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

Steve Eisman · The Real Eisman PlaybookBullish

VantageScore will gain mortgage share quickly after FHFA's grid change and Rocket Mortgage's switch.

FHFA's combined LLPA grids removed VantageScore's 20 basis-point haircut relative to FICO, which probably gives VantageScore a competitive advantage. Rocket Mortgage, one of the largest US mortgage lenders, announced it would move to VantageScore. Eisman expects adoption to accelerate by a lot over the coming months, since the FICO short thesis is that FICO risks losing its mortgage monopoly.

“I expect that over the coming months, the adoption of VantageScore will accelerate by a lot.”at 4:03

Steve Eisman · The Real Eisman PlaybookBearish

FICO is losing its mortgage monopoly after 1600% price hikes; he calls it a company in crisis.

FICO's stock fell over 25% in a day after FHFA head Bill Pulte combined the LLPA grids for FICO and VantageScore, removing VantageScore's 20 basis-point haircut and giving it a competitive advantage. Rocket Mortgage then moved to VantageScore. Eisman's short thesis was that FICO risked losing its mortgage monopoly; it raised prices about 1600% over five years and angered the mortgage ecosystem. He says losing a monopoly this way is about as bad as it gets for a company, the stock is down over 60% year to date, and CEO William Lansing (in the role since 2012) should be fired because the board is not doing its job.

“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.”at 4:27

Steve Eisman · The Real Eisman Playbook

The 10-year yield near 5.3% is the highest since 2002, so the market is nearing a break.

The 10-year Treasury yield is around 5.3%, after a week in which President Trump's offer from Iran drove oil prices and rates higher and the market fell. Eisman says the yield has not been this high since about 2002. He thinks the market is in a period where only oil prices and interest rates matter, and it feels closer to something breaking.

“It hasn't been here since around 2002. It feels like we are getting closer to something breaking.”at 3:16

Steve Eisman · The Real Eisman Playbook

AI can hurt software via slower seat growth and pricing power, even without destroying the companies.

The SaaS apocalypse started as the claim that AI would wipe out existing software, which sent software stocks down from last summer to early summer. It has since morphed. Software companies with moats, such as ServiceNow and Salesforce, may be fine, while B2C firms like Intuit, Booking and Expedia, and some B2B firms, are at risk. Eisman says AI does not have to destroy a software company to hurt it. It could slow seat growth and make it harder to raise prices, which would hurt future profitability and valuations. He says the story is still early.

“However, AI does not have to destroy a software company for it to have an impact. It could simply slow seat growth and make it more difficult to raise prices.”at 9:39

Steve Eisman · The Real Eisman Playbook

Cybersecurity should survive the SaaS disruption, helped by AI-driven hacking and strong public stock performance.

Eisman says the AI models' recent hacking makes cybersecurity a good bet to survive the SaaS apocalypse. Public cybersecurity companies have done very well, and cybersecurity is the large exception among software stocks, which are down about 50% from peak. In his buyout analysis, McAfee (64% debt-funded) and Proofpoint (37%) are not vulnerable to AI, while Citrix, Zendesk and Anaplan are.

“Now given all the hacking that AI models have been doing of late, I hope you've noticed, cybersecurity has a good shot at surviving the SaaS apocalypse.”at 10:45

Steve Eisman · The Real Eisman Playbook

Software buyouts' refinancing math leaves equity at zero; private credit will end up owning the companies.

Corporate loans are interest-only with a bullet repayment, unlike mortgages. Eisman's example: a $1B software buyout, half financed with variable-rate private credit, with the company's value cut 50% to $500M. The debt equals the new value, so equity is worthless. Private credit will demand the PE firm put in another $500M to refinance. He doubts PE firms will do that and expects most to walk away, leaving private credit owning the companies, with the outcome unclear. Private credit has also had bad news with massive quarterly redemptions.

“And now, when the private equity firm approaches a private credit firm to refinance the debt, they have to come up with new equity to shore up their balance sheet.”at 16:58

Steve Eisman · The Real Eisman Playbook

PE is overexposed to debt-funded software buyouts, which will take years to work through.

From 2017 to 2023 PE piled into SaaS, which was about a quarter of the buyout market, with 2021 tech buyouts above $284 billion, $256 billion of it software. Deals were financed with roughly 50% debt, often variable-rate, at the low rates of that era. Higher rates have since inflated interest costs and hurt earnings and cash flow. The SaaS sell-off has cut valuations about 50%, and with a weak IPO market holding periods have stretched from three to four years to about seven. Eisman expects many investments to be marked to zero, and cites the already-failed Pluralsight and Medallia deals, where lenders took over and equity was wiped out.

“...and private equity is overexposed to software companies, which has become extremely problematic. It's going to be years for private equity to work through these problems.”at 19:08

Steve Eisman · The Real Eisman Playbook

The Fed can't control oil prices, so rate hikes are a blunt but necessary response to oil-driven inflation.

The Fed has no control over oil prices, so raising rates does not change oil. But when oil stays elevated, higher prices spread through the economy. Higher oil raises fertilizer costs, then food prices, and more broadly prices. Once that happens the Fed feels it must act, hoping higher short rates slow the economy and bring inflation down. Eisman says this is a very blunt instrument, but it is the best the Fed can do.

“The Fed has zero control over oil prices. So when oil prices are rising and that creates fears of inflation, the Fed raising rates has no impact on oil prices.”at 20:57

Steve Eisman · The Real Eisman Playbook

AI leaders' doom and regulation rhetoric is a subterfuge; they don't believe AI will destroy the world.

Eisman says the problems AI has created so far are largely hacking. Management and better internal oversight can handle those, so guardrails are not needed for an existential threat. He argues that the claim AI will destroy the world is a subterfuge, and that AI leaders don't believe it even though they have said it for a long time. He is answering a listener's question about whether AI leaders want regulation to create a duopoly.

“But the idea that AI is going to destroy the world, I think, is just a subterfuge. I really believe they don't believe it at all even though they have been saying it for a long time.”at 22:27