Private Equity's Software Buying Binge

In 2004 there were, by my count, about 18 acquisitions of public software companies and Private Equity firms made none of them.  By 2006 however, not only had the number of acquisitions risen to 32, but Private Equity firms accounted for 25% of them, up strongly from 11% of deals in 2005 (See table below).

                               

Year	Total Deals	PE Deals	% PE
2004	18	0	0%
2005	27	3	11%
2006	32	8	25%

At this rate I wouldn't be surprised to see private equity account for over 50% of deals in a couple years.

Who Said Maintenance Revenues Aren't Beautiful?
Private equity firms have taken a liking to software firms not because they believe software to be a great growth market but largely because most software firms have what PE firms might call "immature" balance sheets, with little or no debt and relatively high levels of cash.   Rather than targeting fast growing software firms, PE shops typically target "mature" software companies as they not only tend to have lots of cash but they also derive a large percent of their revenues from maintenance revenues.  These revenues are seen by private equity investors and, more importantly their lenders, as a stable source of cash flow that can be used to finance lots of debt.

Seven Steps To Carry
The basic private equity software play book goes something like this:

1. Buy software company
2. Do dividend recap in which you simultaneously lever up the balance sheet and dividend out all the cash you just borrowed plus most of the existing cash on the balance sheet.
3. Raise new fund off of massive IRR created by dividend recap.
4. Do lots of acquisitions to make organic growth impossible to discern
5. Raise prices, slash R&D, increase sales and marketing.
6. Take company public/sell it at same PE you bought it for to investor/large company apparently unfamiliar with the concept of enterprise value.
7. Repeat.

Now I admit this is a bit of snarky characterization of PE software deals because software offers some unique scale effects in SG&A, but I think this characterization is probably closer to the truth than a lot of mumbo jumbo about "value add" "synergies", etc.

And the Winner Is....
For my money,the most notable (and most ironic) private equity buyout of public company in 2006 was the acquisition of SSA Global by Infor. Why?  Because SSA Global was itself a private equity sponsored roll-up of public software companies (including Baan, Ironside, and Epiphany) which was public for all of a year before it was bought by another private equity sponsored roll-up of public companies, Infor, which now rather immodestly claims to be "the fastest growing enterprise software company in the world".

To have the two companies that are following the private equity playbook to a T merge with one another after the first one was only public for a year is just priceless.   I can't wait to see the prospectus for Infor and how they back up their claim to be the fastest growing enterprise software company in the world, it should be a classic.