Investments in the Risk Management software sector

Every day it seems more evidence surfaces that large investment banks are in the midst of a profound identity crisis.  Technology is redefining the very nature of capital markets and will increasingly force bulge bracket firms to make difficult choices with respect to their core businesses.  Hedge funds and asset managers are readily able to design, deploy, and trade their own products without the assistance of intermediaries such as investment banks and brokers.  The model of being all things to all customers - strategic advisor, intermediary, asset manager, financial sponsor, principal investor - is clearly unsustainable.

The ongoing crisis in the fixed income space underscores this point: shareholders will not tolerate for long volatile earnings resulting from a rudderless business model.  A wave of restructuring is indeed on the horizon, but not in the trading/risk management technology space - rather, within the banking & brokerage space.  As these firms race to redefine themselves through spin-offs, divestitures, and other strategic moves, I would expect, rather than consolidation, an explosion in the number of technology players seeking to provide a range of analytics, niche products, and value-added services to the next generation of financial enterprise.

KKR and First Data might argue your point about the Advent and Sophis deal being the most significant private equity deal of recent months, though if you limit the statement to the software sector, you’re probably right.

As for whether it will spark a consolidation wave, I guess it depends on Advent’s reasons for investment and Sophis’ subsequent strategy. Is it an international expansion play? Possibly. Sophis already had a wide network of global offices, but has since pushed to grow its derivatives business presence across its geographies, most recently with the hire of a chief operating officer for North America.

It’s probably not a strategic restructuring play, as Sophis was already quite focused. Is it a high-growth play? Possibly, if you look in the public markets at the performance of Advent Software (no relation), which also sells into this space you can see that there is growth in this market. But then if you look at the performance of Sophis’ fellow French company Linedata, where they hired their new North American COO from, you can see that just riding the wave of increased IT spend from the buy side isn’t enough – execution and product differentiation are key, and building strength in the derivatives side of the business will definitely help Sophis hit whatever targets the private equity team has in mind.