“The Times They Are A Changin’”
Summer saw swings across the globe as geopolitical risk caused investors’ concern in many areas. While the equity markets flirted with new highs, US-China trade tensions, “Hard” Brexit fears amid Parliamentary chaos and general economic sluggishness, resulted in the market staying in a trading range. Like a climber at altitude, the 3,000 level of the S&P 500 limited progress. An inverted yield curve and further deterioration in trade talks in August saw a meaningful decline, with the Russell small capitalization index down 20% , with major indices following suit. By quarter end, the S&P 500 gained 1.2% while NASDAQ lost .1%, its first negative quarter in some time, as “Risk-Off” assets gained favor. Bonds rallied sharply as did the U.S. dollar. As Nobel Prize winning poet laureate Bob Dylan says, “The times they are a changin’.” Adit understands that investors must adapt or perish.
S&P 500 INDEX VS US 10YR TREASURY YIELDS
S&P 500 Index vs US 10yr Treasury YieldsBonds saw much of the action last quarter, as interest rates dropped to levels never seen in the history of the U.S. Treasury market . With over $17 Trillion in negative interest rate debt outstanding, there is growing concern the U.S. will also see negative yields. While the Federal Reserve did, in fact, cut rates twice, by one quarter point each time, it remains to be seen where interest long-term rates will be. Home buyers saw record low levels of costs of financing, for about two weeks, until rates rebounded slightly from recession-fear levels.
The IPO market continued its robust activity, with over $40B raised, and is expected to pass 2018’s total of $47B by year-end. Aftermarket performance has been weak recently, by historic standards, as investors seek stability and profits versus growth. There is a large pipeline of companies ready to go public, either via an Initial Public Offering or a direct listing as Spotify did in April of 2018. Slack did a direct listing, and Adit expects to see additional high-profile firms like Airbnb likely to go this route in 2020. The markets saw 40 IPO’s priced within the last 90 days, with over 58% trade above their offering price .
The key to IPO’s being successful today is strong top-line growth and a clear path to profitability. These two items are vital as the market is not as patient, as in previous years, to see gross revenues grow into net profits. The drama surrounding WeWork is a clear example of this fact. Poor corporate governance, lack of profits and excessive valuation are all hallmarks of what Adit is calling “Just Saying No.” “Won’t Work” is an example of hubris and greed killing a company’s prospects. Many journalists are decrying the “Death of Technology” with the reception received by WeWork. Let’s set the record straight:
WeWork is a real estate company. Adit rejected it several times as it didn’t have depth in management, barriers to entry or a promise of profits that we seek in our investments. While it was pitched as a technology company, it is a real estate company, albeit with a global reach, and strong corporate clients. It is not close to being worth $47 billion as its last round was priced. SoftBank overpaid, as they did in many instances. JPMorgan enabled WeWork by providing loans. A bailout is in the works and the bond trades as junk paper now well below par.
There are many fine companies out there, with excellent prospects, across many industries that offer tremendous opportunities to investors seeking capital growth. In September alone, we saw Datadog, Cloudflare, Exagen, and Medallia to name a few strong performers. Often, difficult markets give rise to some of the best performing companies. Please note the chart of Facebook and Lyft below as an example of a broken IPO recovering into a highly successful company after a time.
Profits have always been a vital part of any equity investment. Equity ownership entitles investors to a share of the cash flows of the business, in theory. Adit invests in companies where it sees robust revenue growth and profits within a reasonable period of time. We see Airbnb, Klarna, Palantir and others all fitting this bill nicely in our portfolio. We look forward to seeing these firms show their management talent, proprietary technology tools, by posting strong profits on growing revenues, in coming quarters.
The fact that the market is discerning, tells us we are not in a “dot-com” era where every deal worked, until they didn’t. This is a healthy, normal process wherein the top performers get rewarded for superior results. The bigger challenges for the market are major global macro risks as discussed earlier. A China-US trade deal will get done at some point, and Britain will sort out its fate at some time, either in or out of the EU. The Italians will form another government. Life will go on, and the sun will likely rise again early tomorrow. The global economy is positive, though growth is generally slower outside of the United States; this is not a recession. The US remains firmly in positive territory on the strength of the consumer, and it appears we will see a decent holiday season, barring any unforeseen disaster. In ’20, there is an election and while this is another source of uncertainty, it’s too soon to tell what will occur there, much less any potential market implications.
Adit remains constructive on its diverse portfolio of growth companies like Decision Sciences, Klarna, Turo, Welltok, Rubrik, Magic Leap and others who are doing positive things in their respective industries and will be part of future liquidity event discussions in the quarters and years ahead. However, it is vital to know & understand that 68% of all venture-backed companies exit via acquisition and liquidation, and not via an IPO according to Pitchbook. Given where interest rates are, the large amount of dry powder in PE/VC funds, and on corporate balance sheets, there are buyers across the spectrum for quality assets with good business models today. Expect to see more volatility given the geo-political events, but understand the cream rises to the top. Quality firms, profits and people will carry the day.
We invest seeking these qualities on your behalf with a three to five year time horizon. Adit stays focused on fundamentals, does its homework and does not let the media sway our beliefs. Bezos invested billions in the cloud when no one believed it would ever turn a profit. Amazon has done pretty well with that investment, and others since then. Adit speaks with global industry leaders, does large amounts of proprietary work, leveraging its insights by purchasing great companies at attractive prices. We seek knowledge on the next wave, so we can become a part of this trend and capture the potential benefit for our investors. Adit travels the world seeking insights like these.
Please reach out to learn more about our firm, our philosophy and process. Keep the faith and feel free to contact us via our website www.aditventures.vc or email anytime. We look forward to speaking with you soon.
Eric Munson & the Team at Adit Ventures
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