Software LBOs: rare bankruptcy shows heavy debt can still be toxic

Sometimes the best deals are the ones that fall through. In 2014, publicly traded US software company Riverbed was the subject of a fierce shareholder activism campaign. Like many such targets before it, Riverbed chose to put itself up for sale. Investor Elliott put forward a bid but it was another top financial player, Thoma Bravo Partners, who won the auction by paying $3.6bn.

Competitors dodged a bullet. On Wednesday, the company filed for bankruptcy protection, staggering under $2bn of debt and scant profits. Since the Riverbed deal, Thoma Bravo has had far more wins than losses, becoming the most prominent software investor in the world. But heavy leverage and evolving technology can be problematic even in an apparently benign era and a booming sector.

Riverbed specialises in the systems that manage so-called wide area networks or WANs. The pandemic forced a debt restructuring that pushed out maturities but increased 2021 interest expense. This reached a level that exceeded forecast cash flow for the year of $152m. In recent weeks, the company has agreed to a new restructuring plan that will slash debt by around a billion dollars. Junior creditors will take over the business, with their recovery pegged at 40 cents on the dollar. New investors, led by Apollo Global Management with Thoma Bravo in a supporting role, will put $100m of new equity into the slimmed down Riverbed.

The bankruptcy comes as the overall bank loan default rate in the US has dipped below one per cent. Riverbed’s decline is the largest single failure in more than a year. Software companies have become ripe leveraged buyout targets as their cash flows, even in shrinking segments, are predictable. Common management practices and cost cuts can be easily applied. Still, the Riverbed disappointment shows that a high debt load narrows any margin for error. As Elliott has discovered it can be, at least occasionally, more profitable to simply sell such execution risk to someone else.