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00:00Congratulations on this story. We talk a lot about the SaaSpocalypse, but this is really a
00:04deep dive into leveraged buyouts and what initially was so attractive to some of these
00:09private equity firms about software. That's where I want to start because, you know, there was this
00:14joke like, you know, oh, that's software margins. The margins on these companies for so long was so
00:19high, and that was part of the attraction. Absolutely, because the better the margins,
00:23the more debt you can load it up with, right? The whole basically private equity business model is
00:29to use debt to lever up a company when they buy it. The debt is not borrowed by the private
00:34equity
00:34firm. The debt is borrowed by the target company being acquired. Please repeat that last part,
00:39because that is a really crucial point when it comes to a leveraged buyout. Wait, isn't that a
00:42classic private equity also move? Yeah, exactly. This is how private equity makes so much money.
00:48It's through leverage, but the key thing is that the private equity firm is not on the hook for
00:52that leverage. The target company is, and that's kind of what's at stake right now.
00:55Well, so let's talk about this, because I think one of the things that we keep thinking,
01:00is it one shoe to drop? Is it two shoes to drop? Is it a lot of shoes to drop?
01:04Because so far,
01:05it seems to be manageable. So tell us about kind of what we are, what we've seen,
01:12but why maybe the situation or environment is changing for some of these names.
01:17Yeah, and so that's an important distinction to make. The SaaS apocalypse has not happened yet,
01:21right? This is all about the fears that it could be coming. So at the heart of it,
01:25AI technology has the potential to disrupt existing software businesses that were considered pretty
01:30much fine. And the fear is that you'll have certain types of software companies especially
01:35affected. If you are providing software that's like the infrastructure layer of a company,
01:39probably okay. If you're doing data visualization and that's your main product, you can just plug
01:44that into Gemini or ChatGPT, and those business models could be especially at risk.
01:48Can you do that that easily?
01:50That's a fair point. And that's one of the defenses people have, which is that if you're
01:55a big corporation, you have all your employees using certain products, you're not going to have
01:59them just go off on their own and use AI. But cloud code has developed very rapidly, and that's
02:05maybe taking the place of some products that would help software developers.
02:08Is the concern specifically that with some of these types of services you describe and you write
02:13about, you would have internally people create some sort of program, maybe vibe coding or use
02:20cloud code to do this, that would replace paying for seats of certain, paying like on a per seat
02:26basis for certain companies?
02:28Exactly. And the fear is that even if this doesn't fully disrupt revenue, it could chip away at it,
02:32can maybe even just chip away at revenue growth. And that's where the debt comes in.
02:36I don't know. I'm still skeptical of the whole thing.
02:42That you believe that it's going to actually work and that companies are going to entrust
02:45doing data analysis or tracking.
02:48Part of it has to do with like the pipeline of innovation at some of these companies. Like
02:51they're constantly iterating on their products and making their products better and better for
02:55their customers. I mean, that's the way, that's the way that it's worked. You can't just get,
03:00you know, one person within a company to create a rep, you know, to replicate something that
03:04they've been paying for for years.
03:06But then, but then have the updates and make it better and better. I don't know.
03:09I think this is the big question.
03:10I'm not trying to be a defender of all these SaaS companies.
03:12No, I think this is the big question. And this exact discussion we're having right now
03:16is what investors are trying to figure out, right? Is this a real risk? Is this not a real
03:20risk? And then you get to this point where, okay, I'm an investor. How do I pick winners
03:25and losers? How do I anticipate winners and losers? And that's where a lot of the questions
03:29are right now.
03:30Yeah. But the thing is the bets have been made. The deals have been made. The debt's been
03:35issued, right? So then who's that risk? Like let's, let's, let's pull, carry it out.
03:41Let's say there is a SaaS apocalypse. It's so hard to say.
03:45Um, but let's say this does happen. What does that look like? Who gets hurt? What investors
03:51get hurt? What companies get hurt? Who's on the line for the debt that ultimately doesn't
03:56get paid back or pennies on the dollar?
03:59So there are a lot of people who could be affected by this in the investment community.
04:03Um, so first let's talk about how a leveraged buyout works. So when a private equity firm decides
04:07to do this kind of transaction, they typically have two types of debt markets.
04:10And I think we have a chart on this. I'm not sure. So, and we'll bring it up and forgive
04:14for everybody on radio, but Paul is going to walk you through it.
04:17Yeah. So basically, you know, the way this works is that the private equity firm is buying
04:22a company and it can essentially finance some of that with its own equity commitment, which
04:27is just cash. And then it can finance part of that with the debt. And when it decides to
04:31finance part of that with debt, it can have one of two markets, the public syndicated debt
04:35markets that consists of high yield bonds and leverage loans, right? Or the private credit
04:39market, which grew very rapidly starting in roughly 2020 to compete with the high yield
04:43bond and leverage loan markets. That private credit component is very interesting. We should
04:47never discount the leverage on a high yield bond markets. Those are still very big parts
04:52of this financing process, but private credit grew a lot. And they were also willing to do
04:55more aggressive deals than the syndicated counterparts. Um, and so, you know, having debt on your balance
05:01sheet really creates two problems for a company. The first is you have to pay the
05:05interest expense. And the second is you have to refinance it. And both of those will have
05:09issues if revenue starts to come down at some of these companies, right? And we just had
05:14a chart up, but it really shows, you know, what the buyer, the title on that graphic was
05:19how a PE fund can buy a $6 billion software company for $3 billion, because they just put
05:23up $3 billion. And then they've got the lenders on the debt side, putting up the rest.
05:28Exactly. And so what we're seeing now is basically questions over how this will unfold. Because when
05:33a private equity firm levers up a company in this way, they're doing it because they believe that
05:37they can rapidly increase revenue and rapidly slash costs so that the company can basically
05:41grow over time to adapt to its large debt load. That means revenue has to grow, right? So if revenue
05:48growth slows or even worse, reverses at all, that makes the debt potentially untenable.
05:53Who's at the top of the debt stack here?
05:55So that would be the senior secured lenders. It varies depending on the exact structure,
05:59but notably the private equity firm is at the bottom of repayment, right? Because the way debt
06:04works is basically the debt investors get paid back first. And if there is restructuring or bankruptcy,
06:09typically the equity is wiped out. Medallia is a very interesting example of this. It's important
06:14to note Medallia is a software company. Its problems predate the current AI concerns. It had its own set
06:20of issues. But in that situation, Toma Bravo and his co-investors lost $5 billion, one of the largest
06:26wipeouts in private equity in years.
06:27Well, let's talk about Toma Bravo. I mean, people who are watching or listen to our program,
06:31we've spoken to Orlando Bravo in the past. We spoke to him at Milken years ago in a different,
06:35completely different environment than it is today. We weren't talking about a SaaS-pocalypse.
06:38No, everybody was just chasing private credit and wanted exposure and put it anywhere.
06:42And this is a firm that for years has been all about software. So talk a little bit about the
06:48Medallia
06:49example, but also Toma Bravo's role in this. Yeah, so Toma Bravo took Medallia private. It seemed like
06:55a very smart investment at the time. They used a $1.8 billion private credit loan to finance it,
06:59and specifically a recurring revenue loan. So what is common in earlier stage companies is they're not
07:05generating a lot of earnings or what's called EBITDA yet. And so an alternative is to base the
07:10loan off of recurring revenue. In old debt times, that would have been considered pretty extreme,
07:16and lenders want to see a history of earnings. But for the newer software companies, that was
07:21considered more common. And so it also had a special feature, this is getting technical,
07:25called pick or payment in kind, where you could basically defer some of the interest by adding
07:30it to the principal payment of the debt later. And so basically, this company tried to increase
07:35earnings. It couldn't, but because it was picking the debt, the actual total debt size kept increasing,
07:40and it ended in a very unfortunate restructuring earlier this year.
07:45Right. So the target for success had to be even higher because the debt load kept hiring because
07:49they kept adding on the interest. Exactly. And again, that's what is hard about debt,
07:54is it amplifies risk. You know, it's so funny. It's not funny. We talk a lot about the software
07:59space. I mean, what do investors look for? Is it a case of a bunch of deals starting to have
08:06problems?
08:07Is it a case of a big deal? Or we just don't know? Like, how do we know that if
08:11this is going to
08:12become a bigger problem? Is it a higher rate environment that all of a sudden makes it trickier?
08:18Like, what's the thing that maybe tips everything over? Or all of a sudden, AI is just doing
08:23everything that these companies do? Yeah, so it's kind of twofold. So first,
08:26can a company pay its interest expense? And that's where the rates question comes in, right?
08:30A lot of these leveraged buyouts were done in the 2020 to 2022 era, and they all use floating rate
08:35debt for the most part. So as the Fed increased interest rates, their borrowing costs also
08:39increased, which caused problems and squeezed their liquidity a bit. And to be fair, I think
08:44they thought, right, three to five years, they would be exiting. Exactly. And then that became
08:48problematic. And that's the other component. As interest rates increased, valuations fell,
08:52making it much harder to sell a company. Private equity firm doesn't want to sell it for less than
08:56it bought it for. That's a nightmare, right? And so a lot of companies are basically just stuck,
09:01and they can't be sold or IPO-ed right now. Then the other part of this, and the real test,
09:06is the refinancing. Because a lot of the debt is roughly seven years of maturity. And so a lot
09:10of that debt's actually coming due. Between now and 2029, there's about $150 billion of it across
09:15syndicated public and also private markets. And so each of those is going to be a test case, basically.
09:22You said earlier in our conversation that it's unclear at this point if the SaaS apocalypse has
09:27actually happened. I think some public market investors would look at some shares of SaaS
09:31companies and the way they performed over the last 12 to 18 months and said, wait a second,
09:35it looks like public market investors have made a decision, at least as of now.
09:40When do you think we'll be able to definitively say whether or not there is or is not a SaaSpocalypse?
09:45I think it's just going to be something that unfolds slowly in the coming years.
09:48At least in the debt markets, it's going to be kind of on a case-by-case basis.
09:51Okay. Well, and the other thing, if we can bring up our last chart, we just have about 30 seconds
09:56here. You have seen basically investors or lenders growing wary, right? So we do have a chart that
10:02shows buyout funds binged on software deals. But if you look at 2026, you can see that has come down
10:09dramatically. Exactly. And lender confidence is key because if you lose access to debt capital markets,
10:14at the very least, your borrowing costs will go up even more. And in a worst case scenario,
10:18you might not be able to refinance at all. And either of those can cause a restructuring.
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