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Retailers Foreshadow Potential Debt Carnage in Tech

Retailers Foreshadow Potential Debt Carnage in Tech
(DreamsTime)

By    |   Friday, 28 April 2017 08:07 AM

U.S. retailers are dropping like flies. And it's worth wondering whether the retail implosion could be a preview of potential pain for the technology industry. 

This year has brought a surge of retailers that are closing stores, slashing jobs and filing for bankruptcy protection in record numbers. The boom of online shopping and a glut of stores are common factors for the retail carnage.

The tipping point, however, was the private equity buyouts in recent years that left many retailers with debt that they couldn't repay. Of the 19 companies on a Moody's list of distressed retailers in February, 15 are owned or part-owned by private equity firms.

Private equity didn't kill these retailers, but they helped make the hangman's noose. 

Some of the same ingredients that created the retail carnage are now present in technology, which became a surprise darling of private equity buyouts. Dell, BMC Software, Rackspace, Informatica and Marketo were among the tech companies purchased in recent years with private equity money and debt.

In the first quarter, about one in five private equity buyouts in the U.S. involved tech companies, according to data from PitchBook. That is far above the industry's typical 10 percent to 15 percent share of U.S. private equity deals. Silver Lake and other private equity firms have raised billions of dollars for even more technology buyouts. And the tech industry's share of loans related to acquisitions and leveraged buyouts has risen by a factor of six since 2007, according to Barclays research published last fall.

That's not to say some of the buyouts in technology will blow up as they have in retail, but the industries have echoes. As in retail, habits can change quickly in technology. And just as in retail, debt burdens could make it tough for tech companies to make acquisitions, invest in new areas or otherwise try to change strategy. Many of the public technology companies purchased by PE firms had fallen behind in innovation,  just as many distressed retailers did. 

So far, private equity owners seem on the whole good for the tech industry. There can be plenty of fat and hubris at fallen tech stars, and a fresh perspective from private equity owners can help. Tech buyout specialists such as Thoma Bravo and Vista Equity have found ways to consolidate companies with overlapping technologies, squeeze out costs and boost spending on research and development. 

While the idea behind PE buyouts in tech is sound, private equity ownership and the resulting debt loads are relatively untested at a large scale in the industry. The belief is companies that sell software and other technology to businesses tend to have predictable cash flows because customers sign contracts that obligate them to pay month after month or year after year.

It doesn't take much, however, for predictable revenue to suddenly became far less so -- a risk that private equity tech specialists have acknowledged. And debt burdened companies don't need much of a revenue hiccup for their borrowing to turn fatal. Tech firm Avaya, radio company iHeart Media and Gymboree, the children's clothing retailer that is preparing to file for bankruptcy protection, are all private equity-owned companies whose revenue held up fairly well during secular changes in their respective industries. But all the companies' cash flow and then some went to repaying debt related to buyouts. 

Money Owed on Junk-Rated Tech Debt in 2021: $39 billion

For the post-2010 technology buyouts, investors won't know whether the resulting debt pile is manageable for three to five years, when the companies have to start paying back a substantial amount of borrowed cash. In 2021, for example, junk-rated tech borrowers will owe their debt investors $39 billion, and $40.3 billion the year after that, according to data compiled by Bloomberg. A big chunk of the debt is related to private equity buyouts. 

To be sure, if private equity-owned tech companies start to go under, it probably wouldn't cause the same pain as the bankruptcies and other financial pains in the retail industry. Apart from Dell, technology companies don't employ fleets of people as retail stores do, nor do they own space in many malls and Main Streets across the country. But these riskier tech companies now have a lot of debt, even more than the retailers by some measures.

And if these companies simply fail to produce the expected earnings, their borrowing costs will most likely rise, possibly substantially because central banks are starting to back away from global low-rate policies. Higher interest payments put even more pressure on debt-burdened companies. 

Private equity-owned technology companies don't have much in common right now with debt-ravaged retailers like Payless. But the risk goes up as more copycat buyouts get done in the tech industry.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

© Copyright 2019 Bloomberg L.P. All Rights Reserved.

   
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Some of the same ingredients that created the retail carnage are now present in technology, which became a surprise darling of private equity buyouts.
Retailers, Debt, Carnage, Tech
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2017-07-28
Friday, 28 April 2017 08:07 AM
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