With technology stocks taking a hit in public markets, scrutiny of private investments in the sector is rising. PE Hub Europe spoke to David Toms, head of research at Hg, for his view.
Hg is headquartered in London with offices in Munich, New York, Paris and San Francisco. It focuses on software and tech-services investments and looks for SaaS companies and firms that provide critical services.
The firm has more than $55 billion in total funds under management and has led over 170 investments in the tech sector. Its large-cap fund, Saturn, has invested in some of Europe’s largest software buyouts, including Access Group and Visma. Earlier this year, it bought most of EQT‘s stake in Linköping, Sweden-based cloud-based enterprise software provider IFS and Holmdel, New-Jersey-based field service management software provider WorkWave. The deal valued the companies at $10 billion.
Other investments this year included Ideagen, the Nottinghamshire, UK-based provider of compliance software for regulated industries, in July. The firm also made a series of promotions across its geographical footprint in April.
Toms is responsible for researching how market trends and data impact potential investments, portfolio companies and possible exits. Here are his thoughts on the outlook for the technology market.
How has the tech sector fared this year compared with last? Are private valuations holding up or are they struggling like in the public market?
The tech sector continues to trade very strongly, with double digit revenue and earnings growth. It also benefits from a high degree of insulation from some of the broader challenges of inflation, with very low input costs and little dependency on energy. By far the largest impact on valuations has been on the high-growth, no/low-profit companies which have seen a circa 70 percent decline since last year. The profitable, cash-generative businesses that form over 90 percent of our portfolio have seen a much smaller valuation decline, more reflective of the general fall in all equities.
Given the backdrop of rising rates and inflation, are there some subsectors of technology that you see as likely to perform better than others? Which subsectors are less likely to perform well?
Software that automates business processes continues to be a key focus for us, due to its high degree of inflation protection. Many of our companies provide software that frees up human labour for higher value-add (and more interesting and stimulating) activities – in an environment of rising labour costs and falling labour availability, anything that helps drive labour productivity is well-positioned for continued strong performance. Consumer-focused tech is clearly facing a more challenging time, as are companies with low or negative margins, where input cost inflation has a much greater impact on earnings.
We’ve heard the market is moving from being a seller’s market to becoming more balanced, or even a buyer’s market. Does that tally with what you see, and what is the picture specifically in the technology sector?
We definitely see a more restrained approach in the markets generally – last year, valuations (particularly in the public environment) were almost entirely driven by growth, with scant regard for underlying economics or profitability. This has shifted rapidly, with a much greater focus on those economics and a more cautious approach to speculative/extreme long-term investments.
How is the exit market? Are all options – IPOs, trade sales, PE sales, etc – on the table, or will you have to be more selective?
Hg typically sells to trade or to other financial investors; IPO is a very rare exit route for us – in fact, on balance we have taken more public companies private than we have undertaken IPOs. From this perspective there will be little change for us, but the IPO market is clearly very different to last year, and the SPAC market has also slowed dramatically.
What is the balance for your European portfolio companies in terms of organic growth versus M&A? Is one approach more attractive just now and if so, why?
Our portfolio companies typically deliver double digit organic growth, and a similar amount of incremental growth through M&A. Over the next 12 months, if the valuation environment remains somewhat depressed, M&A may become relatively more attractive.
Is cross-border consolidation in the European tech market achievable or do regulatory and cultural differences make it too difficult? Is this subsector specific?
This is very subsector specific, and it is worth noting that cross-border M&A is not the same as cross-border consolidation. Some of our businesses (eg, Visma) are very active in cross-border M&A, as they see opportunities to repeat a successful playbook in a less mature market, share learnings and improve products for their underlying customers. This does not necessarily involve consolidating the businesses but may mean leaving them to function largely independently but providing some shared resource and experience. The move to cloud delivery of software aids this by enabling a greater degree of resource-sharing particularly in R&D, operations and delivery infrastructure.