Again, I can't make any claim to being an expert on the subject, but I've made the argument before that PE and technology companies do not mix. As I was showering the other night in preparation for my J.O.B., the primary reason for this state of affairs came to me. I would also like to thank Equity Private for the insight shared with me by e-mail a few nights ago, for this helped crystallize the logic in my mind.
Private equity should be about operations. Squeezing operational efficiencies out of mature businesses (or business models). Expanding into new markets. New leadership. Adjusting the capital structure. Acquiring customers (and competitors). Reducing costs. Involving stakeholders. That's what it *should* be about. Taking a poorly performing enterprise and making it...well...perform.
At least, that's my (somewhat high minded) theory.
It would appear that in the last few years, the performance piece of the puzzle has been lost (intentionally?). Yes, there is plenty of levering and capital structure machinations, but not much else.
I don't think selling off assets (EOP) or the traditional "corporate raider" model can be applied in technology. The technology space never rests. There is always some innovation occurring; tis the nature of the beast. Even the lowly hard drive, courtesy of tech PE darling Seagate Technologies, is evolving constantly. Higher densities are the primary way, but interface technology is also changing. Witness the growth in Serial ATA (SATA) and SAS interconnects. In networking, we have the same thing. Never mind all the dark fiber that was buried and has subsequently been written off by network providers. We've got 10 Gb Ethernet here, and even faster modes on the way. You can peel off tons of lambdas over a given strand of fiber. The race is unending.
This is why technology companies do not (now) make good PE targets. When the basis of your business is innovation, research and development, and your window to get to market and make back the investment grows increasingly shorter, there is no way for even large tech companies to rest on their laurels and collect rivers of cash. Levering is largely, if not exclusively, about being able to service debt. (Commercial real estate shares this property, and it is an equally simple business at the most basic levels.) However, the interest payments on the leverage employed in taking out a technology company cannot be guaranteed to be serviceable based on the standard market fluctuations in technology. Things change too fast to count on that constant cash flow.
Recently, Investment Dealer's Digest had a bit about the new-ish emphasis on bringing operators into PE shops - rockstar CEOs, as the saying goes - with lots of connections, hands-on experience and wisdom. THIS, to my mind, is the essence of the proposition. Financial engineering can only take a business so far. That isn't to fault the VPs and rainmakers, but seriously at some point, the enterprise has to be able to consistently MAKE money.
Last week I was sitting in on a conversation between my business partner and my second cousin's wife who works for IBM. My cousin's wife was making the point that the bean counters have taken over the company and their solution to every problem is to cut - something, anything, just make costs go away. This is not a long term solution to the problem. If you've got a business pipeline that will fund operations profitably, but your staff is already overworked, you can't just leave the staffing where it is. You have to be able to add people and resources to do the work faster and better. Under such circumstances, refusing to add headcount, or even worse, to try to remove it, is absurd. Quality of service delivery will suffer, which will impact the brand and eventually the commitment of those customers to continue to pay for the services. At least, they will probably seek to spend that money elsewhere. The same point applies to IBM as it does to PE shops looking to take out a technology company. Innovation is the name of the tech game.
Now, I can see some exceptions, and as I may have previously mentioned, there are some operators that seem to know where the intersection of technology and private equity lies. Or at least they are closer to finding it than others. Seagate and Flextronics would seem to be too good examples, and both were Silver Lake deals. Silver Lake is much more of the exception however, because technology is all they do. Both of these were manufacturing heavy companies which probably had outdated processes and facilities, and are operating in fields with razor thin margins. There was probably a lot of upside to these deals because they are operating at the intersection of the "real", tangible world and the technology world. That will be less the norm in the future, as fewer companies will be engaged in creating hardware products and even more development is channeled into software. I don't know that the same kind of benefits can be engineered in a software company that have been engineered with Seagate. You can always reduce headcount and spin off divisions, bring in new managers, recapitalize and reorganize, but at some point, you'll need new product which means new ideas, new research, new development, new engineering, plus all the other stuff (QA, documentation, support, distribution, security, sales, etc.).
At the end of the day, the company has to be able to perform. Private equity should be a vehicle, and I have no problems with it being a well compensated vehicle, for increasing corporate performance. Create. Innovate. Execute. Wash, rinse, repeat. All of that takes of precious cash that most of the current generation of PE firms would rather have flow to them, as management/consulting fees or dividends. Technology companies have to be able to move fast, and debt is a burden preventing that kind of dynamism. If you're not moving, you're dead, and a tech company weighed down by debt is well...figure it out.