Investors sound the alarm about possible private equity tech deals

Who wants to sell when prices are low?

Enterprise spend management software company Coupa’s investors are ringing the alarm about a possible sale to private equity, concerned that any such transaction in the current investment environment may unreasonably limit its value.

This is something you don’t see every day. Last week, rumors surfaced that Vista Equity Partners was interested in buying Coupa. Today, Coupa’s largest shareholder, HMI Capital, with 4.8% of the stock, made a letter to the Coupa board public, stating that it would oppose any deal that it believed undervalued the company.

It pegged its value at a minimum of $95 per share. Coupa’s share price hovered around $63 this afternoon, down nearly 3%. Like many SaaS stocks, Coupa’s value has dropped precipitously in 2022, down 60% for the year.

HMI is worried that Coupa’s current value doesn’t reflect what it believes will be a lucrative future once it gets beyond today’s troubled valuation market for software companies.

Unlike the poison-pen letters we are used to seeing from activist investors, this one was full of nothing but praise for the company (probably because its goals were very different):

As we have conveyed to the Board and management team, we invested in Coupa based on our belief that it is an excellent business. Its management team — most notably Chief Executive Officer Rob Bernshteyn — has done an exceptional job building the Company from a startup to a clear market leader, while establishing business spend management as its own critical category. Perhaps most importantly, Coupa’s outlook for future growth and long-term value creation is bright. As Mr. Bernshteyn himself stated only a few months ago:

“Now near-term scenario aside, we are proudly the clear leader in business spend management. Our total addressable market is massive and under-penetrated and we are excited as ever in our pursuit to revolutionize this market and deliver customer success like never seen before.”

It’s our view that we speak for many other shareholders when we say that we would be pleased to own Coupa for the foreseeable future and to bet on the team to continue to build momentum and execute its proven strategy.

It’s almost odd to see an external investor praising a company’s leadership, as most public investor comment is negative. Here we do not see an investor begging management to cut costs or change direction. Instead, it’s praise and a belief in greater value yet to come.

The sunny view of Coupa’s future conflicts with present public market sentiment about the future value of tech companies. That prevailing viewpoint, crossed with huge amounts of private equity dry powder, may have put PE investors in a deal-making mood.

HMI is begging the Coupa crew to stick it out, or at least demand more than they otherwise might settle for. Of course, this is HMI talking its own book, but there may be some substance to its argument. Let’s check the math — and a comp.

The private equity compromise

In October, UserTesting agreed to sell itself to private equity investors for $7.50 per share, or around $1.3 billion. The transaction was valued at around a 94% premium over the value of the company before the deal was announced. Still, the per-share price offered was just over half of the $14 per share that UserTesting commanded when going public back in late 2021.

For the beleaguered public company, and recent unicorn, the deal was a way to claw back some shareholder value. But did it get enough back, in market cap terms, to make the sale the correct move? Given that UserTesting has yet to announce a better, competing offer during a “go-shop” period, the answer is a firm maybe.

The other option was to keep operating. UserTesting’s third quarter included revenues of $49.4 million, growth of 28% year over year and de minimis operating cash burn. Sure, it was struggling to defend its share price, but it had plenty of cash to fund its operations and had a reasonable growth story to boot.

Much like in the case of HMI and Coupa, you could argue that Coupa would be better off not selling and simply chugging its way through the market trough until better times appear, allowing it to either command a higher per-share price in a sale or recapture some of its lost worth as an independent company.

(TechCrunch requested comments from both Coupa and Vista Equity Partners for this story. Vista declined to comment, and Coupa did not immediately respond. Should that change, we will update.)

At this juncture, we need to ask ourselves just how reasonable Coupa at $95 per share would be. In September, Coupa announced its results through July 31, 2022. It posted $211.1 million worth of top line, up 18% on a year-over-year basis. On a GAAP basis, Coupa was unprofitable in the period, posting operating losses of $63.6 million and a net loss of $75.3 million. (Its operating loss was up compared to the year-ago period, while its net loss shrank.)

But what Coupa has that makes it somewhat special is that it kicks off lots of cash. Its operating and free cash flow in its most recently reported quarter — we’ll learn more about its Q3 fiscal 2023 period in a week — came to $29.1 million and $25.0 million, respectively.

Hell, Coupa was generating so much cash that it announced a “share repurchase program of up to $100 million of the Company’s common stock.” You don’t do that if you don’t have free cash and belief that your stock is undervalued.

Coupa at $63.88 per share is worth $4.85 billion. At $95 per share, it would be worth $7.2 billion, give or take. At its now-dated fiscal Q2 run rate, the company would be worth around 8.5x its revenues. (HMI notes that “recent software sponsor take-privates have averaged approximately 9.6x NTM revenues [which] would support a sale of Coupa over $95 per share,” to which we say, correct.

But how reasonable is that multiple? Per data that TechCrunch can see, it is a bit rich for market norms today, given Coupa’s growth rate compared to its peers and their multiples.

This doesn’t undercut the HMI argument; it’s core to it, frankly. Namely that the market is undervaluing software companies, and so selling for a modest premium from a depressed share-price floor is silly. It would, in effect, transfer existing investors’ anticipated future returns to another set of capital backers. That’s provided, of course, that tech valuations are too low today compared to the real value of the assets they represent.

Given that interest rates are set to continue rising, it’s fair enough to argue that tech valuations could fall further. However, with the Fed now signaling a possible moderation in how quickly it raises rates, some pressure could lift off of tech stocks in the coming weeks. That would raise share prices and partially inflate multiples. To sell in the very near future, before the market has a chance to react to Fed movements in the coming weeks, might be jumping the gun.

With potentially good news on the horizon, at a minimum, no software company should sell before we get the next Fed move. If it is more modest than prior hikes, we could see tech stocks gain value. In turn, that would set a new, higher floor for possible sale prices of tech companies. For Coupa investors, such a moment might allow them to command a price more in line with what HMI wants versus what a PE firm might be willing to pay today.

Of course, private equity wants to get busy when it can do so at a cheap entry price. That’s why the UserTesting sale price felt like a blow; the company was selling at a massive discount to its recent IPO price because, well, its value had fallen even lower than what PE was willing to offer. Companies can make that call or decline and execute their plans until the market decides that tech companies are worth a bit more than they thought during an accelerated period of rising rates and increasing geopolitical unease.

A little patience could result in a greater payoff. Or it could mean a missed window. But HMI’s argument that any exit price set using current norms might undervalue the assets in question seems more than reasonable a contention to make. Why else would PE be circling?