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— Dealmakers —
In 2003, Shah founded private equity firm Shah Capital Partners, which raised a $250 million fund in 2004. In November 2006, the firm merged with Silver Lake Sumeru, the middle market-focused fund of tech-oriented buyout shop Silver Lake. Shah, who has experience in both running a company and private equity firm, explains how the Silver Lake merger came about and why he enjoys not running his own firm. Despite the current economic slowdown, Shah insists that the middle market remains active, especially for technology transactions. Another surprise? Internet companies now seem ripe for private equity investing. Shah discussed all this with The Deal's Luisa Beltran.
The Deal: Your firm joined Silver Lake in November 2006, when the buyout market was still hot. Why? Ajay Shah: There were some distinct advantages for everyone. The very broad Silver Lake network is a technology-oriented buyout fund. We wanted to team up with a specialist. In this case, a well-branded specialist where we could essentially slot in and take advantage of everything that Silver Lake has created already but bringing our own capabilities into the middle market. How did it come about? Jim Davidson, who is one of the founders of Silver Lake, and I were at a Silver Lake investor conference in May 2006. We -- Silver Lake and Shah Capital -- were already working together on one, maybe two transactions. This really worked well for Silver Lake. It was a way to be more active in the middle market. The technology middle market in 2006 was about 35% to 40% of the total tech M&A market. It's a pretty decent size chunk. But it's different. As you might imagine, there are lots more midsized companies than large companies. The activity level is different. These companies tend to play in markets that are not as sizable. These are more niche markets. As a result, you have somewhat different types of requirements on how to investigate, understand and drive investments. So you and Jim Davidson were speaking in May 2006 ... He said, "We should find a way to work together more closely. We are
really interested in the middle market." We thought that this was a
good relationship for us. Obviously, Silver Lake felt the same way. I
got a phone call from Dave Roux [another Silver Lake co-founder],
saying, "Come by and let's chat some more." So we got together with
Dave and Glenn [Hutchins, also a co-founder] and Jim. We talked about
what kinds of transactions we wanted to do, what our investment styles
were, where we thought we added value and made money. Two things became
clear: One, our investment styles are very similar, and, secondly, we
liked the people. Everyone got along well, which is a key requirement.
If you don't get along well and don't have a particularly strong sort
of respect and understanding, then it's not much fun trying to work
together. We felt really good about that. Then it evolved to where How is it now with Silver Lake? How different is it from running your own shop? I didn't look at it as running or owning my own shop, although I know my name was on the door. Kyle Ryland [a former Shah Capital senior partner who is now a Silver Lake Sumeru managing director] used to run technology banking at Lehman Brothers. Paul [Mercandante, who was a Shah operating partner and is now a Silver Lake Sumeru managing director] was president of a company called Force Computers, which is a $400 to $500 million business that Motorola bought. I guess my name was on the door because I was the founder. I've been used to working like this for many, many years. It's really no different at Silver Lake Sumeru. The good and bad news is that my name is not on the door. The good news, it may sound odd, but actually having your name on the door means everyone thinks they have to talk to you. It significantly limits how people look at your capabilities. They look at everyone else as not important. Everyone thinks I'm the only one who can make a commitment. This just means we have a professional organization where lots of individuals can advance and decide something. Are you still managing Shah Capital's 2004 fund, which raised $250 million? Are you still making investments? The fund is doing quite well. It's been investing close to four years. We are just about to make our last investment. It's a division of ChoicePoint called I2. It's led by Sumeru. The last two investments, actually the last three investments, have been co-investing along with Sumeru. They are I2, Mobile Messenger and Audio Visual Innovations Inc./Signal Perfection Ltd. (AVI-SPL). Now, two years after your merger, the market has slowed considerably, but there still seems to be some technology M&A occurring. How is the market for technology investing? It depends on how you want to characterize it. If you look at our end of the marketplace, we are very busy. When I talk about our end of the marketplace, these are deals that are not really largely dependent on financing. That's not to say that financing is not available. We have completed two transactions in the last three months where a significant amount of financing is involved. But a core piece is not financing. The core piece is around some transformation of the business. For that kind of thesis, I would even go as far to say, perhaps a little controversially, that this is a better investment environment than a year ago. People aren't nuts anymore. They don't think [the market] just keeps going up. People are much more cautious and rational. That's a better investment environment. Go back and look at some of the best vintages of funds, and you will find that the best vintages are times when things were tough. When things are great, and everyone is very sanguine about prospects, when greed rules and not fear, then you often had some of the worst deals done. That's my view anyway. I think you will find that the data supports it. But we're not trying to be market timers and say, "This is better and that was worse, so we'll invest now but won't invest then," but we do try to meter our investments. We try and actually say, "This is an overoptimistic and an overlevered environment. People are just too optimistic." So maybe we will go a little slower. Conversely, when we feel like we are able to buy the right companies at the right values with the right propositions, which is more likely today than it was a year ago, we are more enthusiastic about investing. Yes, we are seeing better investment opportunities. That's not to say this is a great business environment. It's not. Any particular sectors that are not as good for investing? We are somewhat more cautious about sectors that have to do with capital equipment, especially when it's more U.S.-focused. The U.S. is a little weak. Consumer-related and capital equipment-related businesses are what we would be more nervous about right now. Any sectors that you feel strongly about? Many Internet-enabled businesses are not seeing any significant impact unless they have a very heavy consumer-oriented revenue base. For example, our I2 deal is very focused on government-related spending. The government sector, like the I2 deal, tends to be not as dependent on economic conditions. For example, if there was software that helps customers really save costs in terms of logistics management, or in terms of their overall productivity in a very particular way. Those kinds of businesses, those kinds of products, don't tend to suffer as much of a slowdown. Was it harder to do deals when the credit markets began tightening? I have to tell you, in 2007, we did only one deal, and that was with zero leverage. Zero. It's a round number. That was Mobile Messenger. This was supposedly the hot market for credit. In 2008, which is apparently the other extreme, we've done two transactions, both of which have significant leverage. My view of this is not exactly what newspapers are printing. For typical PE deals in 2007, the debt-to-equity ratio was 70% debt and 30% equity. We now are hearing that some firms are putting in as much as 50% equity. What equity do technology PE firms typically put in? There does seem to be a general trend toward more equity and less dependence on debt, but the ratios still vary substantially from deal to deal and firm to firm, so it's tough to pinpoint specific ranges. Silver Lake has typically been more conservative in its financing structures and often uses less leverage than the market would bear. That's a reflection of the growth inherent in the technology sector as well as our commitment to adding value to our portfolio companies in very specific ways. Leverage can be a plus, but we don't depend on it as the principal factor in driving our investment returns. Sumeru began marketing for its first fund in March 2007 and finished a year later with $1.1 billion -- significantly higher than your $750 million target. How did fundraising change from when you first started versus the end? You have said that some of the investors became nervous. Markets did change in 2007. In the beginning, everyone was rather enthusiastic about private equity. Towards the end of the year, there was a great deal more nervousness. We had to spend a lot more time explaining our strategy. Is it harder to close a deal now? I wouldn't say it's harder. It's different. Just the criteria and issues are different. Financing is more difficult because many of the banks have issues around their balance sheet that are, should we say, inconsistent. Meaning, one side of the bank wants to do one thing, the other side of the bank wants to do something different. And so they end up making proposals, then changing their minds. That's a bit of an issue. Are you having to go to nontraditional lenders? We are hearing that new people are cropping up. Mezzanine financing is back. Yes, we do see more mezzanine sources now. It's changed. Having said that, I don't think we're seeing anything we haven't seen before. It's just a seasonal issue. There are different cycles in the market, and what we have is another cycle right now. What is the future for Sumeru? We see the Internet-related sector as developing into quite an interesting opportunity. We are making sure that we have the right kind of abilities to evaluate that and understand it. What about the Internet-related sector attracts you? It has grown up and become more interesting for private equity. It used to be a VC activity. Many companies have grown and become successful, with strong cash flow. It's a phenomenal model. You've got tremendous leverage and scalability in Internet-related businesses. Social networking companies, from a private equity standpoint, are not as interesting. They're not ready. |
In an information technology career spanning more than a quarter century, Ajay Shah, 48, has sat on both sides of the dealmaking table. He began his career in the early 1980s at Advanced Micro Devices Inc., then joined Samsung Group in 1987 and in 1989 co-founded Smart Modular Technologies Inc. The company went public in 1995 and was sold to Solectron Corp. four years later for $2 billion. 
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