The past few years have represented a bull market for the technology sector. Fuelled by tech expansion necessitated by the covid-19 pandemic, valuations for tech companies rocketed, along with investors’ optimism for the future of the sector.

However, top tech stocks lost $3 trillion of market cap in the first six months of 2022, according to data from S&P Global, in a development that has impacted the private markets as valuations for private tech companies dropped in turn.

But despite lingering uncertainty over what the future holds, buyout firms and investors alike seem undaunted by the challenges facing the sector.

Many in the market say that the drop in valuations represents a market correction and that, going forward, sponsors and investors will be more discerning about what constitutes a good tech investment.

This, they say, will mean taking a more granular approach to value creation over the life cycle of their investments, and focusing anew on the basics, which will pay dividends in the long run.

Choosing the right vertical

Selecting which tech investments will generate returns over a five- to 10-year period is no easy feat, but according to those leading on investment strategies for buyout firms, choosing the right tech vertical is a crucial decision in the good times and the bad.

“In this market environment, it is more important than ever to invest thematically in verticals and companies that are supported by secular growth trends,” Victor Englesson, global co-head of TMT at EQT Growth, tells Private Equity International.

“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.”

$41bn
Capital raised by technology, media and telecoms-focused funds in Q1 2022

Source: Private Equity International

$284bn
Total value of technology deals closed during 2021

Source: Bain & Company

EQT, he says, is set to “double down” on verticals such as “cybersecurity, climate tech, construction technology, DevOps, AI [artificial intelligence] and machine learning”.

Others, like Chris Caulkin, managing director and head of technology for Europe, the Middle East and Africa at General Atlantic, believe that the enterprise software vertical will continue to show resilience regardless of the macro environment.

Meanwhile, Charles Rees, a senior vice-president in the private equity technology investments team at Partners Group, says that an increasing focus on environmental, social and corporate governance issues has meant that investments around supply chain technology, green tech and climate tech are garnering more attention.

By homing in on specific verticals, sponsors are able to take advantage of the drive towards digitalisation across several industries.

Zia Uddin, president of Monroe Capital, says: “We are still in the early innings of this digital transformation, and we are expecting one in three private equity deals to be technology- or software-related by 2025.

“Covid has accelerated some adoption, but at the end of the day, if you believe we are facing a recessionary environment, then technology and software should continue to attract investment from customers because it is one of the only places where companies can create massive productivity gains and operating leverage.”

Value creation takes precedence

As valuations fall, tech-focused professionals are split on how big an opportunity there is for private markets firms to pick up a bargain.

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.”

Many argue that a short-term drop in valuations will create plenty of good buying opportunities for private equity investors looking for longer-term returns. Certainly, more private equity firms are taking companies private, with figures from Dealogic showing PE spent a record $227 billion on delistings in the first half of 2022, up 39 percent on the same period last year. One of the biggest deals was the $16.5 billion acquisition of software company Citrix Systems by affiliates of Elliott Investment Management and Vista Equity Partners.

John Park, who leads the technology industry team within KKR’s Americas private equity platform, says: “We are getting a lot more open-minded interest from boards of directors of public companies. And management teams that weren’t returning our phone calls 18 months ago are now willing to enter into a conversation. They want to know how they can do the things that they want to do without the volatility of the public markets.”

Buyout firms are bullish on their expectation that robust value-creation strategies will be crucial to reassure investors that, regardless of what the wider markets show, technology still holds opportunities.

Chris Russell, managing director of the PE technology industry vertical at Partners Group, says M&A is among the levers that can continue to add value in the current environment. “On the M&A side, we will be more selective, but we are still trying to do portfolio add-ons that make sense,” he says. “We are still investing in growth and pushing all those value-creation levers because our core thesis is that customers need these businesses.”

Investors get selective

Following the latest market developments in the tech industry, private equity LPs are taking a closer look at their tech position and, according to Samer Ghaddar, deputy chief investment officer for the $50 billion Arizona State Retirement System, these investors find themselves in an advantageous position.

The tech market correction, Ghaddar says, benefits certain new PE tech funds launched in late 2022 and early 2023, which will be able to buy assets at attractive multiples. “I think this vintage is going to be phenomenal,” he says.

“ We are still in the early innings of this digital transformation ”

Zia Uddin
Monroe Capital

Meanwhile, Kelly Ford Buckley, general partner at Edison Partners, a tech-focused growth equity firm in Princeton, New Jersey, says that the recent market upset has also given investors some breathing room to evaluate their positions and take a look at which managers they want to continue working with.

“After a crazy couple of years of mega-funds coming back for re-ups at accelerated paces and at higher rates, the LPs now seem to be able to take a breath and step back,” she says. “They seem to have more time and more openness to new managers again.”

Ford Buckley adds that LPs are more likely to favour specialists over generalists in a downturn, even specialists targeting especially hard-hit areas, such as business-to-consumer technology.