You may have seen recent headlines showing U.S. business development companies (BDCs) and private credit managers struggling with software exposure, with many trading well below reported NAVs as investors reassess credit quality and loan valuations tied to the tech/SaaS sector. Software related loans make up a meaningful slice of some BDC portfolios with some reports suggesting it is the single largest industry component of the US corporate loan market and widening investor concern has pushed many BDCs to trade at double digit discounts to their NAVs.
So why is Epsilon in a very different place?
Because we purposely choose not to chase the high yield, high volatility SaaS lending trend. Here’s what we’ve seen:
SaaS lenders are really lending to growth narratives, not cash flows. A significant number of SaaS credits loans are ARR based and loss making, rather than loans to sustainable, cash generative companies with operating leverage that protects lenders.
Valuation risk is real. When trading multiples compress, as they have this year, both equity and debt tied to these companies rerate sharply (and given some of the lofty tech multiples we’ve seen over the last decade, this only amplified the downside risk to the lender’s collateral value).
The continued investment and focus on AI is driving the fears of displacement to the business models and sustainability of some software and technology companies. From the potential for pricing pressure, to product commoditisation, this may mean many SaaS companies now face slower top line growth even as they carry heavy fixed costs and leveraged balance sheets.
As a conservative corporate lender, we have been deliberately opting out of opportunities in the segment, not out of fear, but out of discipline:
if a company can’t consistently generate cash to service real debt, it’s not credit, it is speculation in our view.
that judgement has paid off in portfolio resilience with Epsilon having no exposure to the sharp markdowns witnessed offshore.
Don’t get us wrong, we really like the software sector and have some exposure, but we’ll continue to back fundamentally sustainable cash flow generating companies in this space because when markets swing, discipline matters more than glamour.