After driving ample returns into portfolios for more than a decade, technology companies have hit rough waters recently. With the Nasdaq 100 falling more than 25 percent in the first six months of 2022, many investors are looking to decrease their tech exposure as they build defensive positions against a broad market downturn. But not all news from the tech space is bad, as a specific niche in private equity is well suited for potential sustained growth even amid a recession.
Private debt markets are robust
For starters, the PE market, at large, is giving investors some much-needed optimism and shelter. “The state of play in private debt is robust, and growth in our market has been accelerating,” says Matt Fleming, Managing Director of Antares Capital. With rising rates and greater volatility, investors are seeking private-debt investments with floating rates to protect their portfolios, he notes. But beyond serving that defensive purpose, a tech-focused PE strategy can also be a growth driver.
“Tech-focused PE strategies are holding up even with the decline in public valuations, and in certain cases, create more opportunities for these PE strategies,” he says. “The current environment has created a significant number of private opportunities that would not have been previously available. Some of these have already been announced, and we expect several more before the end of the year.”
Think B2B software
As for targeting a tech niche in the PE market, Fleming says that B2B software companies are offering institutional investors particularly strong opportunities. “At Antares, we are laser-focused on software companies that have business customers rather than consumer end markets,” he says. The recent price declines in the tech sector have mostly affected companies with large consumer end-markets, he notes, while mid-sized software companies in the B2B space haven’t seen these levels of drops.
“As it relates to the inflationary and potentially recessionary environment, B2B software companies are more insulated than the broader market,” says Fleming. They’re considered much less vulnerable to supply chain issues or rising labor costs, and they can also pass increased expenses onto their captive corporate customers, he says. “These companies have recurring revenues, strong retention, and stable free-cash flow – and we expect many to thrive through a downturn just as they have during times when the market’s been strong,” Fleming adds.
Fleming also expects software financing structures to fare quite well during a recession. “One key reason is sponsors have a lot of skin in the game with these companies, so sponsors and experienced direct lenders are both well incentivized to cooperate and work through any issues that might arise in a downturn,” he says. While leverage has increased over recent years, he notes that the average purchase price multiple for B2B software companies has grown at an even faster pace. “We are beginning to see signs of lower purchase price multiples across our broader new opportunity pipeline, but less so with software, where the average purchase price multiple for deals we have financed recently is averaging around 20 times,” says Fleming.
Big advantages in middle market
Antares focuses heavily on middle-market PE investments, and they’re proving resilient in current conditions. “In the middle market, we’re not seeing valuations move,” says Fleming. While they could shift at any time, “there’s so much dry powder on the sidelines of our sponsors, even they’re saying valuations are not moving.”
Additionally, the middle-market tier offers inherent advantages that make B2B software companies even more attractive, Fleming says. In contrast to startups, these businesses have demonstrated models and sufficient scale. And, just as importantly for the PE market, their leadership teams are also far more accessible than those at huge tech companies – which gives lenders greater influence in charting the path ahead.
“Middle market PE is a very relationship-focused place, and at that size we can really drive the discussions, particularly since we lead a majority of deals we do,” Fleming explains. Such qualities – plus the strengths of B2B software companies – put them firmly in the sweet spot for Antares, he says, allowing the company to lead PE deals that still have the scale needed to be attractive. In contrast, large tech companies often have deals involving ten or fifteen lenders, with no single one taking the lead.
It’s critical to be choosey
“We only commit to approximately 25% of the software companies that come through our door,” Fleming notes. “As a relationship-focused lender, we want to pick really strong companies that we want to finance in good times or bad.”
Further, Antares only finances companies that are sponsor-backed and they work closely with those sponsors, he says. “We are going to be consistent and reliable for our sponsor relationships, and they know that even though the market is hitting a tougher patch, we will be there for them on the assets we like.”
Playing offense, not just defense
Rather than only making defensive moves, institutional investors are now continually asking Antares how they can capitalize on the current market to find opportunities, Fleming says. “They still want to deploy money, make money, and go on offense,” he notes, and many have a solid grasp of how middle-tier B2B software companies are poised to outperform, even if – like the PE market at large – they’ll require longer holds if the broad economic landscape continues to get rockier.
Using a tech-focused PE strategy is a versatile way for institutional investors to keep playing offense while also preparing for an economic downturn. “The big headlines aside, tech and software is a very good place to park money right now,” says Fleming. In a larger sense, the ability to play both offense and defense well is a core reason why experienced managers tend to outperform in all economic cycles – and why Antares has thrived for more than 25 years. “In the choppier economic environment we are in now, the best opportunities for investors will come from working with reliable, long-tested asset managers like Antares,” says Fleming.