level:
But investors I talk to are more reticent of getting their tech exposure through public markets.
Last week, I spoke with CDPQ's CEO Charles Emond who told me this to explain their outperformance in Private Equity last year (20.7% vs 9.9% for the benchmark) because of their exposure to healthcare, services and technology:
"We prefer having tech exposure in Private Equity as opposed to chasing the FAANG names higher and higher (they invest in them) because we have a seat at the table and are able to have more control over our investment."
He added: "I tell my depositors, don't look at it as Public and Private Equities, look at it as Equities and when you do this, you'll see it in a more comprehensive way and that we delivered great results."
It makes sense as technology exposure in private markets when you co-invest with strong partners (Blackstone, KKR, Silver Lake, Thoma Bravo, etc.) is where you can reap great gains and have a more meaningful stake in a company.
The big canary in the coalmine is whether or not we are reaching the top of the tech market and what will happen if rates start climbing back up?
Clearly large PE funds aren't worried, they're in bidding wars for top deals but as we all know, private equity needs strong public markets to exit their investments, and a strong IPO market is essential for these growth companies:
Last year, IPOs and hyper-growth Cathie Wood stocks (ARKK) were all the rage.
This year, I'm not so sure that risk appetite for hyper-growth/ IPO shares will remain as elevated but with the Fed out of the way and basically backstopping growth stocks and risk-taking activity, maybe it will come back strong.
I don't know, everything across public and private markets seems so bloody expensive to me, and that includes housing.
Either you hold your nose and play the game, bidding assets up to wazoo, or you sit it out and wait for a big fat crash that may or may not come.
All I know is elite hedge funds and private equity funds don't seem too worried and they're all chasing growth stocks and private companies up.
Their investors are enjoying the ride but they're increasingly nervous as valuations reach record levels.
Lastly, take the time to read this Wall Street Journal article on why Blackstone's Jon Gray is shifting that organization's focus on growth, not value as it barrels toward the trillion-dollar asset goal.
It's really hard betting against Jon Gray and other PE titans focused on growth right now.
But when everyone is positioned toward growth, I start to worry.
Below, in an era of near-constant disruption, what investment themes is Blackstone most excited about for 2021 and beyond? In episode two of Morgan Stanley's new series, Exceptional Leaders / Exceptional Ideas, Jonathan Gray, President and Chief Operating Officer of Blackstone sits down with Michael Cyprys, Head of U.S. Brokers and Asset Management Research, to dive into key megatrends in energy, life sciences and logistics, as well as Blackstone’s approach to innovation and building a culture of meritocracy.
Like I said, listen to Jon Gray, he's one of the best investors in the world and offers great insights in this interview. Watch it all as he also touches on frothy valuations in some of the most speculative companies in public markets and he discusses how Blackstone continuously strives to get the culture right to ensure it can remain a premiere asset manager in every respect.