German healthcare software company Dedalus paused a €1.3 billion leveraged loan deal on February 2nd, signaling growing investor anxiety within the software sector, according to reports.
The pause comes amid a broader trend of stalled deals and declining valuations, reflecting a significant cooling in the market for software-backed debt. Concerns center on the potential for disruption from new technologies, particularly artificial intelligence, leading to increased short selling activity targeting companies perceived as vulnerable.
Hedge funds have already made a $24 billion profit shorting software stocks in 2026, as the overall market value in the industry has decreased by $1 trillion, according to data from S3 Partners. Investors are actively taking short positions on the leveraged loans of several software companies, including SonicWall, Internet Brands, Consilio and Epiq, betting that their ability to remain competitive will be challenged.
SonicWall, a cybersecurity hardware vendor backed by Francisco Partners, has experienced a sharp decline in the value of its $650 million term loan due in 2028. Quotes fell from the mid-90s in September to the low to mid-80s in October, before partially recovering to 86.9/88.9 as of recent trading. The decline prompted some lenders to flag unsettled trades, leading to some positions being closed in late October.
Allegations of naked short selling have surfaced in the case of SonicWall, with claims that artificially low pricing and unsettled trades have resulted, though these claims are currently under investigation. The practice of naked short selling involves selling shares without first borrowing them, potentially manipulating the market.
The shift in sentiment follows a surge in leveraged buyouts of software companies in 2020 and 2021, which commanded valuations that many now consider unsustainable given rising interest rates and the emergence of AI. Analysts at DA Davidson noted that hedge funds are currently “net short software,” indicating a widespread bearish outlook.
The focus of increased short bets appears to be on companies that provide basic automation services for clients, as these are seen as particularly susceptible to disruption from new AI tools. The iShares Expanded Tech-Software ETF (IGV) is down over 21% for the year and 30% from its all-time high in September.
Dedalus is likewise postponing an attempt to lower the margin on its leveraged loans, further demonstrating the increased difficulty software companies are facing in accessing credit. The software sector, a mainstay of private equity investment for years, is facing a growing wave of distress, prompting investors to reassess valuations and triggering a flight to safety in debt markets.
