Why are more and more tech companies going into restructuring while high valuations seem to be the norm these days for such entities? Several tech companies, such as Fortra, Multiplan, and Rackspace, have restructured their debt obligations in the last year after seeing stupendous growth in 2021 and 2022. These are not small companies either, as they are backed by major international private equity firms such as Apollo Global Management, GIC, and Partners Group. So, what exactly is causing these firms to be financially strained? Experts generally point to an industry downturn after two big growth years, but there seems to be more than meets the eye. Swapnil Sawant from 9fin is currently evaluating such entities in the tech industry and finding out what exactly the real story is.
Swapnil currently works as a Senior Distressed Research Analyst at 9fin, an AI-Powered Analytics Platform for Debt Capital Markets, and has worked extensively in distressed investments for well over a decade.
He views this trend in tech restructuring to be due to a variety of factors. While the industry has generally seen some slowdown due to a pullback in tech expenditures at end-user industries, these financially strained companies also are to be blamed. Many of these firms had operational issues crop up, such as outages, which were never fully explained, while some went on a rapid debt-funded acquisition spree of new companies to capture incremental market share. Some of these firms were acquired by PE sponsors at sky-high valuations in an LBO, and some were funded through venture debt in early 2020 on inflated revenue projections, which faced financial struggles once profits started declining post-2022. "The sponsors pushed for growth very aggressively and ended up loading these companies with high leverage, and once profits declined, servicing capabilities started becoming a concern pretty soon," states Swapnil, as he still believes there is a way out for some of the troubled companies.
Such firms have now started to look at the only other option available to them—cut fixed costs and increase variables that can be adjusted as per market demands. "While this can seem like a good solution, tech companies need to spend on R&D to remain competitive and cost-cutting generally may not allow such innovations to take place," he states. One way, according to him, that can truly help is to reduce the debt burden through appropriate discounts while taking significant equity stakes and waiting for the market to rebound while working on a sustainable operational turnaround. Lenders and sponsors have also partly realized this and have started to push maturities ahead by close to three to four years, as was the case in Multiplan and Rackspace. However, the lack of big discounts on total outstanding debt has led to their notes and term loans still trading at distressed levels.
A similar phenomenon is also seen in private companies that were funded by venture capitalists in early 2020. The valuations of many of these startups, some of whom were also proclaimed to be unicorns a while back, are being reappraised today, and there is a push towards a cash-flow centric operating model. Cost reduction in these companies is being witnessed at a much higher level than the public companies, and redundancies have become all too common in Silicon Valley. According to Swapnil, valuation has always been a concern in such entities. Many startups raised debt on the back of high valuations achieved from venture capital firms since the rates were pretty low. However, it has now backfired big time, and to the startup founders who never had the obligation to repay venture capital, their current debt obligations seem to be a very costly lesson, concludes Swapnil. While the fundamental thesis of these firms may remain intact, investors may now be very cautious in investing in such firms. For some others, there is a silver lining as quality assets are now coming to the market at very affordable rates.
It remains to be seen when the industry will hit a trough, but for now, financial strain continues to trouble several of Silicon Valley's former darlings.
