U.S. tech companies and their financial partners have engaged in an increasing number of heavily leveraged deals in recent years, fueled by the broader growth of the technology sector as well as continued access to affordable debt,
An S&P Global Ratings analysis of deal activity within the U.S. tech sector over the past three years finds that the average starting leverage for companies pursuing leveraged buyouts or M&A increased to 7.1x in 2018, up from 5.8x in 2016. Looking just at leveraged buyouts — where a company is acquired using a significant amount of borrowed money to cover the cost of the deal — the increase in average starting leverage was even more significant, rising to 10.6x in 2018 from 8.5x in 2016.
These increases, according to the ratings firm, indicate a growing tolerance for risk within the tech sector, and may also forebode a greater number of credit downgrades in the coming years, especially if the economy weakens or the debt market tightens. "Growing debt burdens can limit companies' financial flexibility and leave little room for error," the firm said.
Historically, leveraged buyouts were less common among U.S. tech firms as compared to other sectors of the economy, because buyers tended to prefer more mature businesses with proven business models and stable cash flows that could support the heavier debt loads.
In recent years, however, private equity firms and other financial buyers have embraced the sector, especially in regards to software firms. S&P Global Ratings attributes this to software companies' predictable revenue streams from subscription sales and their lower capital spending requirements. The rating agency counted only five leveraged buyouts of hardware firms between 2016 and 2018, while there were 30 leveraged buyouts of software companies during that period.
Looking at specific deals, Thoma Bravo LLC's $2.12 billion leveraged buyout of the cybersecurity company Imperva Inc., ranks as the tech transaction in 2018 with the greatest pro forma adjusted leverage — at greater than 18x — as of the deal's close.
In a press release about the deal, Chip Virnig, a partner at the private equity technology investment firm Thoma Bravo, said the software applications and data that make up the backbone of the digital economy are increasingly under cyberattack, putting Imperva in a strong position to play "a huge role" in the rapidly growing security segment.
S&P Global Ratings defines the tech sector as including software and hardware companies, information technology services and semiconductor firms. Sector coverage generally excludes tech-enabled companies and service providers.