Trends Watch: Private Equity Investing in Technology

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Anthony Valencia, Co-Managing Partner, East Los Capital.

What is your outlook for PE investing in the technology sector?

We are constructive on the technology sector broadly speaking despite what was a challenging year in the private markets in 2023. Somewhat paradoxically, the tech-heavy NASDQ index was up an eye popping 43% in 2023 while their private market counterparts lagged the party. We attribute this somewhat to the fact that the public markets tend to be more forward looking and will front run anticipated financial improvements while also getting caught up in the enthusiasm and animal spirits of an exciting bull market. In addition, many of the bellwethers from the public markets have pristine balance sheets and have been less impacted by the higher cost of debt -- which is a major factor in getting new deals done in PE. We believe that it is always a good time to invest in differentiated technology companies that are taking advantage of secular trends if they can be purchased at rational valuations. Pitchbook recently pointed out that since 2010, tech-focused PE funds have outperformed diversified PE funds with an average excess of 580 basis points. We believe that this trend continues over time.  

Where do you see the greatest opportunities and why?

Our strategy revolves around looking for companies that are not effectively taking advantage of available technologies to improve their businesses. While this may sound like a no brainer, there are many companies in the lower middle market, where we focus, that are not leveraging available technologies whether it be for a lack of sophistication or not having the resources or knowledge to implement them. So we find the greatest opportunities in identifying solid business that can be “tech-enabled” to further improve both the top and bottom lines. As a derivative play, we also like IT/cloud service companies as these are the “picks and shovels” that allow companies to become tech-enabled. Amazon CEO Andy Jassy said on their most recent conference call that about 90% of global IT spending is still spent on premises versus in-the-cloud. This suggests that there is still a tremendous opportunity for cloud services companies, and we like Amazon Web Services (AWS)-focused companies given their leadership in the space.  

What are the greatest challenges you face and why?

We are by no means unique in saying that quality deal flow at valuations that allow us to deliver superior returns to our LPs is always at the top of the list. The PE industry is filled with smart and hardworking professionals so the competition to deploy capital into attractive companies is intense. We have a tech-enabled sourcing engine that we’ve developed internally which we believe helps to mitigate this challenge somewhat. More and more PE firms are looking at non-sponsor-backed companies which is increasing the level of competition in the lower middle market where many of these companies exist as they are smaller and have not previously taken institutional capital.  And the fact that there is still estimated to be upwards of $1.0 trillion in dry powder itching to be deployed by PE firms just exacerbates this entire dynamic.

What keeps you up at night?

I am a believer in not worrying too much about things that a person cannot control while still having a contingency plan for various downside scenarios. We can’t control the economy, but we are confident that we can manage through all types of economic scenarios and even grow our companies during a downturn. Many successful companies were launched and grew during periods of economic weakness and even used this uncertainty to gain share versus weaker competitors. All that being said, the level of our national debt and its rate of growth is worrisome. Moreover, the degree to which the Fed has become the primary focus of the investment community almost to the exclusion of everything else is also concerning. Many pundits have commented that the Fed has distorted markets since the great financial crisis such that investors now often have trouble deciphering whether bad news is actually bad news or good news. And vice versa, given that everything is interpreted in terms of what impact it will have on Fed policy. This type of confusion can result in markets, and an economy, that become inherently more risky and unpredictable.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.