Are Tech Buyouts the Next Big Thing?

Founded in 1992, the Texas Pacific Group has grown into a private equity powerhouse with more than $20 billion under management. The firm certainly has its share of typical private equity investments -- cash cows that have strong brands and defensible businesses. Its investments include Burger King, Bally, and J.Crew.

However, as private equity firms bulge with cash (over the past year, several have raised more than $10 billion) -- and available financing -- it's harder to find traditional targets. As a result, these firms are venturing into new territory, such as the tech industry.

Recently, a partner at the Texas Pacific Group, Gene Frantz, said he thinks there's likely to be a $25 billion-to-$35 billion tech leveraged buyout (LBO) in the next year or so. An LBO happens when a buyer completes a purchase using a large amount of debt and little equity -- typically only 10% or so. Assuming management is strong and the acquired company continues to generate cash flows, the acquirer will pay down its debt over time, providing high rates of return for management and the private equity firms.

Now it's kind of a shocking thing to talk about a $30 billion LBO in the tech industry. After all, in a private equity deal, investors normally look for critical factors such as assets and cash flows. True, tech companies may have cash flows, but aren't the assets, such as patents and smart people, really intangible?

Well, over the past few years, the model has changed. There have been a variety of major LBOs in the tech sector, such as the $11.3 billion deal for SunGard -- a solid business with a variety of applications, such as backup, disaster recovery, and risk management.

This isn't the first time that private equity firms have ventured into the tech sector. During the late 1990s, these firms invested heavily in telecom. Of course, it was a terrible bet, and many of the deals were written off.

So, is this time different? Since the dot-com bust, the tech sector has been a laggard. Yet many large tech companies have restructured operations. It also appears that information technology budgets are starting to improve as companies need to replace older technologies.

What might be some targets? The most interesting are likely to be those companies with long-term contracts that provide steady cash flows, such as in IT outsourcing. Such companies include Computer Sciences (NYSE: CSC) and EDS (NYSE: EDS).

Another target would be software companies, which have many ongoing maintenance contracts with customers. Some possibilities here include Sybase (NYSE: SY) and Novell (Nasdaq: NOVL).

But trying to find the next buyout target is really a gamble. After all, not many thought SunGard would be "in play" for private equity groups. So, while there are strong players in big tech, a buyout should be a possible bonus, not a driving factor, when deciding whether to buy the stock.

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Fool contributor Tom Taulli does not own shares of companies mentioned in this article.