The pandemic has made technology the new safe haven for investment. Growth Equity is booming and within it secondary transactions may become more prevalent.
These were some conclusions when, in September 2020, we were privileged to spend 1.5 days off-site and in person with many of our limited partners. One inevitable topic was how the pandemic has changed technology investing.
The pandemic has made technology the new safe haven for investment
The global economy is in what could well become the deepest recession of our lifetime. The lock downs around the world in the first half of the year have slowed the economy in most countries by typically 10–20% and for the full year we are anticipating several percentage points GDP decline for the global economy. This recession is significantly more severe than the Global Financial Crisis or anything else that we have seen in our lifetime.
But not all sectors of the economy are affected equally. Analyzing the impact of the pandemic on total shareholder return in specific industries the Boston Consulting Group has shown (1) that many sectors are hit very hard, but technology, biopharma and med-tech have benefitted.
So why is technology doing so well in the current environment? Our behavioral changes are the reason. We shop online instead of going to the High Street. We buy Pelotons and fitness apps and cancel the fitness studio. We order food online and avoid going to the restaurants. Business behavior changes as well. We do Zooms instead of travelling to meetings. We collaborate in software not in meeting rooms. Companies buy software and upgrade their IT infrastructure to increase work force efficiency and enable remote work. The transformation of our society from the physical, analog world to a virtual, digital world is accelerated by the pandemic. Technology companies are benefitting from this transformation.
Since technology companies seem to benefit despite the severe recession, they are becoming the new safe place for capital. Liquidity is abundant and technology assets is where it goes. Overall European Stocks are down for the year, but technology stocks have risen significantly. Technology giants such as Apple, Google or Tesla have reached record valuations.
What holds true for public markets also holds true for private markets: Fundraising for European technology funds has been strong for the first half of 2020 and it seems that the second half of the year is no different.
Technology assets, both public and private, are the new safe haven for capital in an uncertain world.
Growth Private Equity becomes serious business in Europe
In this context, Growth PE is becoming an increasingly attractive asset class. Growth PE exists at the intersection of venture capital and traditional private equity.
Growth PE companies are generally based on technology, they are growing fast and have very scalable business models — just as in venture capital. But Growth PE companies are more sizeable in revenue and often profitable. They have proven business models and are mature in terms of management team and processes — just as in the buyout business.
In a world where technology is a safe haven for capital it is obvious why this segment is a compelling investment. It combines growth with a degree of scale and security not found in venture capital. Today, European Growth PE funds account for 17% of overall annual European private equity fundraising, a number that 5 years ago was only 5%.
We have analyzed the 24 largest European Growth PE funds raised in 2019/20. Interestingly, most funds raised over the past two years have been raised by Growth PE specialists such as Summit, Vitruvian or Keensight, but some of the major private equity groups such as Permira, CVC and KKR have also taken an interest and recently entered the European Growth PE market.
All these trends point to the fact that Growth PE is emerging as a third, strong private equity investment strategy between the venture capital and the buyout business.
Secondary Growth Equity may particularly benefit from the impact of the pandemic
If technology is seen as a relatively safe investment in an uncertain world and Growth PE is a growing, successful segment in private equity one is tempted to think that all active players in the market will benefit.
However, we believe that not everyone in the market is in a strong position. Specifically, corporate investors that are not tech firms themselves are facing challenges.
When the economy is strong, corporations look for innovation and growth. They want to open a window on technology. And they can arbitrage between their own, low cost of capital and much higher returns of technology investments.
As a result of this favorable situation, the number of corporate tech investors has grown 3-fold over the last decade. In 2019 these corporations invested EUR 16bn in European technology deals which amounts to well over one third of the market.
Most active corporate tech investors in Europe are from traditional industries such as retail, energy, media, telecoms and only a minority regard technology as their core business. This makes them vulnerable today. In a recession the corporate focus moves from innovation to cost reduction. Capital becomes scarce and what used to be an arbitrage opportunity in the good times becomes a funding challenge in a recession.
As a result, in a downturn, technology assets become a liability for investors from traditional industries.
Clearly, we are only at the beginning of a major recession. It may not affect technology assets, but it will certainly drive divestitures from corporate investors not being technology firms themselves.
Conclusion
As challenging as the world may seem for all of us, as exciting are the investment opportunities in European technology. The sector is helping to transform the continent and the world, making it more resilient in the pandemic. Europe starts to see an increasing number of technology companies that achieve real scale. A growing number of Growth PE investors are raising more sizeable funds to back the growth of these companies and provide liquidity to existing shareholders.
(1) Source: BCG: Covid 19 — How the pandemic changes the European Growth Tech ecosystem
