Private Equity Monies Move Into Software & Services Marketplace

Posted on June 4th, by thinkstrategies in HaaS, Hardware-as-a-Service, private equity, SaaS, Software-as-a-Service, utility computing. Comments Off on Private Equity Monies Move Into Software & Services Marketplace

With last week’s announcement of a private equity buyout of major computer hardware and software distributor, CDW, speculation is escalating about where this new influx of investors will strike next within the information technology (IT) industry.

The CDW deal comes two weeks after computer and database services provider Acxiom Corp. agreed to be bought by Silver Lake Partners and ValueAct Capital Partners LP for about $2.24 billion. Now, some see Dell as a likely buyout candidate, others are speculating about whether computer chip software design vendor Cadence will ‘go private’.

I think a series of private equity deals will be aimed at a wide array of publicly-traded, incumbent software vendors (ISVs) in the coming months. These ISVs will boast a significant installed base of customers, but will also be facing significant challenges keeping pace with the Software-as-a-Service (SaaS) movement. I also believe that private equity firms’ focus on the SaaS market will carryover into the hosting and managed services sectors.

These are not necessarily bold predictions. If you follow the software and services sectors closely, you know that in August 2005, a consortium of private equity investment firms organized by Silver Lake Partners acquired SunGard, the disaster recovery and back-up services solutions provider. The consortium also included Bain Capital, The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. L.P., Providence Equity Partners and Texas Pacific Group.

Bain Capital was also among those that pulled USinternetworking (USi) out of bankruptcy in January 2002, which led to its acquisition by AT&T in October 2006.

As recently as March of this year, Silver Lake Partners were rumored to be negotiating to purchase a share of SAP.

However, I think one of the primary motivators for more private equity deals in the software sector will be escalating pressure among ISVs to fundamentally transform their business operations to adopt the SaaS model.

Moving to SaaS requires three traumatic changes in ISV operations—a new web services oriented software architecture; a new amortized subscription pricing revenue recognition methodology; and a new go-to-market sales structure.

Few publicly-traded ISVs will be able to cross this chasm. The majority will be unable to make the necessary investments in R&D, sales and marketing teams at the same time they are coping with flattening revenues, due to SaaS’ pay-as-you-go pricing schedule.

This will drive many ISVs to seek shelter in private equity deals that can take them out of the microscopic spotlight of the public market. These transactions will give the ISVs time to transform their operations before reentering the glare of the public marketplace.

The private equity firms will be happy to capitalize on these opportunities because many ISVs have a strong hold on their current customers by virtue of their entrenched legacy applications and maintenance agreements. Despite plenty of customer dissatisfaction, many of them are essentially held captive by their ISVs or would be willing to remain with their current software vendors if their applications can be made easier and more cost-effective to use.

This means that under the right conditions these ISVs could make the move to SaaS and their private equity investors could reap the rewards of the subscription pricing and annuity revenue model.

These same dynamics will spillover into the web hosting services market where companies like Navisite, in addition to USi, have gained a new lease on life with the infusion of private equity funding. These investments will also be fuelled by the growing popularity of ‘Hardware-as-a-Service’ (HaaS) utility computing service offerings from companies such as Amazon.

It is for these reasons you can expect the tide of private equity deals to rise in the software and services sectors of the IT industry.

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