Private equity firms are increasingly targeting software-as-a-service companies, with five $1 billion-plus deals in the sector already announced in North America in 2022, according to S&P Global Market Intelligence data.

The downward trend in public markets is pressuring valuations enough to spark discounted buying opportunities, such as the recent deal involving customer relationship management specialist Zendesk Inc., which has agreed to go private in an all-cash transaction. The company struck a deal June 24 to be acquired by a consortium led by Permira Advisers LLC and Hellman & Friedman LLC for $77.5 per share or $9.9 billion, a roughly 38% discount to the approximately $16.05 billion private equity bid it turned down in February.

Another factor resulting in lower valuations is a slowdown in business activity, said Bruce Daley, a senior research analyst at 451 Research, in an interview.

Technology business activity, in general, soared during the COVID-19 pandemic. "Businesses were obviously rushing to go through or complete their digital transformation, and they were forced really to go online," Daley said.

Now, businesses think they overspent on digital strategy, resulting in "a secular decline in the software business that started before the high rate of inflation," Daley said. "So [valuations] are a little bit cheaper than they would have been six months ago and a lot cheaper than they would have been a year ago."

After a record $102.33 billion across 517 M&A deals with private equity involvement in 2021, the software and services industry appears on track to exceed last year's total, with $67.5 billion poured into the sector as of June 30, according to Market Intelligence data.

Private equity is attracted to the software-as-a-service, or SaaS, company subscription-based model, which typically locks customers into yearly contracts for services, creating a relatively steady cash flow and predictable revenue stream, Daley said.

With valuations coming down, investors are bargain hunting for SaaS companies that have the potential for expansion beyond their installed customer base, aiming to merge them with complementary vendors. "Private equity firms are cherry-picking," Daley said.

The Citrix Systems Inc. acquisition is an example. The transaction included a partnership between Elliott Investment Management LP affiliate Evergreen Coast Capital Corp. and Vista Equity Partners Management LLC affiliates, which agreed to buy the cloud-computing company for $16.7 billion and roll the business into Vista's Tibco Software Inc.

The U.S. and Canadian SaaS sector saw the strongest private equity M&A activity, with investments totaling $58.13 billion year-to-date. Two notable deals included Thoma Bravo LP, which acquired business planning software company Anaplan Inc. for $10.1 billion and agreed to purchase SailPoint Technologies Holdings Inc. for $7.1 billion.

*Click here to download a spreadsheet with data featured in this story. *Click here to read more about the Zendesk deal.

M&A in the sector is expected to wane throughout the year, as private equity snatches high-quality SaaS companies at a discount compared to historic trading multiples.

"The universe of companies that fit that profile is declining because of acquisitions. It's going to be harder and harder to find those really premium deals," Daley said.

451 Research is part of S&P Global Market Intelligence.