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PE’s software surge is just beginning

While nowhere near the exceptional levels seen in 2021 and 2022, total global software PE deal count and value exceeded pre-pandemic levels in 2023.

A pickup in PE-backed software deals is in the cards for 2024.

While nowhere near the exceptional levels seen in 2021 and 2022, total global software PE deal count and value exceeded pre-pandemic levels in 2023. Compared to the first nine months of each year from 2017 to 2019, average deal activity was 29% higher in value and 28% higher by volume in 2023, according to a PitchBook analyst note.

 


PE’s foothold in software has grown to encompass a bulk of M&A activity in the technology sector, a trend industry players expect to play out into 2024.

Three factors have created an environment primed for PE-sponsored deals in technology and software in 2024: low valuations of private assets relative to the public markets, a recovery in bank lending to LBO transactions and substantial reserves of PE dry powder.

Some of the largest owners of software companies today are buyout firms. Thoma Bravo, with an estimated $26 billion in generated software revenue, is the fifth-largest owner of software companies in the world; Vista Equity Partners, with $23.6 billion in software-related income, is the seventh-largest, according to the analyst note.

Its findings show $163.8 billion in dry powder at technology software-centric buyout shops.

“PE has built up a war chest of 5,000 portfolio companies to go vacuum up lots of other great software companies,” said Benjamin Howe, CEO of AGC Partners, a boutique investment bank that specializes in SaaS, security and cross-border transactions.

Software draws in the bulk of investor dollars. This year, software transactions accounted for 57.3% of total global PE technology deal value, according to the analyst note.

Of the more than 1,500 acquisitions Howe said he’s already expecting for 2024, he estimates that 80% will be add-on deals—transactions in which an investment firm buys a business to merge it with one of its existing portfolio companies. This is largely because the strategy typically requires less debt financing than a traditional LBO.

Lower prices in the private markets relative to listed software companies, which tend to trade at higher valuations, present an opportunity for PE firms to roll-up smaller private market assets into one platform, then exit into the public markets to take advantage of the valuation premium, the analyst note shows.

Why software?

Historically, both public and private investor interest in software has hinged on the sector’s attractive risk-adjusted returns in the face of periodic market volatility. This year, for example, amid heightened interest rates and geopolitical uncertainties, publicly traded software companies displayed continued growth in their EBITDA margins, showing that software companies overall are still profitable.

This is particularly meaningful after a challenging market stifled exit activity and the denominator effect limited the amount of LP capital moving into PE funds.

Now, the anticipated revival in deal activity speaks to the sustained profitability of the underlying software portfolio companies. Both mean and median EBITDA margins this year, which measure the profitability of a company through its operations, surpassed 2021 and 2022 levels, when valuation multiples were higher than the historical average, according to the analyst note.

“Software businesses have really good economic fundamentals, and that’s something that’s still intact,” said Garrett Hinds, a PitchBook senior PE analyst and co-author of the analyst note.

These fundamentals include a recurring revenue model, where businesses offer recurring or multiyear contracts for their product, reducing the risk of instability during a recession.

Deals in Q4 2023 reflected early signs of the predicted pickup. On Monday, Clearlake Capital Group and Insight Partners completed their acquisition of analytics company Alteryx for $4.4 billion, including debt.

Still, Howe said while he expects a meaningful uptick in deal flow in 2023, it won’t be an opening of the floodgates. Instead, he said it will look more like a steady stream of deals across the course of the year.

“It’s not going to be a mad rush in Q1,” he said. “It’s more like companies have started to stabilize. So there are certain companies we feel comfortable with bringing into the market now that their revenue growth is not decelerating anymore.”


Featured image by Shulz/Getty Images

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