Navigator Newsletter #1 – September 2018
Dear Fin VC Partners, Investors & Friends –
It has been a busy several months since we officially launched in mid-April and held our first close in early June. We would like to stay in close touch with you as we continue to build out our firm and hope to find ways to collaborate. As you know, we take a long and patient view on our global relationships and as we serve as fiduciaries and add value for our entrepreneurs and partners, we recognize that growth can only come with merit. We thank our portfolio company CEOs, limited partners, co-investors, and Advisors, for your tremendous support.
In these ongoing communications, we will cover 3 areas – 1) Macro; 2) Micro; and 3) Firm Updates. As always, we welcome your feedback and ideas and look forward to keeping a regular dialogue going with you all. We invite you to visit our website where we will continue to provide company and portfolio updates.
Fin Macro Perspective
In summary: “It is not unusual to see strong economies accompanied by falling stock and other asset prices…we know that we are in the ‘late cycle’.” (Dalio). We see a number of indicators highlighted below that point to a meaningful pull back in public markets and a potential global recession in the coming year. Further, heightened geopolitical uncertainty will exacerbate market conditions and continue to create headwinds and volatility across markets, with certain geo’s hit harder than others. As VCs, we monitor overall market conditions, but in particular cost of capital, valuations, consumer and corporate confidence, SMB support, and the overall regulatory environment for entrepreneurs, venture capital firms and the financial services industry. As we are principally domestically focused, we will focus on US macro but touch on a few international issues we have observed first-hand.
- The economy is overheating. 4.1% annualized GDP growth this year, the strongest on record since 3Q ’14. ~112 month old expansion since the great recession, the longest on record in the 164 years for which the National Bureau of Economic Research has done the analysis; the average expansion has run a mere 39 months. The only one that outlasted this one lived to be 120 months old (1991–2001). To put that in perspective, the S&P is now up 300% since its trough in March ’09, with the NASDAQ up 500%. Despite the growth, Debt:GDP ratios have escalated under this administration to 105% vs. other previous downturns where we stood at 35% at most (2007).
- Labor, particularly skilled = gap. Economic output = labor + capital + productivity. Labor mismatch will continue to get worse – growth has slowed to 0.2% annually and as the baby-boomers exit the workforce, there is an expectation that from ’16-’26, there will be ~12M jobs created and a million fewer people to fill them. The US has historically relied on immigration to fill the “demographic drag,” with 17.1% of the US workforce in ’17, but we have seen immigration restrictions imperil this trend.
- Yield-curve flattening, portends slowdown. The 2-10 spread continues to tighten with rising rates expected to continue and 3-4 total fed fund rate increases this year, accelerating through ’19 and ’20 to 3.4% in ’20 according to the latest dot plot.
- Inflation up (~2.9%). As rates are relatively low compared to historical averages and unemployment has fallen, asset prices have risen.
- Unemployment rate at lowest level (3.9% in July) since 2000. Importantly, a trough in unemployment rate has closely preceded every recession in the last 60 years.
- Valuations peaking in public markets. The current Schiller S&P PE Ratio is ~33, the highest since Dec ’99, with the tech sector (63 co’s) is elevated at 40.10.
- Business & Consumer confidence are at record highs – irrational exuberance? US BCI is at 101.14 (as of July) and has largely been around that level since January, an all time high. The Consumer confidence index reached an 18-year high in August (133.4).
- Trade wars threaten domestic and global economy. We view tariffs, as do most economists, as a relic of the 19/20th centuries and an ineffective economic tool for driving global economic growth / equilibrium. We believe the tariffs are being used as a mechanism for bringing countries to the table to negotiate trade deals that will hopefully reduce trade barriers ultimately but will have short term pains. This is particularly an issue for our partners in China, where the Shanghai index is down 15%+ since January and 40%+ since mid-’15, RMB has depreciated 10%+, government and household Debt:GDP ratio is at an all-time high (~50%), and thus we expect challenges with liquidity and a potentially painful de-leveraging.
Fin Micro Perspective – Venture Capital Asset Class & FinTech Sector
- We encourage you to review our Fin Research Room, where we post much of our relevant research summarized below, with proprietary research reserved for LPs.
- Venture Funding Environment:
- Venture Capital as an asset class continues to outperform and serve as a key satellite allocation for institutional investors with endowment models like Yale allocating 15-20% to the asset class.
- The US funding environment, skewed increasingly to growth/late stage, is on pace to surpass $100 billion in deal value for the first time since the dot-com era. Indeed, there was $57.5 billion of VC invested in US companies through the first half of the year and is higher than six of the past 10 full-year totals. Despite the volume, deal count has remained stable, due to later stage entry points and larger round sizes, and as a result, deployment is at a slower pace than seen in 2013-2015.
- Exit value remains robust despite a slightly slower exit pace than 2017. Near $29 billion in exit value has been realized so far in 2018. 11 companies have exited at a post-money valuation of at least $1 billion, with nine more reaching at least $500 million. Such large exits continue to underpin the high levels of capital being returned to investors and LPs.
- While the fundraising surge from 2014-2016 was thought to be the precursor to a slowdown for GPs raising, the high level of commitments to VC funds has continued. Not including Sequoia’s $6 billion first close on their record-breaking fund (or Lightspeed Venture Partners $1.8 billion in commitments), 2018 has already seen $20.2 billion in commitments received for new vehicles, pacing it for just the second $40B+ year. The year is also pacing to see more than 300 new funds raised in a single year for just the second-time.
- We have aligned our firm to our perspective and quantitative data on the portfolio construction to this asset class: early stage outperforms growth/late stage players (particularly in this environment with $500B+ of dry powder on the side lines ex-Softbank, per Bain), smaller funds outperform mega-funds (inflection at $400M+ per U of Chicago research), specialist players outperform generalists (particularly in FinTech and Health Care), emerging managers outperform established managers (data), global diversification benefits performance and correlation, and co-investment rights are critical in providing more predictable Alpha given the power law return dynamics of venture portfolios.
- Global FinTech Funding YTD: $39.151B invested across 1,062 transactions (805 announced $ amount, 257 unannounced). Represents significant growth (larger fund sizes / later stage and larger allocations, companies staying private longer, etc.) of 137% YOY from the same period in ’17.
- Global FinTech M&A YTD: 562 (120 announced $ amount, 442 unannounced). Represents significant pick-up and continued consolidation, with growth of 58% YOY from the same period in ’17.
- Regulatory Dynamics: The regulatory landscape, particularly in the US, UK, Germany, and Singapore continues to support innovation and reducing obstacles for FinTech players. The Treasury/OCC provided their report and guidelines at the end of October and is worth a read.
- Crypto-Assets: BTC/USD has fallen ~63% since Jan 1 to ~6,300/USD, while ETH/USD is down ~75% to ~202/USD. There are now 1926 coins registered with Coinmarket and per the Digital Currency Group, ICOs have raised $20B+ in capital since the option came into play. We continue to be believers in staying away from crypto/token speculation and rather, investing in the corporate equity of enterprise blockchain companies solving key problems in financial services, extensively vetting them like any other VC bet and receiving token coverage for our ownership as well as supporting the token offering as a form of digital/shadow equity.
- Fund Offerings:
- Main Fund (Early Stage – Seed/A): fund is focused on early stage FinTech companies in specific sub-sectors (outlined on our website), with a US focus (75% of portfolio) and bias to B2B/B2B2C companies where we see greenfield opportunities for scale/outperformance and the ability to add significant operating value. See our Portfolio Tab for further information.
- Opportunities Fund (Growth Stage – C+): We formally launched and announced this vehicle in September. The strategy is focused on growth stage FinTech companies that will consistent primarily of follow-on investments from the Main Fund (given the power law return dynamics of VC as noted above, the ability to selectively invest in the outperforming companies is a compelling opportunity for Alpha) as well as opportunistically in companies that align to our theses. The fund is an offshore entity to support our investors who prefer these domiciles and are seeking more exposure to growth-stage PE. Additionally, this fund will be the first ever Shariah-compliant vehicle in the space, which is a strong differentiator and one which will not impact our return expectations.
- We have comprehensive data rooms available for both funds, please request access via e-mail.
- Co-Investment Platform: Our philosophy on co-investment is to provide LPs with first look co-investment rights at reduced or no fees. We believe LPs are increasingly looking for direct access and optionality in their investments alongside of GPs and we believe this dynamic aligns interests and affords LPs the ability to expand their satellite portfolio / Alpha exposure methodically. We have developed two aspects to our co-investment platform: a) Alongside of our funds (preference to bring LPs/co-investors direct-to-Cap Table) and b) Special Situation – late stage primaries/secondaries where we have unique access and align to our investment theses (via SPV).
- Co-Investment To-Date: We have made one co-investment in a Special Situation pre-IPO round in Tradeshift alongside of Goldman Sachs, Fidelity, and PSP. We are bullish on the company as it intersects FinTech and supply chain/commerce, serving as the leading enterprise tech platform and payments provider in the space. We believe supply chain/trade finance and process management is one of the spaces that is ripe for disruption and plays into a number of macro themes (ag sector, food shortage, last mile supply chains/complexity, eCommerce, sharing economy growth, etc.). Further, the company has meaningful growth upside in its payments, trade finance/lending, and marketplace verticals of its offering, along with its Frontiers initiative (integrating blockchain, AI/ML, and IoT), alongside its SaaS enterprise ARR.
- Take-aways / Calls to Action:
- Invest with or alongside of us. We welcome new long-term limited partners as well as co-investment collaborators.
- Pipeline – we love to meet CEOs early and often, we welcome your ideas and introductions to companies you are bullish on!
- Upcoming travel – we are on planes often, we would enjoy catching up with you and welcome your recommendations on others we should build relationships with.
- Sept – NYC 25-27 and Pittsburgh – 28
- Oct – HK 8-11, Shanghai 11/12, UAE 13-21 (Gitex), and Riyadh 21-25 (FII)
- Nov – Palm Beach/Tampa 1-5, Indianapolis 6-7, and NC/SC – 8-11. Likely visits to Texas, Seattle, Chicago, and Tulsa before year-end.
General Partner & Founder
- See Fin Research Room
- Fin Macro Perspective: Fortune, Forbes, Trading Economics, and publicly available government data
- Fin Micro Perspective: Venture Capital data from Pitchbook and FinTech data from FT Partners. Portfolio construction data from Cambridge Associates, U of Chicago/Harvard research and Preqin.