Apollo warns 40% software buyout share is 'systemic failure'

Private equity firms that poured capital into software at high valuations and debt levels face a reckoning, Apollo Global Management's deputy global head of private equity Antoine Munfakh told CNBC.

Software buyout volumes historically accounted for about 10% of global leveraged buyout activity. That share has swelled to roughly 40%. Munfakh, speaking at the SuperReturn International conference in Berlin, called that shift "a systemic failure of risk management across the asset class."

Hold times for private equity assets have doubled from roughly four years to almost eight years on average. That created a $4 trillion overhang of unsold assets, with sponsors under growing pressure to return capital to investors.

"A pick-up in exits could expose the gap between firms that carried assets at realistic valuations and those that held valuations too high," Munfakh said. "It will shine a spotlight on those GPs that marked their assets conservatively and those GPs who marked their assets aggressively."

Last year was the first time sponsor exits occurred at prices lower than where the assets had been marked, he noted.

The pressure is especially acute in the software sector, where firms piled in at high valuations and high debt levels. Munfakh said artificial intelligence could lower barriers to entry for software companies, compressing growth and margins and making some exits harder even if the underlying business is solid. For companies bought at high multiples with significant leverage, any margin compression could push valuations below entry prices.

"You can have bad deals and bad returns for good companies if you overpay, over-lever them, and price them to perfection," he said.

Apollo has taken a different path by focusing on so-called HALO assets – heavy asset, low obsolescence businesses. Munfakh described those as less vulnerable to rapid technological disruption.

"We focus on using AI as a value creation lever, again buying these non-disruptible, real economy businesses … where AI is not only not a disruptive threat but really a lever for value creation," he said.

Pressed on whether return levels need to fall for investors to see cash returned, Munfakh said: "We'll see." He declined to predict the magnitude of the re-pricing.

Distributions are expected to increase as the industry works through the backlog. The dispersion in returns will make it harder for some firms to raise future funds, he said.

The risk to software portfolio companies is twofold. Longer hold times mean more years of debt service at elevated interest rates. An exit window that opens at lower valuations could force write-downs on equity, pressuring fund returns.

Munfakh's warning applies broadly to buyout shops that built significant software exposure near the cycle top. The sector's buyout share has more than tripled. The re-pricing, he suggested, will be uneven.

"Private equity firms will struggle to raise capital going forward," he said.