A global recession may be creeping up and ongoing turmoil in public markets continues to swipe at the valuations of tech companies, but investors keep lining up to back the most exciting tech verticals. Whether they are flocking to software deals or targeting healthtech, edtech or even supply chain technology, fund managers remain bullish and see a downturn creating as much opportunity as threat.
Chris Caulkin, managing director and head of technology for Europe, the Middle East and Africa at General Atlantic, says: “Software has been a big theme for us over the past decade, and particularly with the scaling of the SaaS [software-as-a-service] business model. Whether those tools allow you to do more real-time data analysis, resulting in more responsive pricing or better inventory management, or whether they can create efficiencies by reducing the demand for labour, those drivers continue to be resilient as we go into a tougher economic environment.”
B2B solutions that can help businesses do more for less are particularly attractive right now. Charles Rees, a senior vice-president in the private equity technology investments team at Partners Group, says: “We organise ourselves around themes, and one of the big themes that we are focused on is the rise of the chief revenue officer and everything that comes into that.
“In this current market, with budgets under pressure, we think companies are going to be focused on protecting their revenue base and driving efficiencies in their go-to-market efforts to be more analytical and ROI-driven.”
Rees adds that another important topic is the development of technology that allows people to add a device to an inert object, a theme coined ‘the Internet of Things’. “We are stepping back and looking at where things are under-digitised and where software and technology can have most impact in the face of inflationary pressure. That is particularly relevant where labour costs are a high percentage of the cost base, and where software adoption has been slow.
“There are many industries that will need to automate, especially in the face of the macro picture driving labour costs with inflation,” he says.
“There are many industries that will need to automate, especially in the face of the macro picture driving labour costs with inflation”
Then come opportunities around supply chain technology, green tech and climate tech. “Supply chains are an area that has been digitising over the past decade, but the pressures are now different,” adds Rees. “Particularly with the rise of ESG and energy supply issues, there is a lot more focus on visibility, and being able to track impact is a subset of supply chain tech that we are particularly interested in.”
Helena Svancar is a partner at European growth equity specialist Verdane. She says: “We believe software is very important when it comes to simplifying business models, cutting costs and achieving efficiencies, so regardless of market turmoil, that trend will continue. Overall, the market may see slowing investment in the space, but it remains top of the agenda. There has been a general slowdown in the investment pace globally as compared to a year ago, but we’re focused on the long term and continue to meet and partner with great companies.”
Verdane recently invested $21 million in Onomondo, a Danish tech scale-up that has redesigned existing Internet of Things-connectivity architecture, offering customers real-time monitoring and debugging, and an easy-to-use management platform.
Svancar says: “Verdane is very much focused on three core areas: software, digital consumer and sustainability. I’m seeing many exciting opportunities in operational and IT infrastructure and communications software, where the move from on-premises to the cloud has created new business models with more resilient revenue streams compared to one-off licence fees. There is also an opportunity around IT solutions in relation to hardware and the cloud, as there is a big piece around securing networks.”
“The market may see slowing investment in the space, but it remains top of the agenda”
At the same time, non-cyclical sectors such as healthcare and education offer their own tech investment opportunities. General Atlantic’s Caulkin says: “The percentage of health spending and education spending that currently goes to digital is still very low, so if you look forward 10 or 20 years, there are clear opportunities for that to go higher, both from an effectiveness and an efficiency perspective. We see very different themes within healthcare and education technology, but they have very similar drivers in terms of potential for digitalisation.”
Victor Englesson, global co-head of TMT at EQT Growth, says: “In this market environment, it is more important than ever to invest thematically in verticals and companies that are supported by secular growth trends.
“We are also focused on business models with good revenue visibility and recurring revenues, as well as companies that are providing mission-critical services with attractive return on the investment for their customers. Some of the specific themes we are doubling down on are cybersecurity, climate tech, construction technology, DevOps, AI and machine learning.”
The valuation challenge
While the drop-off in valuations in the public markets has impacted pricing on private deals, there are not necessarily bargains to be had.
“We see very different themes within healthcare and education technology, but they have very similar drivers in terms of potential for digitalisation”
Oakley Capital partner and tech sector head Arthur Mornington says: “In times like these, you see a big bifurcation in value. Very strong businesses maintain their valuations and will remain highly regarded, with lots of sponsor appetite. Anything that is second- or third-tier quality will drop off in valuation, so you can see interesting buyside opportunities.
“Both of these factors are independent of what is happening in public markets. Publicly traded companies are valued on a different basis to how sponsors value companies. Sponsors will ignore the market noise and will focus on a company’s five-year profit projection, while a public market investor will be focused on the 18-month growth outlook.”
Caulkin says private markets are feeling their own effects, with deals harder to find. “In private markets, many businesses are very well capitalised, so the challenge is that prices are down but nothing is for sale. That means that public markets are currently compelling as firms explore potential new opportunities.”
EQT’s Englesson says: “We see two opportunities emerging as a consequence of the current market turmoil in private equity: supporting companies in the transition from growth to profitable growth, and P2Ps. In the old market paradigm, growth at almost whatever cost was rewarded. Many of these companies need to do a reset. They require support to drive efficiency and simplify business models to shift to profitable growth.”
Along with take-privates, the market conditions are serving to bring new sellers to the market. Rees says: “In our pipeline today, we have more take-privates given equity market moves in 2022, and more corporate spin-offs as the macro picture changes from the benign environment that we had.
“The macroeconomic conditions are opening a new type of seller because in a rising tide there is less focus on unlocking value but there is now more willingness from a broad range of corporates to engage with PE to address assets that may not be in the best home.”
Svancar, who joined Verdane in September from her role as head of M&A at Ericsson, the Swedish telecoms company, adds: “The market is very likely to see take-privates and carve-outs emerging much more as corporates look at asset sales. History tells us that capital is likely to be more constrained everywhere, so corporates will be more mindful of which businesses they retain, whether that’s for liquidity or strategic reasons.”
The challenge for tech investors is to stand out in a crowded market of buyers. Svancar says: “We have a fairly flexible mandate, so we can invest in majority stakes or minority deals. We can find opportunities where sellers don’t want to do a majority deal as prices come down, and we can be a partner on a minority basis. We can also buy portfolios of unlisted assets, so if there is a seller that wants to sell multiple assets in one go, we can be a partner for that. In a market in this kind of flux, having many ways to be relevant is really powerful.”
Caulkin argues that tech-focused firms are becoming even more specialist. “Saying you invest in software is not enough – there are very different themes within enterprise software versus edtech or healthcare – and very different dynamics selling SaaS to an HR vertical versus a data team,” he says. “There is a clear need for investors to understand each of those business models and verticals, especially in times like these, when everyone needs to be more creative, and deals are harder to find and execute.”
In September, General Atlantic bought out SoftBank’s 15 percent stake in Kahoot, the Norwegian start-up that provides a platform for people to build and use educational games. Caulkin says the company has significant potential for further growth as digital learning solutions continue to be adopted at work, school and home.
Tech goes the distance
Partners Group’s Rees sees the opportunity set for deals across Europe to keep gathering pace and rival the US market. “We have seen the continued growth of tech in Europe over the last five to 10 years. Historically, there was a much greater opportunity in the US, and that continues, but we are seeing more and more great technology companies being built out of Europe.
“In this market environment, it is more important than ever to invest thematically in verticals”
“The same is true of the tech talent, where we are increasingly impressed by the sophistication and capabilities of European management teams.”
Mornington at Oakley Capital adds: “We have been investing for several funds now in the transmission of tech trends from Northern to Southern Europe. We see two interesting trends for investors: digital under-penetration in specific regions, such as Southern Europe; as well as regional ecosystems that provide interesting investment opportunities, in particular Iberia.”
New geographies are also emerging as opportunity creators for tech firms. Caulkin says: “We are increasingly active in the Middle East and Africa, where the opportunity is often in differentiated technology that creates innovative business models different to what we might see in Europe. Those businesses are also starting to look more global, for example, coming out of the Middle East into other emerging markets and beyond.”
Meanwhile, the sector’s appetite for enterprise software shows no signs of abating. Mornington says: “ERP [enterprise resource planning] software, CRM [customer relationship management] software and cloud computing are all exciting verticals right now, and typically only around 20 percent of SMEs have adopted these digital tools, providing a long runway for growth. These digital tools help businesses to better manage boring but mission-critical activities such as accounting, project management, supply chain operations and sales.
“In times like these, you see a big bifurcation in value”
“What’s also exciting is the gradual shift from on-premises to SaaS – 2020 was the first year in which total enterprise cloud infrastructure spend exceeded on-premises spend, which is a major milestone. However, we are still in the foothills of SaaS adoption, with significant further headroom to grow – in particular across core sectors such as business services, telecoms, healthcare and education.”