Why Private Equity's Software Bet Is Going to Zero | The Weekly Wrap

SUMMARY

Steve Eisman delivers a critical assessment of private equity’s heavy exposure to software buyouts, highlighting the risks posed by rising interest rates and declining valuations. He also addresses recent turmoil for FICO, the implications of oil-driven inflation, AI regulation, and lessons from the 2008 financial crisis.

MAIN POINTS

• FICO loses its mortgage monopoly as Vantage Score gains regulatory support and major lenders shift allegiance. [2:00]
• Private equity’s surge in software buyouts from 2017 to 2023 was driven by low interest rates and the appeal of the SaaS model. [6:02]
• Valuations for software companies have dropped by roughly 50%, raising the risk that equity in leveraged buyouts will be wiped out at refinancing. [12:00]
• Recent examples show lenders taking control of software firms as private equity equity stakes are erased, with cybersecurity proving more resilient. [17:00]
• Mailbag questions cover the Fed’s limited ability to fight oil-driven inflation, skepticism about AI regulation motives, and insights into spotting subprime mortgage risks before the 2008 crisis. [19:00]
• Upcoming interviews and content are previewed, and listeners are encouraged to subscribe for further analysis. [24:00]

DETAILED ANALYSIS

The episode opens with a focus on the sharp rise in the 10-year Treasury yield to 5.3%, a level not seen since 2002, signaling mounting pressure on financial markets. This environment set the stage for significant developments, notably the collapse of FICO’s longstanding dominance in mortgage credit scoring. Regulatory changes by the FHFA eliminated a disadvantage for Vantage Score, prompting major lenders like Rocket Mortgage to switch away from FICO.

The root cause is identified as FICO’s aggressive price hikes—raising fees by 1,600% over five years—which alienated the mortgage industry and led to a dramatic loss of market share and a 60% year-to-date stock price decline. Eisman criticizes FICO’s leadership and board for failing to respond to this crisis.

Attention then shifts to the private equity sector, which experienced an unprecedented boom in software company buyouts between 2017 and 2023. The appeal of SaaS businesses—predictable recurring revenues, high margins, and scalability—attracted massive capital, with specialist funds like Thoma Bravo, Vista Equity, and Silver Lake leading the charge. In 2021 alone, U.S. private equity buyouts of technology companies totaled over $284 billion, with $256 billion allocated to software.

This surge was fueled by a low interest rate environment, enabling firms to use significant leverage in their acquisitions.

However, the landscape changed dramatically as the Federal Reserve raised rates to combat post-pandemic inflation. Higher rates increased debt servicing costs for these highly leveraged companies, while the so-called 'SaaSpocalypse'—the fear that AI could disrupt or replace existing software—triggered a sharp contraction in valuations. Eisman notes that while some enterprise-focused software firms may retain their moats, many B2C and even some B2B companies face existential threats from AI.

The average software company is now valued at roughly half its peak, with Adobe cited as a proxy, having fallen 62% from its high.

Eisman details several high-profile software buyouts, analyzing their debt structures and vulnerability to AI disruption. For instance, Citrix (52% debt-funded) and Zendesk (49%) are seen as vulnerable, while cybersecurity firms like McAfee and Proofpoint are more resilient. Across the sector, the typical buyout was financed with about 50% debt.

The critical issue arises at refinancing: if a company’s value has halved, the equity is effectively wiped out, and private equity sponsors are unlikely to inject fresh capital to cover the shortfall. In such cases, lenders—often private credit funds—take control, as seen recently with Pluralsight and Medallia, both non-cybersecurity software firms.

Eisman argues that while this wave of failed software buyouts is unlikely to threaten the broader economy, it poses a significant reputational risk to the private equity industry. The traditional three-to-four-year monetization window has stretched to seven years or more due to weak IPO markets, and many software investments are now considered 'dead money.' He also highlights the accounting sleight of hand that attracted institutions to private equity post-2008, as it masked volatility by avoiding daily mark-to-market pricing.

The mailbag segment addresses several topical issues. On inflation, Eisman explains that the Federal Reserve has little control over oil prices, making rate hikes a blunt tool when energy costs drive inflation. Regarding AI regulation, he expresses skepticism about industry leaders’ motives, suggesting that calls for regulation are more about entrenching market power than genuine safety concerns.

Finally, Eisman recounts how access to Moody’s securitization database enabled him to identify deteriorating subprime mortgage performance ahead of the 2008 crisis, reinforcing the value of granular data in risk assessment.

The episode concludes with previews of upcoming interviews and a reminder for listeners to subscribe for further insights.

LINKS

• The Real Eisman Playbook Premium subscription page.
• Steve Eisman's Financial Literacy Masterclass video.
• Steve Eisman's Masterclass on the 2008 Financial Crisis.
• YouTube subscription link for The Real Eisman Playbook.
• Central hub for Steve Eisman's social links, episodes, and updates.

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