Private-Equity Secrets of Thoma Bravo's Billionaire Boss

[Music] i'm eric schatzker and welcome to bloomberg's front row today i'm talking to orlando bravo the puerto rican billionaire who's shaking up the pinstriped world of private equity his firm toma bravo has grown at a blistering pace from 10 billion dollars in assets to 80 billion in five years unlike his peers across the buyout landscape orlando does deals in only one industry software he calls it the best business in the world you have recurring revenues you have high rates of growth you have gross margins that are 90 you have the potential for big cash flow margins and software is becoming the business of everything the field is getting more crowded orlando and i discuss growing competition from hedge funds why he'd never invest like arcs kathy would how to do a spack the right way cheering on the next short squeeze here's my conversation with orlando bravo you buy software companies and only software companies why well that's easy because software is the best business in the world think about it you have recurring revenues you have high rates of growth you have gross margins that are 90 you have the potential for big cash flow margins it's a fragmented industry where you can consolidate markets and software is becoming the business of everything software was definitely hot before the pandemic but now it's on fire right and money is pouring in tell me about the competitive landscape we have always had great competitors and we continue to do so now our competitive advantage in the market is that we've been doing this for 22 years and in the process of buying 300 software companies we have developed an operating know-how that really adds value to the businesses that we're partnering with and most of the industry to this day while you have seen great innovation and software easy is eating the world most of the industry today is unprofitable so to buy a whole company and do a private equity deal based on fundamental investing which is what we do you have to recreate that p l and you have to turn these great innovative companies into also cash producing businesses you have to combine the best of both and if you've been doing it for a long time and have an operating model around it you're able to achieve that and that's what keeps many players really on the sidelines of this great software industry to this day it's true that many players are on the sidelines but increasingly there are firms that want to compete with you right some of the largest private equity firms in the world are raising growth equity funds they want to be the next tomah bravo or maybe they want to be the next softbank hedge funds are becoming serious players in late stage venture capital all of a sudden tiger global d1 others is that changing the competitive landscape it has to be it's making it better and this is why competition is a very good thing for us and it's a very good thing for our peers because when there's competition we alone don't have to create a market when a company receives many different kinds of proposals maybe a growth round proposal an acquisition proposal they feel a lot better about where they should be valued at and where they should trade and that's what sure because the valuations tend to get higher but that makes it a market where you have more assets available to be able to be bought and where you really make the return in a firm like ours is in operations that's when you really make the return it's not really on the buy because especially now nothing is cheap and particularly in software because as you you pointed out correctly many people see the benefit of it for the third time you know we've been through crises uh and software has always proven very stable and growing through them and the last pandemic proved that again that not only were people holding on to their recurring revenue but people accelerated their move towards going digital has the entry of these i'll call them revised hedge funds in growth equity and late stage venture capital upset the order of things in your world if you look at it five years ago you could count in one hand probably the number of software private venture-backed companies that had a valuation round of more than a billion now there's about 250 of them so the financial markets are innovating themselves on how to absorb and support and invest in these great assets so if you get a world of small partnerships and venture capital that are successful but maybe have remained small they don't have the wherewithal to participate in that game in these large venture rounds and the hedge funds being entrepreneurial and being great investors drop down and cost these worlds that are colliding now between venture capital public investors and private equity as well i hear that some of these hedge funds are doing limited due diligence they're racing for the finish line and paying silly prices in the process is that true look your first point that they're doing very limited due diligence is absolutely true based on our truth based on our world our world is to do due diligence for two months to get to know a company for 15 years to get to know how the recurring revenue is doing their net retention growth retention and really get to know management based on our truth and our world yes their due diligence is very limited but on the other hand that limited due diligence is creating good returns which shows you they're making good decisions they have a process themselves of making good decisions producing good returns and it's helping these companies that need that capital so in that environment how do you retain a competitive advantage and what i mean by that is not just a competitive advantage but a competitive advantage while maintaining some sense of discipline the main thing about our competitive advantage is our culture i like to say that in private equity culture is not the most important thing it's the only thing and we have a culture that's defined by being open-minded which got us into software in the first place when it wasn't popular being collaborative and with that's what allows us to back existing management and be able to form deep partnerships and do monthly operating reviews and third we're performance oriented now everyone's performance oriented what we mean by that is we focus on what matters so we take that culture that produces no turnover in our base of colleagues and employees with a deep mission and our mission is to help as many innovative software companies as we can become great enterprises as well not just great innovators and that'll allow them to innovate for a longer period of time and it improves their leadership and when you combine those two a culture and a mission we just end up attracting better people we end up buying the better companies people want to work with good people that see things in a similar way and that have a mission we just don't do deals just to do deals we do deals because it means something and we have something to prove and you believe that in the kind of competitive environment that you've described that actually matters to the to the seller because to many sellers right it doesn't matter whose dollar it is it's it's the same color of green it matters deeply think about it if you had a small business or a large company and you had spent 20 years building it and you had made promises to your customers to your employees and to your colleagues would you care who buys that company would you care who you're going to be working with semi-reporting to or totally reporting to absolutely and if they're sellers that don't care about that we may not be their best partner so if software is as attractive as you say it is and i believe you and furthermore you have a track record to back it up why hasn't everybody figure this out one is the lack of profitability in the industry overall keeps many players out we started when we are very small so you're doing small deals so you can take the risk of learning operations and learning how to run these things in partnership with management when you're investing 50 million dollars are you ready to take that risk when you're investing seven billion dollars on doing it for the first time of turning a company from negative 10 to 40 while not hurting their growth rate and allowing that innovation curve to continue that's a tall order that's the number one reason the second reason which you as totally pointed out is it's interesting how things work in our favor when it doesn't seem like they should which is the high valuations of software those are a natural barrier to entry in the space if software today traded for 12 times ebitda and it was there we would have 40 competitors but that in essence keeps many players out of the business you describe your approach to buying and operating companies as not silicon valley what do you mean by that well what i mean by that is if you look at any conversation i've had with great venture capitalists in silicon valley or any textbook about tech the conversation is in order to grow and innovate you need to quote unquote invest and of course you need to invest but what silicon valley has termed that is you can go ahead and lose money for a very long period of time in order to grow and public investors almost believe that if you show them a company growing at 50 revenue while being highly profitable we get asked the question are we not investing enough in the business should we be unprofitable we come from the school where we've been mentored by these great operators that at a given stage of a company the more profitable you are the faster you can actually grow because you can take those excess margins and invest them in strategic growth which is development and in tactical growth which is sales and you create a bootstrap effect of that company where you don't need outside capital and many different shareholders with many agendas funding the company then you can also use your balance sheet to make a creative acquisitions without the dilutive effect of additional capital but that's not really how many of these companies are encouraged to operate i'm thinking for example of many if not most of the companies in say the arc innovation etf these are companies that are just going for it right that's the thesis underpinning those investments spend whatever it takes to create a total addressable even if you don't even know what the tam is spend whatever it takes to create a tam and somewhere down the road everything's going to be fine is that wrong we don't subscribe to that philosophy we are perhaps too conservative we could not invest other people's money on that hope on a pipe dream we just couldn't do it why is it so fashionable then it could be look in times when capital is very cheap when there's a lot of it when there's a great tolerance for risk i'm not saying that that doesn't work but on average and over time it's all about fundamentals you still believe that 100 and and fundamentals are a dirty word and some tech circles and once again that does not mean that you need to absorb things that are different you can be a great fundamental investor but notice what's going on in the gaming industry notice what's going on in blockchain notice how you can get disrupted in many different ways and be open-minded enough to get into those areas and don't be afraid to take risk as long as that risk is consistent with the type of culture that you have and your ability to absorb it and for us a risk that is let's invest for 10 years and see what's behind the door after those 10 years it's it's too far out it would not work what's the um the perfect example of the classic toma bravo deal great example you take compuware right the mainframe company publicly traded competitor to bmc competitor to ca the old computer associates public company within that business we saw two important companies actually we saw dynatrace and the opportunity to invest in a business that could be very high growth and disruptive and the mainframe business which many investors would throw away because of the challenges of growth in that general market we took the company private for about 2.2 billion and we separated the company into two independent companies going back to the point of separating your investments so you can measure have people be accountable for results and you can have clear line of sight into both the strategy and the operations and track it see how it is achieving month by month we ended up selling compyware to bmc ultimately returning the capital and the investment and then dynatrace has become one of the most important public companies in the application performance management space a company that we invested aggressively behind building a next generation product which has been wildly successful in the market while producing high rates of ebitda margins at the same time both in both of those situations we back the existing management of each operating unit and we work collaboratively collaboratively with them to achieve their goals tomo bravo has been on something of a rocket ship trajectory right five years ago which is to say back in 2016 if i'm not mistaken you managed about 10 billion dollars today that number is what 80 80. so you've grown the firm grown aum eight-fold in five years how does that happen it's pretty uncommon i appreciate that and it's humbling when we started 20 years ago with 550 million under management one important thing is right place at the right time we can't underestimate the luck of being in software and in private equity i say that for the last 20 years you were in software and private equity there's almost no wrong you can do from an investment perspective now in terms of our growth of assets under management the industry has taken us there i spoke about this watch list of companies that we have when you extrapolate their growth rates of 20 compounded a year they double every four years in size not counting the acquisitions that they'll do so in order for us to pursue those same businesses we have to have high rates of growth in capital to be able to absorb them and invest in them the other way we did it is proving it by doing one deal at a time at first the deals that we did back 20 years ago were 50 million all in size roughly then it was a hundred then it was 250. there was about a billion then compy where two billion and now we're doing deals that are 10 but we've been fortunate to prove that they have worked so that we can keep uh doing larger things now if the investments continue to perform as well as they have and if you're able to continue doing all the other things required to grow eight x and five years are you growing eight hex in the next five years that's going to be tough to do and it would not be difficult for the industry to absorb that capital in the way we do business but it'll be difficult for capital sources to put that much money in software it's not an industry issue the industry is there to make that investable in a very productive way in a value-added way it's an issue of how much capital can institutions or do institutions want to deploy in private equity and in software in particular so it's a capital constraint correct how important is scale it's very important and it's increasingly important now why because one of the things that our team has done so well in the most innovative places in tech in software has been to buy the number one player sometimes the number two player whether it's in a vertical a horizontal in infrastructure software and in cyber security where a team has a huge portfolio of companies and a great track record of success and those number one or number two players given their compounding rates of growth and a multiple on their recurring revenues which is a higher number are very large deals to do so scale is critical and it's it's more important now than it was before and scale translates into what what are the you know as you look at the business today and you think about what you want it to be tomorrow and the day after that and the day after that scale translates into what you mean in terms of dollars yes i guess that's probably the best way to measure it where do you feel the dividing line is between sort of scale derived competitive advantage and kind of everybody else above an 8 billion deal that scale derived competitive advantage today and that's where you want to be i might be and i feel that's where we are now if you want to be and i think that that's where you're going with this if you want to be the sole buyer or the favored buyer of very large software companies to the degree that you're not already how do you get there we need to prove it and once we prove it we can take another step function increase in our industry once again our industry can absorb it two things need to happen the performance needs to be there and the institutions need to be comfortable to deploy more in private equity and software if if scale is a competitive advantage and it clearly is not just in software private equity but across right the alternative investing landscape does that mean by definition that you need to be bigger tomorrow and bigger next quarter and bigger next year and bigger five years from now to be able to write bigger checks and to maintain that competitive advantage you do you do and once again going back to it the only thing that will make it possible is performance and out of any other industry the alternative assets industry is all about performance i do believe that institutions from the partnerships that we have with them are slowly getting to the point where they will not perceive software as an industry where they will see it as a business model and that will free up more capital in terms of allocations to the space rather than an institution saying i've got 25 in software that's too much i can't have more because i need to allocate it to some other industries given diversification reasons and i think we're getting there and once we get there it'll deploy there will be more capital deployed in the space so there needs to be a change in the mindset of the lp to accommodate this there needs to be a change in the in the mindset toma brava has also become a player in spax special purpose acquisition companies the blank checks why there are so many private software unicorns that are looking to go public why couldn't we help a subset of that achieve their ipo goals or going public goals with a long-term partner that has an actual operating strategy to help him in that in that mission so we set up our spac given our core competencies and what we do and we just completed our first deal and we're likely to do others as well my cynical view is that there has to be something wrong fundamentally wrong with a product a financial product if hedge funds can build a consistently profitable trading strategy around it which they have been able to do with spax am i wrong i think that's i think you are the arbitrages exist and they get out arbitraged over time as with any financial innovation and new system think about it a spac is a great model as long as it's done right number one individual investors can participate unlike the difficulties of participating in the cozy world of ipos so what our view on that is give them real companies do specs that only have a a revenue size that produce real companies if it's for individual investors to have some real companies in the game not venture startups in the game secondly you can project your business investors love that underwriting projections being able to analyze them questioning management on how they think it through how conservative they are how do they make of these projections so if you're going to have projections have accountability have every company that goes through a spec process always report how they're doing versus their original projections and have the spac sponsor if they come to market again put in the front page of their prospectus how their companies have done versus their projections there are many great disclosures that can be provided to the industry to actually make this another good vehicle for companies to get capital there is no single space structure in your view orlando what is a fair structure for respect what features should a spac have and not have to make it fair i think you have to have in addition to what i said you have to have alignment of interests between the spac sponsor that's receiving the potential profits and all the investors and the company alike so i believe that a spac sponsor just you need to borrow good things from private equity and one of those on alignment of interest is you have to invest real dollars behind the company that you're helping take public so a spac sponsor should buy at least 10 percent of that pipe that gets issued by these companies and secondly a spac sponsor should also stand behind any redemptions that happen so that that company can secure the amount of capital it intended to raise in the first place that way you have these sponsors really investing hard dollars out of their own institutions to match up the incentive arrangement what about warrants we we don't do warrants uh i believe we were the first bag or one of the first packs not to do warrants i don't see why that's another necessary set of incentives i feel there's enough with the promote that goes on in spax the spat craze has coincided with two other powerful trends in finance one i'll describe with one word because it kind of sums it up wall street bets and the other is crypto where do those fit in your world view what these two big movements are showing us is the need for inclusion in wall street and in the financial system by individual investors so you take wall street bets i read a blog the other day that there was a spac sponsor that said well my spac is not for retail investors i was like well i'm a retail investor could it be for me retail investors are smart highly educated they make good decisions and they want in the game and talking about one of the arbitrage situations they have figured out one of them in the market and they're doing that very successfully so so good for them take investing on your own hands have fun at it and yeah they'll take risks and sometimes they'll make money sometimes i'll lose money but i think it's a really really good thing and it's really inclusive and people want that in the world of wall street and investing and in crypto you have a world of young people that want their own financial system and their own culture and it is very powerful and i'm a big believer in it blockchain technology is completely disruptive and on top of that the currencies they'll be worth more if more people adopt them and the bet is it's highly likely that more people will adopt them than less so when there's a wall street bets driven short squeeze of whatever hedge fund happens to be short whatever stock are you sitting there sort of cheering from the sidelines i'm cheering so much because i also don't like shorting i don't i don't like betting against people i don't like betting against companies i don't like the short game uh it's uh you're trying to hope somebody does poorly and even spreading potentially bad information that doesn't exist on that company and this other movement uh makes hedge funds think about that again sometimes that information is good information sometimes it's real and sometimes the companies that are being shorted really are pretty lousy companies and maybe worse than that maybe they're fraudulent how do we deal with that problem if they're no shorts i would say don't buy the stock things will figure figure themselves out but just don't buy the stock how did growing up in puerto rico and and for that matter being a tennis prodigy you know who trained with with the legendary nick boleteri how did that shape who you became big time and i appreciate the word tennis prodigy i was okay but but for puerto rico i was good is when i started going to voluntary that i was there with my friend and roommate jim currier and that was a different level it has influenced so much of who i am and in tennis like any sport but tennis being an individual sport you have to prove it when you get on the court at that time against that opponent no matter who you are no matter how many wins you've had no matter what your ranking is or your status in the sport and that is very motivating as a private equity professional to know that despite we've had luck in the past we need to prove it on every deal and if you don't do things right and you don't work hard enough things can change pretty rapidly if you played jim courier today what would the score be he would beat me 6-0 just like he did when we were 12 years old tell me what do you look for in the people you hire the number one thing i look for is that they're a good person good people attract good people good people create a sense of trust so that you know your colleagues partners and individuals in the organization are doing things that are good for the firm and you prevent infighting you prevent personal agendas and that creates such a much better environment you attract better companies people that want to be good partners people that care who the buyer is of that company i also look for people that have a strong opinion on whatever it is that come with a very strong point of view and a basis for that you are or have relocated to miami along with the growing number of titans in the investing business how come we've always been very different and we've always been relatively early whether it's in software doing infrastructure software then doing cyber security we've been one of the first entrants into that so i feel we're one of the first large groups to have a significant presence in miami from from the perspective of our colleagues going through the pandemic there was also the question of where should i live people reconsidered am i living in the right place people are going we're going through life-changing events getting married having a new child rethinking urban life versus otherwise we feel that our community of colleagues we have a very deep mentorship culture so most of the time not all the time but most of the time we need to be in the office together and by offering a very different location on the east coast with a very different lifestyle different culture different norms we're able to offer our colleagues two different ways two different places to be where they can collaborate in an office environment are tax rates as important a part of the equation for you as they are for other people not at all they're not important to me i don't believe they're important to my colleagues at tomo bravo there's enough money to be made in private equity if you do things right this is a we have a highly uh intense incentive compensation system that our industry has produced so if people want more wealth we can do more deals and we can do better deals we're not into we're not a group that's looking to maximize a given a given tax rate what do you think orlando are some of the other longer term effects of the pandemic on the way that we live and the way that we do business we'll look back on it 10 years from now and say i can't believe that's how things used to be because this is the way they are now life is going to be much better in the future than it was before i like your optimism keep going okay first individuals proved and companies together collaborating prove that you can work from home very well so giving colleagues more choices to improve both their work life and their personal life is it's here to stay a lot of young people don't even want to go to the office anymore i'm not saying that that's a good thing but young people prove that they can be pretty self-sufficient and do a great job from working from home and i think you're going to see the whole corporate environment allowing for a lot more flexibility which improves the lifestyles of many young people uh at companies so that that's one and we'll navigate through that i don't think it's a risk anymore going hybrid because we were just all remote and we did great so it's no longer going to be an experiment in in the business world the deal cycles now are so much shorter again so is there a need to have four meetings with a company fly all over the country before you can make a decision or was that too much did you have enough input executives ceos are very willing to transact over a couple of zoom conversations straight to the point no time wasted not three or four dinners to get there they can make a decision very quickly so i think the speed of moving capital and companies around the economy is is much greater which is a good thing as well and it's going to stay at an accelerated pace it will stay on people have a lot less patience things are quicker and they're going to stay that way better as a result better as a result less time wasted when you feel that something is not right on a deal people are going to move on very quickly when they feel there's something very good they're going to be ready to execute and usually the first impressions are right it's been a pleasure thank you thank you thanks so much

Channel: Bloomberg Television

Views: 88,181

Keywords: Bloomberg

Id: zN4emAH2ivo

Length: 35min 8sec (2108 seconds)

Published: Wed Jun 30 2021