Rebooting Software Slowpokes Yields Riches for Two Buyout Firm
- Thoma Bravo and Vista Equity Partners competing for tech deals
- `They know software, and they have been very successful’
Orlando Bravo grew up in Mayaguez, Puerto Rico, the son of a shipping agent, and dreamed of becoming a professional tennis player. Robert Smith, raised in a middle-class black family in Denver, was a tech whiz.
Today, the two run private-equity funds raking in profits in a once overlooked corner of the technology industry: business-software companies past their prime. Their firms, Thoma Bravo and Vista Equity Partners, have led or co-led six of the 10 biggest leveraged enterprise-software buyouts since 2013, data compiled by Bloomberg show.
Mustering $17 billion between them in new funds since 2012, the firms have barged into the top tier in tech buyouts, mixing it up with giants such as Blackstone Group LP, Carlyle Group LP and Permira Advisers. This year Thoma Bravo rounded up $9 billion in debt and equity to finance what would have been the second-biggest tech takeover in eight years, a buyout of software and ATM maker NCR Corp. NCR’s board spurned the bid in July.
“Thoma and Vista are great at what they do,” said Dave Johnson, head of technology investing at Blackstone, the world’s largest private-equity firm. “They know software, and they have been very successful.”
The firms are fierce rivals. In a bidding contest decided in mid-September, Vista edged out Thoma Bravo to capture Solera Holdings Inc., which makes software for auto insurers, for $6.5 billion including debt. It also snatched control of Tibco Software Inc. last year for $4.3 billion, while Thoma Bravo won Compuware Corp., a seller of software and information technology products, for $2.5 billion.
Still, they have more in common than they care to admit — more than being led by executives from minority groups. Vista, which solely does software deals, and Thoma Bravo, with more than 80 percent of its money in software, are the only buyout firms with at least $5 billion in assets focused predominantly on that corner of tech. Their expertise has helped generate strong returns plying the more than $300 billion-in-revenue global enterprise-software market.
Both firms strive to cut waste, boost margins and productivity, and fire up sales. The cash-flow margins of companies Vista has owned for more than three years have almost doubled, to 32 percent on average from 17 percent, with revenue gaining more than 20 percent, according to a confidential marketing document obtained by Bloomberg. Thoma Bravo angles to double earnings and lift margins to more than 30 percent.
“Our strategy starts with the premise that you can have both high margins and high growth,” said Bravo, 45, who got his start with Chicago buyout firm GTCR LLC. “That view is not widely shared in our business.”
Underpinning the firms’ performance is a breakthrough idea that other buyout shops were late to grasp, said Paul Crisci, co-head of U.S. technology investment banking at Jefferies Group, who has financed deals for both firms.
“Because tech investing was supposedly all about growth, other firms wouldn’t touch a company that wasn’t growing fast,” Crisci said. “They’d say, ‘Oh, that’s a Thoma-Vista deal.’”
Thoma Bravo and Vista upended that thinking, Crisci said, showing they could find gains by overhauling older software companies, as buyout firms do when they take over a lagging chemicals distributor or cosmetics maker.
“We saw that the value these enterprise-software companies bring to customers is enormous,” said Smith, 52, a former Goldman Sachs Group Inc. technology banker. “Yet most are still run by their founders, and many aren’t run that well.”
Vista, based in Austin, Texas, has developed a playbook for how its companies should operate, and that often involves replacing former management. The manual, known as “Vista Standard Operating Procedures,” has grown to more than 50 white papers covering every aspect of business, from internal controls to product development and sales.
Employees of Vista’s companies learn what to do in six-month boot camps. A cadre of 78 veteran tech executives and consultants leads the training.
“These companies are more alike than they are different in how you should run them,” said Smith, who favors three-piece suits and loves to riff on the wonders of software. “We break it down into discrete steps.”
When Vista bought Sunquest Information Systems Inc. in 2007, the designer of medical diagnostic-testing software had endured five straight years of declining sales. Vista homed in on the product pipeline, cutting 57 projects Sunquest had percolating to 17 it judged could turn the most profit, Smith said.
The company moved about 60 engineering jobs from Bangalore, India, to its headquarters in Tucson, Arizona, training the group to pump out code faster with fewer mistakes. It stepped up research and development spending by 30 percent, and almost tripled its sales force.
Vista’s technological prowess has evolved to where it can reduce the time needed to install enterprise software by weeks or months, a key selling point, according to Smith.
“We cut the install time by half, and we nearly tripled the amount of code we put out, with fewer bugs,” Smith said of Sunquest.
Vista made three small acquisitions to add products. All 17 projects in the pipeline panned out, Smith said, as did the rest of the program. When Vista sold Sunquest to what’s now Roper Technologies Inc. in 2012, revenue was up 43 percent to $210 million, and cash flow had soared 166 percent to $125 million, Smith said. The payoff was among Vista’s biggest: an $881 million profit on a $200 million investment.
Thoma Bravo, based in Chicago, takes a different approach, working whenever possible with existing management. It has focused on public companies under fire from activist investors as their growth stagnated. Since 2012 it has scooped up three — Blue Coat Systems Inc., Compuware Corp. and Riverbed Technology Inc. It makes changes swiftly to increase margins and cash flow.
At Blue Coat, a maker of security and networking software that was slumping badly when Thoma Bravo bought it in 2012, the company increased research and development spending and added technology through acquisitions that boosted market share, according to Greg Clark, chief executive officer before and after the acquisition. In May, Thoma Bravo sold the company to Bain Capital LLC for $2.4 billion, reaping a more than $600 million gain on an equity investment of about a $260 million.
Growth, not cost cuts, drove that result, said Clark, pointing out that the company introduced almost 50 new products last year.
“You can’t cut your way to 200 percent cash-flow growth and 50 percent revenue growth,” Clark said. “We didn’t rip out costs. We innovated.”
Bravo, who has business and law degrees from Stanford University, abandoned a tennis career after playing against future star Jim Courier at Nick Bollettierri’s tennis academy in Florida.
He spent a year working for GTCR in San Francisco, where he still lives, before following Carl Thoma, one of the firm’s co-founders, and Bryan Cressey to their breakaway shop, Thoma Cressey Equity Partners. The firm was renamed Thoma Bravo and trained its sights on software after Cressey’s departure in 2008. Thoma, 66, described his role today as being “a sounding board and adviser to Orlando.”
Smith landed an internship as a 17-year-old at Bell Labs in Denver, where his parents taught school. After earning degrees in chemical engineering from Cornell University and business from Columbia University, he did technology research before joining Goldman Sachs in 1994, later becoming one of its first tech mergers and acquisitions bankers in San Francisco. He left in 2000 with colleague Brian Sheth to start Vista.
Today, Vista has $15.9 billion of investor capital, more than twice what it had two years ago. It has put $7 billion of equity into more than 30 companies since 2007, while posting annualized returns after fees of 29 percent and 25 percent at two funds that started making investments that year and in 2011, according to the marketing document.
Thoma Bravo, which oversees $10 billion of capital, has generated annualized returns after fees of 44 percent and 37 percent on the funds it started deploying in 2008 and 2011, according to a person with knowledge of the matter who asked not to be named because the information is private. That compares with median returns of 14.5 percent and 14.9 percent for North American private-equity funds that began investing in those years, according to London-based research firm Preqin.
Those returns could tumble. As they hunt larger targets amid intensifying competition, Vista and Thoma Bravo face a challenge that didn’t exist when they were smaller, said Scott Kamran, a senior managing director and technology banker at Evercore Partners Inc.
“These guys have crossed a threshold,” Kamran said. “They’ve raised bigger and bigger funds, but there aren’t that many large software companies” left to acquire that match their criteria, he said.
Bravo said his firm’s seven-year joyride may not last. A threat to its performance looms over what has helped fuel it: toppy prices. Vista paid more than 18 times Tibco’s previous 12-month Ebitda, or earnings before interest, depreciation amortization and taxes, a measure of cash flow. Thoma Bravo spent 13 times Ebitda for Riverbed. That compares with a median value of 11.5 times Ebitda for all leveraged buyouts in the U.S. over the past two years, according to data compiled Bloomberg.
The torrid market has also been a boon, enabling the firms to unwind older bets for big gains — sales that have left them less exposed if prices dive. Both have billions of dollars of unspent capital to unleash.
“I absolutely expect our returns to come down,” Bravo said. “Based on the prices we’ve been paying, they are unsustainable.”
At the same time, given its knack for jump-starting growth, Thoma Bravo should do just fine, he said.
“More important than what you pay is what you do after you buy,” Bravo said. “You’ve got to innovate in your methods and stay focused. If we do that, we’ll deliver very good returns.”