Farhad Manjoo of the New York Times tweeted out a thought-provoking question the other week:
I don’t keep tabs on medical device innovations. Surely there have been new products released over the last decade that are materially improving lives.
And there must be developments in AI, batteries, miniaturization, robotics, satellites, etc. that are radically altering the cost curves of goods and services, and enabling unseen innovations that increase well-being.
But I struggle to think of any *new* technology over the last 10 years that has completely changed my life. Can you?
There have been superb incremental changes, of course. For instance, advancements in ICT and software empowered me to launch a global business with cash outlays that were de minimis. Stripe has meaningfully disrupted international payments.
Taking a step back, though, it’s all a bit astonishing.
Think about it. Interest rates have been flirting with the zero-bound for most of the last decade, and data from Pitchbook and EMPEA show that global private markets investments amounted to $4.3 trillion between 2010-2018.
Why isn’t Farhad’s question easier to answer?
I’d argue that this is partly a consequence of institutionalization — the process by which instruments and organizations become less effective at achieving their original purpose.
In Portico’s first newsletter, I highlighted some passages from Carroll Quigley’s Evolution of Civilizations (1961). You should go back and read it (as well as the September 2017 edition). Since most of you won’t, here’s the most germane line:
The purpose of any economic system is to produce, distribute, and consume goods … As [the economic system] became institutionalized, profits became an end in themselves to the jeopardy of production, distribution, and consumption.
I think this institutionalized search for profits — or “returns” — goes a long way toward explaining why VC in developed markets appears to have evolved from investing in semiconductors and hardware to dogpiling into things like an enterprise version of AOL Instant Messenger, and a regulatory & labor arbitrage in the taxi industry.
Whereas outsized returns once were a consequence of developing a transformative technology, nowadays startups are filtered up-front for the building blocks of geometric growth.
The ends reign supreme. The means have been gamified.
On cue, from FT Weekend:
Anarghya Vardhana, a partner at Maveron, a venture capital firm that led Co-Star’s $5m seed round, thinks niche, single-purpose platforms such as Co-Star will thrive as social platforms like Facebook and Instagram get unwieldy in size and purpose. I ask her why she invested. “The early growth and engagement were really impressive,” she says, “Even in its early days, Co-Star was quickly becoming the brand around astrology. It’s allowing people to ask the right questions, think about different aspects of life in a more in-depth way, then use those snippets to have deeper and more meaningful questions.”
I’m reminded of a remark Elon Musk made about the founding of SpaceX:
If the objective was to achieve the best risk-adjusted return, starting a rocket company [would be] insane. But that was not my objective.
To ascertain a proxy for “risky” and “hard” technological innovation, I went through NVCA’s 2019 yearbook to see how many VCs are investing in life sciences (e.g., biotech, diagnostics, devices, pharmaceuticals, etc.).
The data are suggestive. Life science VC firms constituted 36% of the universe of active U.S. VCs in the aughts, and their share declined by 10 percentage points during this decade.
Similarly, capital deployed into life sciences deals has been declining as a share of the total — from more than a quarter in the aughts, to less than one-fifth in the current decade (see below).
Is this a sound proxy?
If astrology platforms are an attractive investment due to their engagement metrics, then maybe we’re on the cusp of transitioning from a focus on the ethereal world of bits to the tangible world of atoms. If so, I wonder if the institutionalized VC firms that have done well in the internet economy are likely to identify and fund the next great discoveries.
Perhaps U.S. VC will need a software update.
* * *
There’s another element to this chasing of profits that’s worth investigating.
In private markets, what does it mean to chase profits?
It means to allocate based on past performance.
The rub, of course, is that everyone’s looking at the same performance figures. These data are sliced, diced, crunched, sorted, filtered, pivot-tabled, modeled, correlated, regressioned, extrapolated, back-tested, benchmarked, charted, and lovingly displayed in PowerPoint slides to demonstrate our collective capacity to undertake granular analyses, yet say little about what matters.
Invariably, a consensus view emerges (Hmm … Asia new economy exposure has performed well. We should probably get some Asia new economy exposure).
And invariably, investors herd into the same markets (often in the same segments).
The conformity of investor opinion leads to competition — to get into funds (going easy on terms), to get into markets (bidding up currencies), and to get into deals (paying higher prices).
Alas, competition destroys profits.
Let’s reflect on Hillhouse.
In 2004, PE / VC fund managers raised less than $3 billion for all of Emerging Asia. Zhang Lei founds Hillhouse in 2005 with $20 million from Yale.
David Swensen had the courage to do something different — a flexible mandate for a first-time fund manager in a nascent market.
Somehow, Hillhouse is an early investor in Tencent and the firm shoots the lights out.
Fast forward to 2018, and Hillhouse raises a $10.6 billion fund — the annual management fees are 10x the size of funds that got them started! — in a year when PE / VC managers raised $76 billion for Emerging Asia. The three-year total for fundraising in the region is $175 billion … and this excludes the constellation of deep-pocketed non-fund investors that are scouring the landscape for deals.
I don’t know how that Hillhouse fund will perform. The LPs have underwritten their view. Hillhouse is investing in Africa. We’ll see what happens.
You know what I do think, though? There ain’t going to be another Tencent — that ship has sailed.
Yale and Zhang Lei had the vision to do something bold at a fortuitous moment in China’s economic transition.
There were no profits to chase.
* * *
Let’s assume that Farhad’s premise is sound: there haven’t been any new life-changing technologies created (or at least distributed in the United States) over the last decade.
Is that such a bad thing?
What if — à la Carlota Perez’s Technological Revolutions and Financial Capital — the 2010s were a “deployment phase” for prior technological discoveries?
Wouldn’t it be great if existing technologies and computing power were distributed to more people around the world? A democratization of innovation?
In actual fact, this is what we’re seeing across the emerging markets. Thousands of entrepreneurs are leveraging existing technologies to build companies that deliver tailored solutions to the acute challenges besetting households and businesses.
The 99s, Careems, Didis, Gojeks, and Grabs garner gobs of attention (and capital), but there are loads of startups across EM toiling away in obscurity — a meaningful number of which have attained product-market fit and achieved a modicum of scale.
There is enormous scope to drive financial inclusion, expand access to quality goods and services, improve logistics, and create much-needed efficiency and productivity gains (and much else besides) across EM.
Indeed, maybe these markets are where the greatest technological innovations are taking place?
While most investors are chasing profits in Asia, few are exhibiting the courage to invest in other EM regions, particularly in smaller funds (i.e., sub-$250m). No mystery why — past performance!
But, I suspect that investors who buck the trend will discover two things. First, they will have had an opportunity to finance the growth of businesses that can enhance the well-being of millions and millions of lives.
Second, they will enjoy the prospect of multiple expansion when institutional investors detect a whiff of success, and the rumbling herd stampedes their way, ravenous in its perpetual chasing of profits.
Calling All Investment Professionals
Portico is undertaking a brief survey to measure sentiment toward the investable market in EM. If you invest in EM, we’d truly value your input!
The survey should only take *3-5 minutes* to complete, and responses are completely anonymous. All you need to do is click this link.
Note: this is an internal study, and we are not being commissioned to run the survey.
Thank you in advance!
WeWork + SoftBank
I don’t have much to add to the bajillions of pixels that have been dedicated to discussing The We Company and SoftBank over the last few months, but some things are worth sharing.
Arash Massoudi & co. at the FT put out a great piece on SoftBank that’s worth reading. Of note: $40B of the Vision Fund is in coupon-paying preferred shares. And, employees are apparently being encouraged to take out loans of up to 10x their salary — from a SoftBank subsidiary — to invest in the Vision Fund.
Also, these are actual slides from SoftBank’s earnings results (h/t FT Alphaville):
Also, legendary PE firm Hony Capital helped launch WeWork China and participated in its Series B last year, a funding round that valued the company at $5B. Alas, the company is apparently “bleeding cash” and LPs must be asking themselves whether they’ve funded a grand experiment in strategy drift.
What Drives Value in European Buyouts?
Bain analyzed the outcomes of 65 mature deals invested in since the global financial crisis, for which we had full access to fund and management projections. We found that most of them (71% of investments) fell short of projected margins—and not by a little. On average, margins ended up 330 basis points below the deal model forecast.
- China — Cambridge Associates, advocate for dedicated China exposure, says “the biggest risk for investors with exposure to China in 2020 is not the Chinese Communist Party, but the US government.” The Wall Street Journal reports “No more easy profits as China’s venture-capital boom fizzles.” The New York Times scoops internal documents on the mass detention programs in Xinjiang.
- Fund Terms — Akin Gump Partner argues that “we’re not in Kansas anymore” and EM funds should embrace more innovative terms. MJ Hudson releases 5th edition of its Private Equity Fund Terms Research report.
- Private Equity’s Governance Advantage: A Requiem — Duke Law professor says “‘private equity’ has become a misnomer for the industry.” Also: “Simply put, private equity’s primary contribution to U.S. firms today appears to be cheap debt financing, rather than governance, strategy, and operations … Indeed, private equity firms appear to be responding to their newly competitive environment not by increasing their efforts at governance, but by switching tactics to drive returns and even branching out into new asset classes.”
- KKR 💜 Walgreens Boots — Biggest buyout ever. They owned it three years ago.
From the Bookshelf
At the rate of progress since 1800, every American who lived to the year 2000 would know how to control unlimited power. He would think in complexities unimaginable to an earlier mind. He would deal with problems altogether beyond the range of earlier society …
The movement from unity into multiplicity, between 1200 and 1900, was unbroken in sequence, and rapid in acceleration. Prolonged one generation longer, it would require a new social mind. As though thought were common salt in indefinite solution it must enter a new phase subject to new laws. Thus far, since five or ten thousand years, the mind had successfully reacted, and nothing yet provide that it would fail to react — but it would need to jump.
— Henry Adams, The Education of Henry Adams (Oxford World’s Classics: 2008)
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