I am firmly, firmly on the side of no regulatory capture. Let competition go. Let the open models go and place liability where it belongs.
Welcome back to another episode of Compound Interest. I'm Liz Hoffman, Semafor's business and finance editor, and joined as always by my colleague Rohan Kaswami. Hey, Rohan.
Hi, Liz. So, it's been about a year since the SaaS apocalypse started tanking software stocks. They've come back a bit, but there are still huge questions hanging over this industry about how much of their business AI is going to steal, how much of it it might turbocharge. These are software programs that neither you nor I, Rohan, have ever used, will ever use. They help big companies onboard customers and manage their inventory and fulfill their sales and hit payroll. Basically, run their business. Or at least they did until AI showed up and raised the question of, wait, could we just build this all ourselves?
Today we're talking to someone who has perhaps more riding on the answer to that question than anyone in the world. We're talking to Orlando Bravo, who is the managing partner of Thoma Bravo, one of the biggest private equity firms in the world and one that does basically nothing but buy enterprise software companies, owns about $200 billion of this stuff, which means that Orlando is right at the middle of this question. We want to get into all of that with him, ask him what he thinks is the difference between a winner and a loser in the AI world and when it comes to software. We also want to talk about what AI is doing to his own business. Private equity is an industry that, you know, but for the advent of Excel and the marginal cost of debt, hasn't really changed that much in a while, and I suspect is being totally upended by AI, and how he's staffing deals and recruiting junior talent. It's also consolidation pressures. So, we're going to get into all of that with Orlando, and he's waiting for us. So, let's let him in.
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Orlando Bravo, welcome to the show.
So, when I saw you about a year ago, I came down to Miami, we were just at the beginning of what we would then, I think, eventually call the SaaS apocalypse. You have just declared that it is over. What makes you say that, and what is your lay of the land in software as you see it right now?
You know, I repeated that it's over in, I think it was mid-June of this year. And one, from a technical standpoint, one of the reasons why it's over is that at that time, when a foundation model was making an announcement, software stocks were no longer crashing and cyber was coming back as well. So from a public investor standpoint, people were figuring out that the perceived risks that are dreamed about are not real, that that is not the way technology works in corporations and in governments and in production environments.
Now, what people are starting to figure out now is that AI is an incredible tailwind for software. In a few years, there will be no difference between, oh, you're only a software company, not an AI company. It'll merge together. And this is very important. So, I'm going to be a bit long-winded, but I want to give you an example of that. Take cybersecurity, that area of software. When Metas got released in April, those stocks crashed. I remember I was talking to the CEO of a public cybersecurity firm and we were talking about some business and he mentioned, I'm trying to figure out what implications this has for my business and whether this is going to affect it negatively. So I called our cyber team, my partner Seth Boro, who has been doing cyber here for over 20 years, Chip Vernick, Andrew Ameda, and said, guys, isn't this like an unbelievable tailwind for securing AI identities, protecting your firewall, protecting your network, protecting your endpoints? And we called our CEOs and literally we're working over the weekend going, we don't get it. And now the market has said, ah, what you really need is a lot of the basic principles of cybersecurity. And now those stocks are trading at over 30 times free cash flow, some of them at 60, and they're at an all-time high. And they've beaten every index almost.
But on the software side, you know, AI is clearly going to mint some winners and losers, and no CEO that I've talked to in the space thinks they are a loser. So when you look across your portfolio, across, you know, the broader ecosystem, like what distinguishes a company that is going to ride the AI wave from one that's going to be swamped by it?
Leadership. It really is leadership, right? Investors are doing a lot of analysis. Oh, if you're a system of record, okay, you might be better off. If you are working in heavily regulated industries, you see a lot of governance and you have to be more deterministic potentially, okay, you're better off. If you are working in the payments industry with a lot of deterministic payment rails and transactions, okay, maybe that's an area. But overall, AI will be a transformation or represents a huge transformation and opportunity for these companies, but you do have to transform them. And if you have leaders at the company that understand their domain cold and their area, and they're entrepreneurial, and this comes a lot from founders even of the big companies, and they're willing to move them forward, this is a huge opportunity. If you have, quote-unquote, modes that you're dreaming about and are thinking about, but you don't do anything about the agentic future of your customer solutions, about how your apps are going to change from letting your customer build their apps and how you're going to have to serve agents with your systems. If you don't do anything about that, you're going to be left behind anyway. And in the public markets now, if you look at what ServiceNow is doing, amazing leader. If you look at Salesforce, amazing leader. Those are actually two very good role models of the very large-cap companies that will have a big tailwind for AI because they have excellent leaders of the future.
How much attention did you pay over the last six months to public market marks? And I guess adjacent to that, where did your portfolio sort of bottom out, if it did at all?
So a lot of attention to public marks, right? Those players that are, call it, two billion to twenty billion of enterprise value in the public markets, those are our acquisition targets. So we're always looking at those, and many of those are public comps, you know, including Workday in payroll software, or they're more human capital management company. So we had to look at, I mean, we mark our portfolio every quarter, and it's pretty much based on public comps. So we had to bring it down, and I would say that bottomed in Q2 of this year, right, that June quarter.
One of the things that surprised Liz and I a lot is the reactions to tech earnings are double-digit reactions without fail. They are wildly blown out in a way that I don't think any of us have really ever seen before, barring maybe the dot-com bubble. Does that make it harder to do deals? Do you think it's giving CEOs and boards a sort of false sense of where they should be transacting and where they should be valued at?
Right now, it's a really, really hard time to buy and sell a company. We've been through four in our history in software of thirty years. There have been four times the software industry has been doubted, and this is one of them. But in every other time, it's boomed after it's been doubted. People got it wrong. It'll be the same thing this time. And we can get more and we can get more into AI. But in terms of the difference, though, this time in the other periods, it was hard to sell, but we would load up buying. Now it's hard to buy as well because the stocks have come back relatively significantly in the public markets, and they're trading at about eight times EBITDA, the non-cyber ones.
Do you think that's cheap?
I do, because many of those targets, unlike ServiceNow and CRM and Salesforce, many of those targets are actually behind in AI. I had my partner Holden Spate meet with a bunch of M&A targets a couple weeks ago in a series of meetings. These are the smaller cap, right? Two to twenty billion. And he calls me and he goes, these meetings were a yoner. Our portfolio, and this is a true comment, even though it may sound self-serving, our portfolio companies, we have been grinding on them on the future of their businesses over the last two years, and I promise you that they're AI-centric companies today, and we're very excited about what they're doing. But then you meet all these other companies, and they talk about protecting their core, their AI strategy a little bit less clear. So if you don't see that, it's really hard to buy them and to put five billion dollars of equity in the deal.
Because maybe you could say financing was an issue earlier this year. You could say that, you know, multiples were an issue earlier this year. When do you think or what causes those CEOs and those companies to realize your point of view?
Competition. The truth of the matter is right now that still in all these spaces, all these domain-specific areas of manufacturing, payroll, Jison and aviation, in all these spaces, the customers, the corporate customers in the real world, they have just scratched the surface on AI. So the corporate environment is evolutionary, but that'll continue to evolve to more and more and more of this upper layer of the stack that augments human judgment. So one is the customers should be taking those companies there, and we'll tell those companies if they're interested or not, they're going to go elsewhere. And second is competition in all those domain-specific segments. Yeah, maybe once in a while we see what people call an, quote-unquote, AI-native company. I don't love the term, but call it a new upstart that is thinking about things a little bit differently, but we haven't had a lot of huge threats from that yet, but that will come to those companies at some point, and they'll have to react.
But if I'm a CEO of a publicly traded big software company and I see this thing coming at me, I know I've got to pivot. I would much rather do it outside of the public markets. Remember, this is a pivot that Dell executed ten, fifteen years ago spectacularly, said, we cannot change this company if we're on quarterly marks, we've got to go private. I would think there would be, as much as there's a resistance to maybe selling at a lower valuation and when things are a little uncertain, I would think they'd like to sell it to you and try to make this transformation in private hands.
We have had many, like the deal activity is picking up a lot, but also it was kind of nice to see that the industry was not willing to entertain selling near bottom. It showed you kind of the confidence that people had on their boards in their business. Now it could be at a bit of a better level right for them to listen to this and transact. But I agree with you, look at the transformation that they have to make from a P&L standpoint because a lot of these investments are internal, plus they may have to do M&A. We've spent billions of dollars of our capital to support M&A of our portfolio companies to buy AI businesses because we needed to get there faster or we saw capabilities that would be difficult to build in-house. And in the public markets, if you do that, you'd get crushed. You just can't.
Do you think that the investors are driving this at all? This unwillingness to transact?
I think it's the corporate boards.
I really think it's management and the board.
Directors behaving badly.
No. Well, I can't say that. I can't say that, but there always has to be a champion of the deal internally, and usually that's the CEO. We are seeing more boards kind of push back on some CEOs that want to do this transformation privately, and they're thinking through that.
I'm curious, do you think that we'll see hostiles if boards are unwilling to transact, sponsor-backed hostile takeovers or attempts to do so?
I really don't. You do see activist hedge funds that we hadn't heard from in ten years calling and establishing positions in these companies. But we've always taken the view that trying to buy something from somebody that doesn't want to sell it to you is not a good business. And in practice, you end up wasting a lot of time. It's a low likelihood of a deal. And we do very, very well when we're partners with existing management. That's kind of been our strategy.
Nicest guy in Miami. Orlando Bravo.
You see, I told you you should join our team.
Let's pause for a second. We're going to rejoin Orlando with more after this.
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Could you finance a big software LBO today? Could you go raise forty billion dollars in sub-investment-grade debt?
There is so much money in the world. It is unbelievable. And remember, private credit, despite some redemptions by retail in those vehicles, they're flush with money and there are no deals right now. The bond market is hungry for deals. We're looking at financing a new recap, a new acquisition, and we're oversubscribed by like ten x. We're getting term sheets from everywhere.
You can be a little picky.
You actually, it's super interesting. So there's money. The key thing is that it just has to be a really good deal. So to your point, the core competency of our type of firms used to be, okay, you really know how to invest and you really know how to operate. Now we have to add, we really know where to find the liquidity, and we like that because then there's alpha in finding that money.
What are things that are coming up in your investment committee meetings when PMs and analysts are pitching ideas? What are questions that are being asked that weren't being asked a year ago?
For the first twenty years of our existence, we literally only backed existing management, but you were buying the people that knew the most about flight planning in the world.
Exactly. Or about paying frontline workers on time and by the day so they don't have to live paycheck to paycheck. It's that domain expertise that, once again, it evolves, the technology evolves over time, but that's what you're buying. So therefore we would say back only the existing people at the company and then put up our model next to that and help them run the company better for shareholders while they continue to innovate. I think a mistake private equity did to these companies from 2018 to 2022 was replacing managers that really knew their domain with generalist management that were very good at managing companies and they forgot to innovate. And that's especially coming to light now with the speed that you need in an accelerated computing world. We made some of those mistakes as well. Now, we had a reason for it. The operating practices of many of these companies were so bad in the bubble of COVID. All these remote hiring, fast hiring, that they were actually losing a lot of money. So taking a company from negative ten percent margin to forty had to require, in many cases, a change in leadership. And those changes in leadership, many of them did not serve us well. So now we're very, very focused on going back to the basics of finding that founder and domain leader, but that is also, and that's the second point, not only is where's the AI strategy and roadmap today, but what are the results of it? And those are two big things now that we're focused on on top of everything else.
Is the rule of forty still an important thing in software investing?
Look, for us, you got to hit your numbers. Like if you look at our priorities, one is hit your numbers. Two is to transform every company to be AI-centric. And third is to get them liquidity. And that rule of, you know what, and the third part has always been hard, and I can talk about that at length about all the sales I've been involved in. But the first part of the rule of forty, if you're not hitting your numbers, you could do everything right and you're not going to make any money. For us, it's actually like rule of sixty. Now, we got to be close to a fifty percent margin and you got to be growing at least fifteen percent. If you want somebody to write you a check of twenty billion dollars for the business, you really do.
On the liquidity question, this is how we've built a good business. How do we get out of this? Your options are basically IPOs. And I'd be curious what you think. These giant IPOs coming down the pipeline, are they just going to be this huge sucking sound on the public markets that there's room for Anthropic and maybe an OpenAI, but literally no one else?
I do. I do. And we've known that for a while. I remember talking to Seth about it, my partner. What is it, nine months ago? And he was mentioning, look at this pipeline, SpaceX, Anthropic, OpenAI, maybe Databricks, these monster companies. It's not a capital issue. It's a time issue. Who's going to pay attention with this stuff when they have to make big decisions on this enormous capital, right? So, no, I think it really crowds out these twenty to a hundred billion dollar market cap potential IPOs. It won't be like that forever, right? And not everything will work all the time. So there'll be opportunities, but in the near term, it's tough.
The other way that PE firms used to get out of investments is to sell to another PE firm. And for a bunch of reasons, that has been harder to do over the last few years, too. I mean, you've had a couple to Francisco over the last year or two, right?
We have. We've done a couple there. Of our total sales over twenty-five years, it's been about sixty percent strategic, forty percent private equity. I think the sponsor-to-sponsor sales are great. I have a bit of a disagreement with the industry that says, well, I'm doing it in this fund and I'm, you know, paying fees. I'm doing that because people pay fees to money managers and they're buying each other's stocks all the time.
Right. And I am like very old school in terms of owning a company. You know, I could have an idea of how I want to run this business and why I'm doing it and the M&A I'm doing, the people that I'm backing, the strategy of the company, the tactical choices of the company, and then somebody could pay me what I consider to be an okay exit price for their own journey on it, which could be totally different. And I think if the people that believe in the power of ownership, that owners matter in a company, I think it's totally fine that that happens. Right now, I think the private equity industry is very challenged and it's a cultural problem that it's undergoing. The people that started the business in the eighties, Henry Kravis, George Roberts, my mentor Carl Thoma, Rose Stamps, Stan Golder, those were unbelievable investors and dealmakers. They were artists in the field. They would carry their own bag. They would spend, if there was a problem in a company, they would spend a week, two weeks working at the company. And, you know, with private equity getting so big and becoming, quote-unquote, asset managers and AUM and investment committees, that art of owning a company and doing a deal and building it, I'm a little bit worried that it's not as alive as it should be.
Blackstone has a trillion dollars on their way to two trillion, and KKR is not that far behind them. It seems to me that their deal performance, their quality is held up okay, but I wonder whether it can forever if ultimately you get paid based on how much money you manage, not how well you manage it. I wonder if you think that returns at some of the really big shops will just have to fall.
Well, you know, I can't criticize them because they have phenomenal people and we know them and we know the ones that work in software and tech and they're phenomenal. Right now, given the issues the industry has had with exits and performance in the last five years, preferred deals look good, but long term that won't create the alpha that LPs are looking for. Because if you do a preferred deal at seventeen percent and that's pretty rich, net return is twelve. Sure. I mean, maybe you can stay in business, but you're not really, you know, pushing through the expectations of your partners. I also think right now the minority investments in some of the very large AI companies are unbelievable home runs and they look really good, but that won't be, people can keep replicating that for a very long time.
