Arini’s Cestar: Europe faces its own software reckoning

Sitting down with Alternative Credit Investor, Mathew Cestar (pictured), president of $20bn Arini, discusses the fallout from the so-called “SaaSpocalypse” for private credit and why Europe has not emerged unscathed.

Private credit’s concentrated exposure to software businesses “is not just a US issue, but it is also an issue in Europe”, says Mathew Cestar, president at alternative asset manager Arini.

At the start of the year, the so-called “SaaSpocalypse” rattled markets after artificial intelligence (AI) developer Anthropic unveiled tools that raised questions about the future of software. The fallout spread to private credit, given lenders’ and funds’ heavy exposure to software companies, triggering sell-offs in US-listed vehicles, including those managed by Apollo, Ares, KKR and TPG.

A trend which is still hitting some business development companies at the time of writing, almost five months on.

Over the past few months, many in the industry have argued that the software concentration issue is primarily a US private market concern, with Europe being less exposed due to software and technology making up a smaller share of economic activity than in the US.

Sitting down with Alternative Credit Investor, Cestar agrees that the US private credit market is overexposed to the sector, with 30–50 per cent of the market in software or software-related loans.

However, he cautions that even though the European economy is driven by fundamentally different factors to the US, it does not mean that the private credit market on the continent is not also heavily exposed to software.

In fact, the opposite: European lenders saw the success of the strategy and wanted a piece.

“The European economy is driven by fundamentally different factors, with software representing a lower share of economic activity than the US,” Cestar tells ACI. “Despite this, due to the perceived attractive credit characteristics of software, many private credit managers in Europe are nonetheless meaningfully overweight to software.

“So, it is not just a US issue, but it is also an issue in Europe.”

Following the global financial crisis, US regulators discouraged banks from high-leverage lending, which pushed much of software-related financing out of the hands of traditional banks and into private credit markets, helping fuel the sector’s growth amid high valuations, Cestar explains.

Overall, this made the software space “one of the most successful strategies in private equity… and credit is the second derivative of that”. “That’s why the representation of software has grown so rapidly in private markets.”

For Arini, which oversees £20.03bn (£15.1bn) of assets, Cestar states that the alternative manager has stayed clear of software companies.

“Our perspective is that if you have one sector making up 30–50 per cent of your exposure, there is too much concentration,” he says. “These loans were also priced for perfection, given they were perceived to be the least risky.”

Even without the future of software being called into question by AI disruption, this intense concentration in software and its pricing was likely to catch up with the industry at some point, argues Cestar.

“What has happened as of late is the concerns around AI, but it could have been anything really, when you price for perfection,” he says.

Looking forward, Cestar states that it is still too early to tell where the disruption from AI will hit software companies, with the sector still “figuring out what business models will be sticky”.

However, recent events have marked a turning point. Cestar explains that for a period of time you really couldn’t discern between the managers. They were all lending at the same rates and the same leverage levels.

So, what you will see now is a real differentiation between managers, both in the US and Europe, he says. Those who have done the solid credit work and ones who didn’t and had too much industry concentration.

“On the negative side it is a shakeout; on the positive side it is a real catalyst for continuing to institutionalise this marketplace”.

Arini’s investment focus is on financing mid-sized companies, which Cestar states is a space that is “uncorrelated” to some of the risk profiles found in institutional portfolios.

“A lot of institutional investors have exposure to the private equity space and are increasingly allocating to the credit market, but a lot of that tends to be in the large cap space and sponsor driven,” he explains.

“Most players in Europe tend to be generalists and this market does not reward generalist skill sets.”