Private equity giant executive openly states industry risk management failure: Software bubble should have been seen three years ago

Apollo Global Management executives stated that the private equity industry is facing a prolonged period of software investment pain, as the industry failed to recognize in time that new technologies such as artificial intelligence would disrupt this long-standing favored track for private equity.

David Sambur, co-head of private equity at Apollo, said in an interview, “People are only now beginning to realize that a multi-car pileup is about to happen on the software investment highway. In fact, all the signs were there as early as 2022.”

Sambur pointed out that about three years ago, the launch of OpenAI’s AI chatbot ChatGPT, combined with rising interest rates, became the main cause of the recent tech stock sell-off that has shaken the market in recent weeks.

Recently, Wall Street has been selling off software stocks, with investors worried that next-generation AI tools from companies like Anthropic could ultimately render existing Software-as-a-Service (SaaS) providers obsolete.

Earlier today, Anthropic introduced a new feature in its AI models that scans code repositories for security vulnerabilities. Following this news, CrowdStrike and Cloudflare both fell more than 7%.

The private equity industry has significant exposure to the SaaS sector because they value these software companies’ stable, predictable revenue models based on loyal customer bases. Over the past few years, private equity investments in this area have been substantial, reaching a record $348 billion in 2021.

Sambur said, “Are we falling into groupthink, with 30% to 40% of M&A deals concentrated in the software sector? In hindsight, this is a pretty serious warning sign. When looking back at this period, it will be seen as a failure of risk management.”

As many software investments made during the pandemic approach the end of their traditional private equity holding periods, the market is increasingly concerned about whether these companies can sell assets at desirable prices and realize returns. This could also harm private equity fundraising efforts and weaken their ability to pursue new deals.

Sambur stated that the industry needs to prepare for an “urgent reset” of valuations, as investors reassess the economic models and future growth prospects of software companies. “When it’s time to actually sell these companies, you’ll see the results—this process takes time to fully manifest.”

As of December 31 last year, Apollo managed approximately $938 billion in assets. According to Sambur, the firm’s private equity exposure to the software sector is “zero,” and the overall group’s exposure is less than 2%.

Nevertheless, Apollo’s stock price has been dragged down by the industry, declining over 14% this year.

In a letter sent to clients this week, Apollo’s private equity management team, including Sambur, mentioned that the decision to “avoid this sector is driven by investment and risk management considerations, rather than a blanket rejection of the entire industry.”

They wrote that the software industry has both winners and losers, but “in leveraged buyout funds, we believe potential returns do not justify the risks.” The letter also stated that Apollo will continue to seek new opportunities arising from market turbulence.

Other well-known M&A firms have recently reassured investors, emphasizing their limited or controllable exposure to the software sector. Reports indicate that Thoma Bravo and Vista Equity Partners have met with investors to ease concerns.

(Source: Caixin)