Were Tech Buyouts Better?

Erin Griffith lists 49 PE deals that went Chapter 11 in 2008, up from just two in 2007. Wow! But, not one technology deal made the list. (Wow again?)

Leveraged buyouts in the technology sector are not new, as firms like Welsh Carson, TA Associates, GA and Warburg Pincus have been at it for over 25 years. But when the tech bubble burst and the IPO market became terminally ill back in 2000, these old-line firms were joined by a rush of overfed VCs (Battery, NorthBridge, Insight), generalist buyout shops and several new tech-focused PE firms – all of whom went on a remarkable fund-raising and shopping spree. 

The new breed of tech-focused PE firms were lead by names like Silver Lake, Francisco, Golden Gate, Vista and Vector.  Many of these firms were built on tech banking talent that spent the 1990’s taking companies public. With the public markets dominated by hedge funds, day traders and regulators – these PE firms focused taking their old banking clients private. Like all LBO activity – the velocity and amplitude to tech buyout deals were dramatically enhanced by free credit and peaked in Q2 of 2007, when Kronos was taken private by Hellman and JMI for $1.8b, or 17x EBITDA.

Interestingly, not one of these firms is found among the 48 deals that filed for bankruptcy in 2008.

Tech PE firms seem to be out performing the generalists so far, but why? With a universal forecast of tougher times ahead, it is too early to declare the sector immune to failure.  Judging from 2008 earning trends, the recession was slower to affect the tech sector than other sectors of the economy. Cisco, Google and Oracle were enjoying growth at the midpoint of 2008 while banks, homebuilders, newspapers and retailers were already hitting the skids. By last quarter it was clear that the recession had hit tech spending, and it’s fair to assume that if spending continues to decline in 2009, we will see some tech deals on the 2009 list.

But don’t be surprised if the sector comes away with a better track record than any others.  Much of the tech LBO activity was focused on software and services companies. These companies are blessed with little or no real assets like real estate or inventory and to put the “L” in LBO they must rely exclusively on cash flow estimates. Many of the mature software companies P&L’s look more like Cable TV franchises without the PP&E/CAPEX. Just diligence the maintenance contracts and build your future cash flow forecast off a very stable monthly billing history.  While this may be an oversimplification of the population of tech buyouts – it holds up that these deals were easier to forecast than were luxury goods, airlines or banks!

It takes some optimism, but I am rooting for most tech deals to keep off the Chapter 11 list.  As someone who was trained in the “3 ‘C’s’ of Credit” – Cash-flow, Collateral and Character – it would be great to see that the sector with the least collateral more than makes up for it with the other 2 key attributes.