Industry: Investing in enterprise software

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on October 22, 2018 - October 28, 2018.
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Robert Smith, the founder, chairman and CEO of Vista Equity Partners, was working as a chemical engineer when he realised the importance of the software that businesses use to improve productivity — known collectively as enterprise software. At the time, one of his tasks was to automate a processing plant using a software-based system.

“It improved the operations of that plant by 26%, so, to a great extent I really started to evaluate the impact of enterprise software on the underlying productivity. One of the things that became very clear was that enterprise software was and is now the most productive tool that has been introduced into our business economy over the last 50 years,” Smith says. He was a speaker at the recent EPF Private Equity Summit 2018 in Kuala Lumpur.

Smith went on to have a career in Goldman Sachs in tech investment banking, where he executed and advised on a large number of mergers and acquisitions, according to his biography. During this time, he realised that not many buyouts in the area of enterprise software were occurring.

“I came to recognise that enterprise software was becoming more pervasive across every single industry and you could bring specific operational improvements to enterprise software businesses,” he says.

In 2000, Smith set up Vista, which mainly invests in enterprise software, one of the first private equity firms in the world to do so. According to alternative assets data provider Preqin, Vista was the 18th of the top 100 private equity firms in the world, ranked by total amount of capital raised in the last decade, and it is one of the buyout fund managers with the most consistent performance. The firm had over US$31 billion in assets under management as at last month, according to its website.

“The ultimate insight here is that enterprise software is the most productive tool introduced to our business economy over the last 50 years, and no one was doing buyouts in that space. If you teach enterprise software companies how to run their businesses better, you should have the ability to capture what I call the economic rent,” Smith says.

Other private equity firms are also eyeing the enterprise software space. According to a 2017 report by Boston Consulting Group (BCG,) private equity firms’ investments in software companies increased from 4% in 2007 to 8% in 2016, with revenue totalling US$154 billion for enterprise software in 2016. The rate of revenue growth is expected to outpace other industries, and returns from software acquisitions have generally outperformed the market.

Smith attributes the expansion of the enterprise software sector to the advancements in computing power and connectivity.

“Those two events unleashed what I call the capacity for human invention. Leveraging computing power and connectivity, you can develop applications and products now that you couldn’t 20 or 30 years ago because of the scarcity of computing power. This has led to the Fourth Industrial Revolution, which leverages computing power to connect Internet-of-Things devices to the cloud and utilise data to create productive systems, networks and ecosystems. Those are the main factors that have led to the mass expansion and adoption of enterprise software,” Smith says.

According to Forbes, Smith is on the top 500 billionaires list (out of 72 countries) with a net worth of US$4.4 billion. He is also known for his philanthropy, being a signatory of The Giving Pledge, a campaign that encourages the wealthy to contribute their wealth to philanthropic causes.

Enterprise software across all sectors
Vista invests in enterprise software companies across every industry, covering fintech, insurtech and even agritech. Technologies such as artificial intelligence, machine learning and blockchain are the latest factors that will accelerate the growth of the enterprise software industry, Smith says, as the market demand for digitalisation is rising.

“New technologies like artificial intelligence, machine learning and blockchain are going to change the way companies engage with each other. These are all enterprise software initiatives. Investing in them is an important part of making sure you are staying ahead of the curve and delivering to your clients the capabilities to serve their customers well,” Smith says.

Vista has invested in over 50 different companies. Last month, it closed an investment in iCIMS Inc, according to reports and press releases, a cloud-based talent acquisition solutions company based in the US. Vista’s portfolio company Marketo, which provides a cloud platform for business-to-business marketing engagement, was acquired by Adobe in September for US$4.75 billion. Vista acquired the company in 2016 for US$1.8 billion.

Other portfolio companies listed on Vista’s website include EagleView, which has a patented image capture process and 3D modelling software that can be used to support property claims and risk management; Omnitracs, which provides fleet management software applications; Finastra, a fintech firm based in London; and Automated Insights, which provides real-time data analysis and content generation solutions.

Asia is a fast-growing market for enterprise software, given its expanding youth population who are digital natives. Many industries in the region are also digitalising their processes, from their supply chain management to go-to-market strategies.

“This is a market we think is ripe for the Fourth Industrial Revolution. We are looking for and continuing to work with partners in this area. For example, one of the enterprises we have spoken to, called Cyberport, in Hong Kong has seen over 1,100 fintech companies emerge in the last six months,” Smith says.

“We need to create the right partnerships so we can see all the opportunities and figure out which ones to invest in. The one dynamic that continues to exist in enterprise software is that 99% of software companies are private, so, if you are not in the private market, you do not have an opportunity to participate in this Fourth Industrial Revolution.”

Enterprise software is not a sector that is easy to understand. Investors have to think about the precise workflow behind the products, Smith says. “You need to know what you are doing. There are technology investors who have lost money on software. You have to understand product development systems and enterprise software. If you don’t get that right, it is going to be a very risky investment space.”

According to the BCG report, expertise matters in private equity dealmaking within the software space. Experienced software investors (whose software deals represent at least 20% of their total deals) and serial software investors (who have made at least 10 software deals) outperformed the median internal rate of return of other industries by a higher margin than opportunistic (neither serial nor experienced) investors in this sector. The difference lies in the former’s ability to “apply a distinct set of value creation levers to generate higher returns from their software investments”.

“Enterprise software requires two distinct components. One is product superiority and the second is execution excellence, and not all companies get that right. Some have great products but do not execute, while others do so well. Managing that dynamic is important. Of course, you have the disintermediation that can occur from new technologies. Like now, all of sudden, some 23-year-old has come up with an AI solution that can render your current enterprise software worthless. We need to be thoughtful about that risk,” Smith says.