The New Trend Ripping Through the Tech Sector
Imagine you’re the CEO of a struggling public company.
Sales are tumbling… Profits are non-existent… You’ve got little cash on hand… Debts are mounting… Shareholders are beating down your door, demanding to know how you’re going to turn things around.
Yet many of your options, like cost cuts and layoffs, aren’t exactly ideal.
So what do you do?
The answer doesn’t always come from within. Oftentimes, like a white knight to the rescue, the savior can come from outside the company.
Wall Street’s Corporate “Fixers”
I’m talking about a leveraged buyout (LBO).
Back in the 1980s, specialized Wall Street firms like Forstmann Little & Co. or Kohlberg Kravis Roberts & Co. were experts at buying inefficient public companies. They either broke them up and sold them for their parts, or fixed them and returned them to investors in a healthier state.
Yet technology companies were all but immune to the threats and rewards of these firms. The business risk was simply too high.
Historically, LBO firms have preferred to buy more-mature companies with more-stable cash flows or predictable business cycles, so that the large debt loads associated with these kinds of buyouts could be more easily supported. Younger companies with higher risk tended to be left to venture capital firms.
But the game is changing. And it’s reaping massive rewards for tech investors who know where to find the profits…
LBO Firms Follow Tech Sector Money Trail
A new wave of tech buyouts has begun – one in which smaller firms with less-developed products are being taken private with large amounts of debt and relatively scant equity.
This wave began as a mere ripple in the early 2000s, with a few high-profile tech buyouts. Back then, LBO firms preferred to buy companies that boasted many characteristics of their more-traditional targets – particularly stable cash flow.
Examples include companies like SunGard Data, which had a tried-and-tested pipeline of financial services software, plus secure data backup technology. Similarly, Freescale Semiconductor (FSL) had a huge inventory of off-the-shelf computer chips used in multiple industries for several applications. This firm also entered private hands.
And while these investments weren’t the blockbusters that their “sponsors” hoped for, it did prove that technology LBOs could be done profitably – and set the stage for more to come.
One LBO that was a blockbuster happened when Michael Dell successfully partnered with Silver Lake Partners to buy Seagate Technology, an investment that returned over 700%. Dell and Silver Lake teamed up again on a much larger buyout – his own Dell Computer. Dell says his company is now recovering in a way that wouldn’t have been possible in the public market.
Fueled by those successes, a flood of money has hit the tech LBO market…
Three Trends Firing up the LBO Market
The leader of this new movement is a company called Thoma Bravo. It’s raised over $ 3.6 billion to direct to tech sector buyouts – and is said to be raising $ 1 billion more.
With the addition of leverage, the firm has enough power to spend $ 15 billion-plus on technology companies! Indeed, it’s already started. The firm has completed the purchase of Compuware Corp.(CPWR) and has agreed to buy Riverbed Technology (RVBD).
So what’s driving this new tech trend? A few things…
- Go Private, Reap Profits: You know the deal with Wall Street. If something is possible, someone will do it. As I mentioned, LBO companies have proved that it’s now possible to take tech firms private and not kill them. On the contrary, it can be quite profitable.
- Interest Rates: Even after a recent increase in yields, LBOs can be funded at rates that would have been unthinkable before the financial collapse of 2008. Low interest rates and relatively small risk premiums assigned to lower-rated debt are two compelling forces propelling the tech LBO market.
- The Power of Rarity: Like a vintage wine or rare coin, a shortage of other opportunities is pushing tech LBO demand higher. This is arguably the biggest trend. After three decades of buyouts, just about any traditional, cash-rich company that could have been bought has been bought. It’s reached the point where some have even seriously discussed whether a giant like Home Depot (HD) might be taken private! In addition, LBO firms have seen their returns falling, with hedge funds also finding it tough to beat the market averages. So to chase returns, these firms have had to move into areas where they previously felt uncomfortable.
The Most Powerful Force Driving Tech Stocks Higher
With these trends all in play, Thoma Bravo isn’t alone in raising money for tech buyouts right now. And if these buyouts succeed, you bet that others will follow.
The question is: How do we take advantage?
Well, for a start, we’ll leave the bulk of the risk to LBO firms. While there are opportunities, there are risks, too, as the number of tech firms available for investment will decline. That’s because LBO firms will join private equity firms and other strategic buyers in taking companies off the public markets, or even buying companies before they go public at all!
Rather, the opportunity for us is two-fold.
Opportunity #1: Takeover Targets. When an LBO firm buys a tech company, it’s already thinking about how to eventually sell it. Sometimes, it will sell to a strategic buyer, or another buyout firm. By identifying companies ripe for a takeover, savvy investors may be able to profit.
Opportunity #2: Institutional Interest. Most often, LBO firms are thinking about how to take their acquisitions public. This means they’re buying companies that will prove highly attractive to heavy-hitting institutional investors. Institutions that find companies soattractive, in fact, that they buy up tons of shares… and drive the stock price significantly higher.
How do I know this? Because I used to do it for a living in the heart of Wall Street!
Over my 20 years in the financial industry, I was an institutional investor, who directly helped finance some of the biggest LBOs in history. So I know precisely what factors these institutions are looking for in companies.
Ultimately, I’m always on the hunt for companies that are poised to receive serious attention from the kinds of institutions that buy enough to double, or even triple, the share price.
In fact, this strategy is a major cornerstone of my research advisory service. To learn more about this strategy, and how I incorporate several other indicators to pinpoint small-cap stocks destined to hit the stratosphere, click here.
To living and investing in the future,
Greg Miller
