Tech spotlight: Sponsors cash in on tech overhaul of legacy industries

When thinking about the cutting edge of technology investing, perhaps automotive manufacturing isn’t the first sector that comes to mind.

And yet automotive is one sector that is experiencing an overhaul of a perhaps different kind than it is used to. The sector has been the target of several software deals this year focused on the digital transformation of legacy industries.

One example of this is Thoma Bravo’s acquisition of AutoData in March. AutoData provides software that helps support and promote the sale of vehicles, parts and services. The company also provides data-driven consumer-focused marketing.

Other such deals in the sector include Providence Equity’s sale process for OEConnection, which kicked off in May. OEConnection makes software for automakers and their franchised dealers. Its business includes e-commerce, pricing, supply chain, and other components, that help automakers and their dealer networks sell more original equipment parts.

In July CIP Capital backed the merger of Affinitiv and AutoLoop, which provide data-driven marketing automation and software for the automotive market.

Besides those, more deals are currently in the market: HGGC is in the second round to sell AutoAlert, a software provider of cloud-based services for car dealerships, and XIO Group is receiving bids for consumer rating and automotive marketing company J.D. Power.

These deals focus on software companies that serve a specific sector, known as vertical software. Private equity has intensified its focus on this type of software company that targets specific markets and niches, like automotive. Vertical software checks private equity’s boxes: secular growth, recurring revenue and strong intellectual property.

By value, technology broadly comprised 28 percent of all deal value in the quarter, which reached $160.4 billion in Q2 2019, according to latest Private Equity Deals Insights report by PwC.

Between 2016 and 2018, the number of PE exits from vertical software companies has more than doubled, reaching 22 deals worth $3.4 billion in 2018, PitchBook data shows. Growth in the category this year appears to have slowed, with just three transactions worth $300 million.

Taking more risk

The dropoff in M&A activity could be from oversaturation, one source told Buyouts. Many of the ripe PE targets within vertical software have already been picked, leaving a gap that could be filled by young but growing VC-backed software companies once they reached maturity, Stephen Master, vice president at GTCR, told Buyouts.

Blackstone Group is part of this trend. The firm said in July it would acquire Vungle, a mobile video advertisement startup. The deal was worth nearly $750 million, WSJ reported citing sources familiar with the deal. Since Vungle’s funding in 2011, the company said it has raised close to $30 million in venture capital.

Vungle is an example of a vertical software company that historically wouldn’t attract the interest of an established PE firm due to a riskier market focus and earlier stage, even if it does have strong growth and category leadership, Master said. “Investors are being pushed up the risk curve as GTCR and other PE firms have already acquired most of the available vertical software companies,” Master said.

Moreover, those assets have become highly expensive, forcing sponsors to look for alternative paths to capitalize on such assets: either via investing in software companies serving riskier markets—like media and local advertising—or by investing in earlier-stage, less profitable companies.

Software companies with stable growth currently trade in the high teens and some at 20x Ebitda, according to industry observers. Some trade even higher. Quick Base traded at 25x Ebitda, according to a person familiar with the auction process. The company, which allows people without coding experience to build business applications, was acquired by Vista Equity in January for more than $1 billion, WSJ reported at the time.

Attractive exits

GPs are more alert to attractive exit opportunities amid high valuations. Having a vertical software angle in a portfolio company can lift its price tag prior to sale, GTCR’s Master said. For instance, GTCR has doubled down its efforts to turn Cision, the owner of PR Newswire and provider of software for PR professionals, into a vertical software company. “When I think of vertical software companies, they are deeply embedded in many aspects of workflow for the vertical they serve,” Master said.

“When we acquired Cision, it was a regional business that was very good at one area of public relations workflow—identifying journalists by topic area. To make Cision more like a valuable workflow software company, we made a number of acquisitions to add capabilities that expand our coverage to a greater percentage of PR workflow,” he said.

In January Cision acquired TrendKite, responsible for media monitoring and analytics, and, a platform for social media engagement. Those add-ons were aimed at making the company look more like a vertical software company in terms of high retention of customers, high cash-flow generation and valuable underlying intellectual property and technology, Master said.

In March Cision was in talks with PE firms about a potential sale, Reuters reported. The company received a few in-bound inquiries from PE firms and hired Rothschild to address them, according to a source familiar with a process. The company is not actively looking for a buyer, the person said.

Move to DevOps

Even with a headwind of high valuations, interest in vertical software is going to persist and likely intensify in the next few years, Nehal Raj, partner at TPG, told Buyouts. “Companies in vertical markets like healthcare and insurance are buying software from third parties to automate previously manual processes. We want to invest in the companies that provide this software,” Raj said. “For example, an insurance company buying software to automate the management of their policy book.”

TPG is looking to invest in companies that provide software for those businesses to help them automate previously manual processes, Raj said. This trend leads to another one, much newer and with a slightly longer runway: the development of software products for developers writing code for new programs and applications, known as DevOps. “It’s a big trend, because you have new companies and new individuals building software companies for the first time,” Raj said. “We see an increase in demand for DevOps because we see a demand in software overall.”

The DevOps market is fragmented, with a number of small VC-backed companies and a few sizable ones. However, such fragmented landscape presents an opportunity for PE consolidation, Raj said.

Sponsors sold six DevOps companies in 2019 with a total value of $2.8 billion, compared to five deals in 2018 totaling $300 million in deal value, according to PitchBook data.

For some PE firms, such as Thoma Bravo, investing in DevOps is not new. In January, the firm acquired VeraCode Software, a provider of next-generation application security testing (AST). “Today, across every industry, companies are building their own software applications to run their businesses. As these digital transformations become more prolific, dev ops, including security at the application layer, becomes increasingly critical,” Seth Boro, managing partner at Thoma Bravo, told Buyouts.

The firm is also looking for new opportunities in earlier-stage companies, Boro said. “We have very forward-looking software companies in our portfolio – very entrepreneurial, with significant growth potential and a focus on driving innovation to match the evolving technology landscape,” he said.

Update: This report was updated to provide more context around Nehal Raj’s quotes.