Why Private Equity's Software Bet Is Going to Zero | The Weekly Wrap

The Real Eisman Playbook

Steve Eisman breaks down FICO's dramatic loss of its mortgage scoring monopoly after regulatory changes favored VantageScore, setting the stage for a broader critique of private equity's heavy leverage in software

Key takeaways

• FICO stock plummeted over 25% after FHFA head Bill Pulte merged scoring grids, prompting Rocket Mortgage to adopt VantageScore and effectively ending FICO's pricing power.
• Private equity software buyouts from 2017-2023 averaged 50% debt financing, with peak tech acquisitions exceeding $284 billion in 2021 alone.

Main topics

• FICO vs VantageScore mortgage scoring competition
• Private equity overexposure to software/SaaS buyouts

Notable quotes

"The days of easy money are over."

Conclusion

The episode serves as a structural warning about the end of the low-rate

Transcript preview

Speaker 1 (0:00) The 10-year is at 5.3%. It hasn't been here since around 2002. It feels like we are getting closer to something breaking. FICO had a very bad week. FICO's stock price was down over 25%. This change probably puts VantageScore at a competitive advantage over FICO. The Sarsaparilla story has not gone away. It has just morphed. And I think these software investments are largely dead money, meaning investors are never going to see any return. The days of easy money are over. Private equity is overexposed to software companies. Soon, some number of investors who piled into private equity deals offering a great potential return will find their investments are worthless. Here is the problem. Speaker 1 (0:53) Hi, this is Steve Eisman, and welcome to the Weekly Wrap. This is for the week ending Friday, October 2nd, but recorded Thursday night, October 1st. We have an exciting announcement to share. Starting this coming Monday, October 5th, we are offering early access for premium subscribers. Monday and Friday will be released early exclusively to paid Substack premium subscribers. All Monday episodes will now be released at 12 p.m. Eastern Standard Time every Sunday. The Friday Rack will now be released at 12 p.m. Eastern Standard Time every Friday. For those of you who are not premium members, the Monday and Friday episodes will be released at the usual times, Monday at noon and Friday at Fortune Key. On this week's Rack, we will discuss, one, the war in Iran, oil prices and interest rates. Two, more negative news for poor FICO. Three, an analysis of private equity and private credit exposure to software, and four, three mailbags. Let's get started. In more news, the week began with President Trump projecting an offer from Iran. That drove both oil prices and interest rates higher and caused the market to decline. We are in an odd period right now where the only two variables that matter are oil prices and interest rates. The 10-year is at around 5.5%. It hasn't been here since around 2002. It feels like we are getting closer to something breaking. Moving on. FICO had a very bad week. On Tuesday, FICO's stock price was down over 25%. Why? Bill Pulte, the head of the FHFA, which is the regulator of Fannie Mae and Freddie Mac, posted on X that he was combining the LLPA grids for FICO and VantageScore. thereby removing the 20-point haircut on VantageScore. This change probably puts VantageScore at a competitive advantage over FICO. As a result, Rocket Mortgage, one of the largest mortgage lenders in the United States, announced that it would be defaulting to VantageScore. I expect that over the coming months, the adoption of VantageScore will accelerate by a lot. The FICO short thesis has been that FICO risks losing its mortgage monopoly. It raised prices 1,600 % over the last five years and has angered the entire mortgage ecosystem. The lesson here is don't piss off your regulator. One more point on FICO. Losing a monopoly because of bad strategic decisions is as bad a result for a company as imaginable. The strategic mistake was to be greedy and to raise prices by an insane amount. FICO has lost its monopoly in less than a year. Astonishing. The stock was down over 25 % on Tuesday and is down over 60 % year to date. William Lansing is the CEO of FICO. He has been the CEO since 2012. He should be fired immediately. This is a company in crisis and it needs new leadership. that he has not been fired is evidence that most boards are window dressing. Most board members don't take their jobs seriously. They just take a check and smile. Earnings season is two weeks away, so I thought now would be a good time to do a deep dive on private equity and private credit. There was a time not long ago when we would discuss private credit literally every week. The news was mostly bad with massive quarterly redemptions. Things have gone temporarily quiet, but the big question to be answered is whether equity will be wiped out after the debt is refinanced. This deep dive will set the stage by looking at the sheer size of private equity investments from 2017 to 2023. We will then look at how and why and where these software buyouts occurred and which were mostly SaaS, which is software as a subscription. And finally... we will ask, why did private equity have so much money to invest? Throughout the past decade, many private equity firms place a major emphasis on SaaS companies due to predictable revenues, high margins, and high growth. 90 % of all tech buyouts were SaaS companies, and SaaS deal volume made up a quarter of the whole private equity buyout market. Massive specialist funds such as Thomas Bravo, Vista Equity, and Silverlake made up about 60 % of the total SaaS buyout. From 2017 to 2023, private equity grew exponentially and averaged between $100 billion and $400 billion in transactions a year. The exact amount of private equity buyouts is difficult to completely figure out, but to give you a flavor of the annual size of the buyouts, let's look at 2021 through 2023. In 2021, which was the peak year, U.S. private equity buyouts of technology companies accounted for more than $284 billion. $256 billion was for software. The business model of steady revenues driven by technological moats Strong client relationships and a low-rate environment made these companies highly attractive. Again, don't ever forget the importance of low interest rates in buyouts. Private equity investors backed up the debt truck when rates were really low. In 2022, there was something of a correction to the unbridled enthusiasm