Today I want to tell you all about a highly lucrative tech sector trend that's flying under Wall Street's radar.
I'm talking about private equity's plunge into Silicon Valley in order to take advantage of software's high profit margins. Publicly held software companies are now regularly agreeing to be acquired and taken private.
In the last 18 months, four software firms have been delisted in leveraged-buyout deals worth a combined $18.3 billion. On April 7, software publisher Informatica Corp. (Nasdaq: INFA) agreed to be taken private in a deal valued at $5.3 billion – the biggest leveraged buyout in 2015 so far.
With money like that flying around, you'd think this would get more attention. But Wall Street's ignorance is fine with us.
We often find that the best way to make money is to jump on a trend before other investors wake up.
Now, I understand the temptation to start trying to guess the next software buyout candidate. When a company becomes a buyout target, its share price soars.
Before you start such guesswork, though, you should know that's a dangerous game. Unless you have "inside information," you might as well be flipping a coin in most cases.
However, I've found one simple way to hitch a ride on this trend with very little risk – and a very big upside.
Let's take a look…
The Most Profitable
Software companies are so profitable because they don't have to spend heavily on "plant and equipment" the way hardware companies like chip makers do.
And with the movement to cloud computing, in which software developers deliver applications via the Web, they don't spend much time burning CDs and shipping them out anymore either.
According to data from IBISWorld, five of the most profitable "micro-sectors" are in software: urban planning software (with profit margins of 37%), business analytics and enterprise software (37%), human resources and payroll software (40%), and online survey software (55%).
Big and growing revenue numbers are important, but profits are where companies – and their investors – live or die. So, software is a good place to be.
To get an even better sense of the software industry's high profit margins, let's take a look at the operating margins of two big players in the space.
Microsoft Corp. (Nasdaq: MSFT) has operating margins of 30%, and those of Oracle Corp. (Nasdaq: ORCL) come in at 38%. By comparison, the highly respected chip firm NVIDIA Corp. (Nasdaq: NVDA) has operating margins of 16%.
Private equity's recent foray into software began in December 2013, with the $6.9 billion buyout of BMC Software Inc.
Besides Informatica and BMC, Compuware Corp. agreed to go private last December 2014 in a deal valued at $2.5 billon. And in September 2014, Riverbed Technology Inc. struck a deal valued at $3.6 billion.
Like I said, we're not going to be guessing which software firm is next in line to get snapped up.
But with fewer software stocks available, investors will be bidding up the value of shares as a group.
About the Author
Michael A. Robinson is one of the top financial analysts working today. His book "Overdrawn: The Bailout of American Savings" was a prescient look at the anatomy of the nation's S&L crisis, long before the word "bailout" became part of our daily lexicon. He's a Pulitzer Prize-nominated writer and reporter, lauded by the Columbia Journalism Review for his aggressive style. His 30-year track record as a leading tech analyst has garnered him rave reviews, too. Today he is the editor of the monthly tech investing newsletter Nova-X Report as well as Radical Technology Profits, where he covers truly radical technologies – ones that have the power to sweep across the globe and change the very fabric of our lives – and profit opportunities they give rise to. He also explores "what's next" in the tech investing world at Strategic Tech Investor.