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Private equity is on a spending blitz in cloud software

Key Points
  • Thoma Bravo is paying a similar multiple for Ellie Mae as Vista did for Mindbody and Apptio.
  • Thoma Bravo, Vista and Hellman & Friedman have been actively pursuing software companies.

Cloud software companies have been commanding hefty price tags, but all of the action is coming from private equity so far in 2019.

Thoma Bravo's $3.7 billion agreement on Tuesday to buy Ellie Mae, a provider of software to the mortgage industry, marks the third proposed multibillion-dollar software deal this year. In each case, the buyer has been one or more private equity firms.

Private equity shops are using their massive funds to compete with Microsoft, Salesforce, IBM and Oracle in the M&A market, where plenty of small and mid-size software companies are there for the taking. According to the Bessemer Cloud Index, which tracks publicly-traded subscription software companies, there are over 30 companies valued between about $1 billion and $10 billion. Thoma Bravo and Vista have led the charge over the last few years, snapping up cloud companies focused on everything from marketing automation and event planning to analytics and financial transparency.

In the past, private equity buyers were more focused on cutting costs in favor of profits, often leading to big cuts in headcount. Of late, the playbook has changed: Now they're focused on growth.

The biggest announced deal in 2019 came earlier this month, when an investor group led by Hellman & Friedman agreed to buy Ultimate Software for about $11 billion, or $331.50 a share, a 19 percent premium to its price before the offer.

Both Ultimate, which sells to human resources departments, and Ellie Mae indicated in their press releases that the acquirers are looking for growth.

"We believe this deal represents another clear sign of the value strategics and PE shops place on software's secular growth and expect the M&A environment to remain robust for years to come," wrote Brad Reback, an analyst at Stifel Nicolaus, following the announcement of the Ultimate deal.

Ellie Mae shares surged 21 percent to $98.95 on Tuesday after the Thoma Bravo agreement was announced. Brent Bracelin, an analyst at KeyBanc, said that with an enterprise value-to-sales multiple for the next 12 months of 6.4, the deal is comparable to the prices Vista paid for Mindbody and Apptio.

Bracelin wrote that the price was fair for a business "that has been plagued by challenging mortgage industry conditions that appear likely to continue pressuring growth into 2019." Prior to the announcement, Ellie Mae shares were 30 percent below their 52-week high reached in June. Analysts project sales growth of 6.1 percent this year, down from 15 percent in 2018.

There's not a long track record of buyout shops making significant returns in growth-oriented cloud software.

The only clear recent success was Marketo, which Vista bought for $1.8 billion in 2016 and sold to Adobe late last year for $4.75 billion. Vista shook up the executive team and improved Marketo's profit margin but kept investing in growth. Investors still need to see some IPOs and more high-dollar sales before determining if the model works.

According to the Bessemer Index, the cloud company with the highest forward revenue multiple is security software vendor Zscaler at 20.4, followed by identity management company Okta at 19.8. Before their acquisition offers, Mindbody, Ellie Mae and Ultimate were all towards the bottom of the list, meaning investors were less optimistic about their growth and profitability.

While most of the private equity deals are friendly, not all of the targets are amenable to signing the offer sheets.

Last month, Hellman & Friedman and Blackstone led a group offering to buy Germany's Scout24 for 4.7 billion euros ($5.3 billion). Scout24, an online marketplace for the real estate and auto markets, rejected the offer as inadequate.

Correction: In the Key Points section, a prior version of this story mistakenly said Vista is buying Ellie Mae. The acquirer is Thoma Bravo.

WATCH: Private equity firm Thoma Bravo to take Ellie Mae private for $3.7 billion

Private equity firm Thoma Bravo to take Ellie Mae private for $3.7B