A sluggish market for initial public offerings and a steady appetite for growth capital means private credit has an opportunity to play a vital role in bridging that gap for burgeoning tech firms, according to Viral Patel, Blackstone Credit’s global head of technology investing.
Patel spoke with Bloomberg’s Ellen Schneider about a rift in valuations between buyers and sellers, along with Blackstone’s eye on long-term tailwinds and defensive investments. Comments have been edited and condensed.
There was a lot of take-private activity in 2022, but things have slowed in the first half of this year. What’s your outlook for the remainder of 2023?
The take-private part of our pipeline continues to be fairly active.
Sponsor-to-sponsor activity we’ve seen to-date continues to be muted because of bid-ask spreads. There’s a valuation gap between buyers and sellers. A lot of companies are still trading meaningfully off their highs, ands we continue to see sponsors looking at those assets as a way to find attractive companies that were historically unattainable.
With the market rallying a bit this year, it’s little bit slower, but we have an active part of our pipeline focused on that and sponsors are continuing to call on it.
At the company level, what are some of the biggest challenges facing tech companies today?
One of the biggest issues the tech sector faces right now is access to capital, the way they it had historically.
Valuations are down significantly from their peaks and that’s directly correlated to the rate environment. What that means for companies looking for access to capital on the equity side is, you’re looking at a down round.
Second is broad macroeconomic uncertainty. One of the things the sector is seeing is sales cycles are taking longer right now. So, all company buying decisions at the customer level are undergoing more scrutiny.
Third has been a balance between growth and profitability. Historically, a lot of these companies have been driving their operating models focused more on growth, less on profitability. As it relates to lending to tech companies, the credit story has gotten more attractive because what we’re seeing is that even though growth is slowing, it’s still growing.
When it comes to growth capital for tech companies, what makes private credit a good solution versus venture capital?
At Blackstone, we focus on mature late-stage businesses. We’re fundamentally cash flow-based investors. We don’t participate on the core venture lending or early-stage growth lending side.
One of the key themes that we’re seeing play out across the tech sector is consolidation. There’s been a lot of point solutions that were created over the last decade, but customers are looking more for companies that can provide a suite of solutions, versus just one singular one.
The reason private debt has become more interesting is that historically, a lot of these businesses have been rated. Private credit provides confidentiality and efficiency because companies don’t need to get a rating, and there’s certainty of execution.
Many of the tech lending deals have come in the form of ARR loans and some companies are struggling to meet the conversion to Ebitda deadlines. How are you handling these situations?
Our platform is primarily focused on underwriting cash flow-based loans, so while we do have some ARR loans in our book, it is not a major focus for our platform.
We’ve focused on ARR loans that are in larger, faster growing companies with strong gross margins and unit economics, so they can shift into an Ebitda-based loan. The thesis behind it is as companies slow their top-line growth, they reduce the amount of spend on marketing and sales, and drive profitability margins up. The businesses that we focused on can reduce the cost load to get to that Ebitda break-even point.
What’s your outlook on IPOs?
The IPO markets will continue to be an attractive option for tech companies.
There’s a healthy backlog of businesses that are waiting to go back once the market opens up and you could see some more IPOs in the second half of 2023.
I think the question is how deep is the bid in the markets today for an IPO of size? Most of the deals that have happened recently have been on the smaller side.
That said, there’s a lot of private equity capital and private growth equity capital that can continue to fund these businesses for a longer period.
I don’t think these businesses will feel the pressure to go public sooner than they have to. They have a lot of alternatives to stay private and wait until it feels like it’s the right time and valuation environment to go public in.
What parts of the sector are you staying away from, and which are you excited about?
One is cybersecurity. If you think about the threats that are facing corporations today, those are ever increasing, they’re not going away. We like cybersecurity because it’s highly defensive, it’s difficult to turn off your cybersecurity software. It’s not something a company is going to do lightly.
Another area we like is software companies focused on the increasing volume of data among corporates. Corporations are creating and using data more than ever. But in order to get the most out of that data, they need to be able to organize and analyze it. A lot of companies provide software and tools to help do that. We think that’s a trend that’s going stick around, so we’re investing heavily behind that.
We tend to avoid lower-quality tech businesses that are slower growing and have poor unit economics and big components of their businesses that are non-recurring or services-oriented that don’t have the ability to drive profitability and margin.
