Circle of Competence Issue #47
Quote of the week: "All that glitters is not gold." - William Shakespeare
FOOD FOR THOUGHT
After sharing Fast Company's profile on Masa Son's Vision Fund in last week's edition, I started to think a little bit more about the implications of the massive scale at which he was deploying capital in private companies.
First let's place the fund in historic context in terms of size. After researching just how big the Vision Fund was relative to the largest private equity funds ever, the sheer magnitude of the fund was staggering. The largest (ever) private equity fund was raised by Apollo, weighing in at a massive $24.7B in 2017! By comparison, Son's Vision Fund ($100B) is 4 times as large as Apollo's fund, and will invest in late stage private companies.Their major investors include Saudi Arabia's Public Investment Fund ($45B), SoftBank ($28B), Abu Dhabi's Mubadala ($15B), and a consortium consisting of Apple, Foxconn, and Sharp ($5B).
Since raising the fund in 2017, it has deployed over $70B in (sector) late stage private companies that include (real estate) WeWork, Compass, OpenDoor, (transportation) Uber, Grab, Didi Chuxing, Cruise, (e-commerce) Flipkart, Wag, (artificial intelligence and computing) Nvidia, ARM, and Slack. Keep in mind that there was a record $300B or so of Venture Capital activity in 2018 alone. The structure of the fund is also noteworthy, given that the investors will receive a 7% preferred return on 62% of their capital, with the remaining 38% as equity up(or down)side, according to the Financial Times.
So what will the returns be to such a massive pool of capital? Making some simple assumptions, I calculated that Son will have to return something on a magnitude of over $300B in capital to investors to achieve around a 10-12% IRR over a 12 year period (please note these are very rough estimations!). Not only will he have to distribute this much capital, but given that the fund likes to take a meaningful minority equity position at 15-30% of the equity (see TechCrunch article), this could represent somewhere in the $500-750B range of equity value. Incredible numbers when you think about it. Masa Son is on a quest to create another Google, Microsoft, Amazon, or Apple.
The question that I have been pondering most about the pool of capital is how this fund was able to be raised in the first place. In the spirit of Charlie Munger, it seems that a lollapalooza effect is at work here:
- We are currently in a macro environment of cheap money and low interest rates and a dearth of reinvestment opportunities. This certainly forces investors up stream into more risky investments in search of higher returns (see quote below).
- Masa Son possesses the imminent presence and limitless ambition of a founder, a massive vision for the future of technology, and complicit LPs with abundant capital who are hungry for returns.
- Public markets are extremely competitive but private markets allow founders and companies to think “long term” away from the quarterly timelines of analysts. However, the returns to these investments are 'on-paper' returns until there is some sort of liquidity event (IPO, merger, etc.). These will have to be some of the largest in history if they are to produce the real returns promised.
- When massive 'valuations' are negotiated on paper and billions of dollars are crammed down startup founders' throats, what can their response be other than a resigned 'yes'?
I want to end with a couple age old lessons from Trammell Crow and Warren Buffett. Buffett was famous for his concept of the 'institutional imperative' and realized once he began his investing career that when a sort of company wide or industry wide momentum was in sway, it was very hard to be rational if it meant swimming against the tide. When capital is abundant, why not invest it? Investors aren't content to just sit tight and wait for 'fat pitches' as Buffett says. They get antsy and reach for returns, because if they don't, others will:
"Individuals close to the three Japanese banks said their investment was motivated by their quest for returns in Japan’s environment of ultra-low interest rates and the desire to further strengthen their relationships with what is by far Japan’s most active corporate name."
A few weeks ago, I shared a gem of a memo that was circulated by Trammell Crow managers after a particularly harsh economic decline punished their investments. One of the lessons that was repeated time and time again was the following: "just because there is abundant funding available doesn’t mean that you should take it and deploy it." This lesson seems timeless to me because it can easily be applied during the 1980's to the LBO boom, in the 1990's to the internet bubble, in the early 2000's to leveraged real estate... In the late 2010's will it be late stage private companies?
I haven't the slightest clue what will happen with the private companies taking hundreds of millions, and in some cases billions, of dollars in private funding from Son's Vision Fund. Only time will tell whether the vision fund is a long term bet that turns out to be prescient, or a lollapalooza representing an over ambitious scheme founded on abundant capital, hungry investors, and willful suspension of disbelief.
Have a great week!
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