Amid another week of chaos in the US banking sector, a market watcher could be forgiven for not having his or her attention captured by anything else. Not the least being a 15 minute CNBC hit featuring private equity investor Thoma Bravo’s Orlando Bravo, sitting down with anchor David Faber at the Milken Institute Global Conference. But for technology investors and bankers, especially those whose business it is to be connected 24/7 to all things enterprise software, the interview was, to a man, ‘must see TV’. Though not nearly as engrossing as watching PacWest Bancorp’s stock price crash 60% in extended hours Wednesday, Orlando Bravo’s hot takes on current software valuations, market constraints, and how to continue to deliver quality returns to limited partners, made for compelling listening – they were insightful, useful, and in my opinion, 100% correct.
First, he addressed enterprise software valuations. He stated that the days of big multiples being assigned to high-growth software companies with no profits are gone. The market is being driven by fundamentals now and will be for a long time to come. Thus, a company’s unlevered FCF position has become the fundamental driver of valuation, something I myself touched upon a few weeks ago here.
Second, he addressed the growing importance of the private credit markets. Even before this year’s banking crisis, private equity had begun tapping the private markets for leveraged buy-outs, moving away from legacy institutions which had historically fed these types of transactions. Though he acknowledged that private lender capital is also very expensive right now, averaging a yield of 13%, he views private credit as a more reliable source in light of the increasing volatility in the banking sector.
And third, Orlando Bravo pushed the idea that despite the challenging macro-environment, there’s still a ton of opportunity in the marketplace for enterprise software deals. This includes more take-privates, even at dramatically lowered valuations, provided that Boards and activist investors can be persuaded to cut loose their mental anchors to current stock prices, and buy-in to a new pathway with greater upside.
But with this comment came some nuance, the implications of which ought to play out over the next few years, especially among growth equity shops. Bravo averred that financial sponsors need to figure out how to turn unprofitable companies into capital efficient, bottomline growth stories. The ability to do this will impact how private equity currently evaluates personnel too. Where the last decade of cheap capital has assigned a premium to associates who could sell their way into a company and structure the transaction financially, Bravo suggested that now a premium should be assigned to more operationally-minded personnel that understand the business of the acquired asset, and can rework the business, top-to-bottom to get to positive FCF.
But the best nugget of wisdom from the CNBC/Bravo interview was this (and I’m paraphrasing) – you play the hand you’ve been dealt. This was a pointed comment in response to a question from David Faber on how private equity groups in the enterprise software game – like Thoma Bravo, Insight Partners, and Vista Equity – can adapt to, and outperform, under the current market constraints of expensive capital, increased scrutiny from the government (FTC) on large transactions, and a large bid/ask spread between buyers and sellers. There’s simply no other option for financial sponsors – they’ll just have to make do.
To which I say, Bravo Orlando! Bravo!
