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Podcast

Jay Hoag - Keys to Successful Growth Investing - [Invest Like the Best, EP.429]

Invest Like the Best with Patrick O'Shaughnessy

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  • Macroeconomics Shape Tech Investing
    • Regulation and macro factors now heavily influence technology investing, unlike in the past.
    • This adds complexity and uncertainty to investment decisions in tech sectors. Transcript: Jay Hoag I mentioned, yeah, we did this, I think, in September of 2021. And as a long time Chicago Cubs fan, I’m quite superstitious. So I’m sure it didn’t cause the tech reset in 2022, but let’s hope that we’ll not have a recurrence. Let’s see what’s different. There’s always parallels and similarities to prior periods of time. I guess what is different is, particularly as technology has gotten so big over now the 30 years of TCB and the 43 years of my career, the focus on macro, which is not something I spent a Lot of time focusing on, really is different. So regulation of tech, how do tariffs impact global trade, all those issues, which really were never part of the lexicon or focus for technology, is probably something that’s pretty New. (Time 0:05:40)
  • Opportunity in Consumer Internet
    • Consumer internet is significantly undervalued now as investors chase SaaS and AI deals.
    • The vast smartphone user base creates broad opportunities for new consumer franchises. Transcript: Jay Hoag And again, I’m leaving COVID out for the moment because that is such an unusual time where I think as you think about technology investors, huge focus on SaaS, huge focus on all things AI, and huge de-emphasis of consumer-based internet businesses. And so I think that’s actually a pretty interesting opportunity where one can be contrarian. And we continue to see interesting private opportunities that I think most of the world’s not focused on. Patrick O’Shaughnessy I was talking to a founder actually building something new in consumer today. There’s a heavy AI angle to it, but nonetheless, consumer. And he made an interesting observation, which was how hard it was for him to go find venture investors who are great, who primarily focus on consumer. It’s almost like a dying breed of people, exactly to your point. (Time 0:06:54)
  • Technology vs. Commercialization Gap
    • Technology availability doesn’t equal commercialization; many promising innovations take longer to monetize than expected.
    • Applicability and monetization models determine investment success, not just tech readiness. Transcript: Jay Hoag Really, really fast. What have you learned about that difference? Many super interesting technologies have taken far longer to reach commercial scale from a revenue and monetization standpoint than predicted. Would be examples of recent vintage autonomous vehicles where the pure technologists said it was ready for prime time five, seven years ago. Now appears to just be that. AR and VR, generally great opportunity set, but still really looking for commercialization. (Time 0:09:20)
  • Beware Short-Term Overoptimism
    • Avoid overestimating short-term progress while underestimating long-term potential in technology investments.
    • Prepare for nonlinear growth marked by cycles of disillusionment and investor skepticism. Transcript: Jay Hoag Technologists, and sometimes it feeds into technology investors, there is a often overestimating the near term on your way to underestimate the long term. And that’s just something to be careful of. And the other thing, I think we talked about last time, I was going back through any of the most valuable tech companies in the world today. Are they exceptions to this statement? I don’t think they are. But every area and every great company goes through a desert of disillusionment in investors’ minds where it was great. And then all of a sudden, there’s people casting dispersions on the sustainability of it. (Time 0:10:31)
  • Puzzle of a Quiet Tech IPO Market
    • The tech IPO market is unusually stagnant despite the growth of private capital and large private companies.
    • Public markets offer discipline and liquidity benefits that companies often miss by staying private too long. Transcript: Jay Hoag Healthy? I’m not sure it’s a permanent shift. I’ll get into the reasons for that in a minute. Everything is bigger. It’s given that it is TCV’s 30th year. Actually, technically, it’s June 23rd. It’s our 30-year anniversary. I went back and looked at some stats, just to give you a scale difference. The entire venture industry in 1994 raised $4 billion. Today, that’s a small fund for some, which is pretty staggering. In terms of market cap, at the end of 1994, the NASDAQ was at 751. Today, it’s north of 17,000. So that’s about a 23x increase in the NASDAQ value. And I didn’t have it from 94. But in 1991, as you looked at the large public technology companies, there were 31 companies north of a billion dollars and another 13 companies between 500 million and a billion. That was large tech back then. And I mentioned today, there are six companies north of a trillion. So in addition to Microsoft and Apple, I mentioned NVIDIA is at 2.8 trillion, Amazon and Google at 2 trillion, pretty staggering. And then Facebook slash Meta at $1.5 trillion. So that’s dramatically different market values than 30 years ago. Today’s market puzzles me for at least one reason. I understand it’s standard to say, oh, companies want to stay private longer, et cetera. I think that’s true in some cases, although that was pre-Google going public. That was also the concern. They were staying private too long. And I understand if companies have specific things they want to invest in under the cloak of being private, probably going public. But I’m old school in that I believe the vast majority of the best companies will benefit by being public over the long run. There is discipline of being public. These days, you can manage the guidance expectations however you want, including not providing guidance. It provides a public currency. It provides a fully liquid stock for all your employees on a persistent basis over time. I’m totally puzzled as to why the technology IPO market is just so moribund. We’re now in our fourth year of pathetic numbers overall. (Time 0:12:00)
  • Focus on Company Quality Over Market
    • Selecting companies is more critical than choosing public or private markets for investment today.
    • True category leaders command strong multiples and value regardless of their market status. Transcript: Jay Hoag Not totally flexible. The C and TCB is crossover, but I tend to think we’re more one of the early players in growth, distinct from early stage venture and private equity. Certain characteristics of growth that we found attractive and continue to find attractive. We will hold our private investments as they go public, the best ones for a long period of time. That’s an economically driven decision. We may take one times our money out, but the best companies over time, like Netflix, Spotify, et cetera, compounded high rates for a long period of time. So we’re being, hopefully, economically selfish by retaining our stake. And then we will selectively and opportunistically deploy capital publicly, the Netflix pipe in 2011 being a great example, or just situations where our view is, if this is a private Company, it’s at a compelling value. And there might have been a dislocating event, but we’re trying to get actively involved and treat it as if it was private and ignore the day-to public trading. So that’s a little bit of a long answer. In today’s world, I don’t think of it as quite as much as public or private. I think of it very much as a company selection criterion where we have a very private market, very bifurcated public market. Tech’s always been a world where there are haves and have-nots. (Time 0:15:32)
  • Growth Investing Sweet Spot
    • Growth investing targets companies post-tech risk once products prove viable and ready for scale.
    • This stage balances lower principal risk with high returns driven by rapid growth and top-line expansion. Transcript: Jay Hoag So the original pitch, which remains true today, I think, and everything was a lot smaller, as I mentioned, venture. Venture was a lot smaller. Private equity is a lot smaller in 95. Think about KKR, others were still tiny enterprises. And growth didn’t really exist. It was infused as a separate category. The way I think about it is early stage venture will invest in, to some extent, science projects, meaning undeveloped technology that they have to develop a product or service and prove That it works and it’s cost effective and then start to ramp the monetization of the business. And inherent in that model is the successful ones can generate 50 or 100x return and return an entire fund. But I think inherent in the early stage model is very high loss rates. So it could be 30%, 50% for a seed or early stage fund. Successful ones, it’s all baked in the model that you can end up with great funds. At the other end, large private equity, I tend to think of, and of course, they invest across all swaths of the economy, not just tech. They tend to be much bigger businesses, more slow growing. And the way to generate returns could be through the facile use of leverage. It could be through cost cutting. It could be through lots of different acquisitions and consolidations. And the best of those firms also generate good returns, but I think much more through financial measures than otherwise. And in a world where rates went down for 10 years, 15 years, that was a huge tailwind. I’m not a forecaster of interest rates, so I can’t say whether it’ll be a headwind or not, but I think that was a huge tailwind. Growth sits in between and the original virtues were investing after the technology risk has been eliminated. A product or service is available. Consumers are touching it, or enterprises are touching it, or small businesses are touching it. And our job then is to evaluate the rate of market adoption and then help grow those companies. The benefit of growth is you’re typically investing in a decent-sized business that hopefully means a hopefully senior in the structure, your risk of principal loss is quite low. And then if you’re fortunate to stumble into the Expedia or Netflix or Spotify or Revolut in Europe or others, you’re generating returns from very rapid growth. Ends up about half our businesses were profitable at the time we invest, half are not. But the compound effect of top-line growth and very high incremental operating margins means ultimately earnings are growing a lot faster. (Time 0:17:17)
  • Compete Through Focus and Contrarianism
    • Stay focused on technology and resist the temptation to scale too quickly into unrelated areas.
    • Compete by finding contrarian, underexploited segments rather than following momentum. Transcript: Jay Hoag When we started, as you might imagine, it wasn’t just there was not much interest in growth. There actually wasn’t that much interest in technology. So now it obviously is obvious to everyone, but people view it as a tiny prize. As technology returns have been robust, money follows. That just seems to be how capitalism works. And so there are a lot of growth investors, many of them built very successful firms. Some have gone from success and growth to really scaling assets and becoming much more private equity like big buyout funds, et cetera. And that’s not bad. That’s just different. And many have gone from being purely focused on a tech vertical to other categories of growth, be it retail, healthcare, I mean, healthcare to IT, just hospitals, et cetera. We’ve made the decision to stay, I’d say relatively small, although first of all, it was a hundred million and our last fund was 3 billion. So it’s relative, but really just stay focused on technology because we think it’s the greatest industry. And it also requires a tremendous amount of expertise to be able to execute against. Yes, competition’s increased, but I’d say in the last four years, it’s actually decreased. If you harken back to last time I was here, everybody had entered technology and growth investing in 2021. And that led to its own challenges for a lot of the capital that was deployed during that period of time. Many early stage funds doing growth, many public funds doing growth, many private equity funds doing growth. And some will be successful, but a lot may not. I tend to think firms generally have a center of gravity. You can think about collecting assets across lots of different vehicles, but you have to make sure each of the disciplines you’re exercising are great. Otherwise, you won’t continue to get capital. I suspect that a number of folks have retrenched based upon having deployed a lot of capital in 2021, but not necessarily having a great return associated with that. (Time 0:20:30)
  • AI-Powered Deal Sourcing
    • TCV evolved from cold calling to AI-driven sourcing analyzing 11 million companies for efficient deal flow.
    • This automation reduces hiring needs and enhances human prioritization in investment sourcing. Transcript: Jay Hoag And then for us, see if I can walk through it. There’s also a sector overlay because we go to market in different sectors. So consumer application software, infrastructure software in Europe, four big sectors. But way back in the day, well before TCV, there were outbound deal sourcing factories, TA Associates being a classic one. And then some of the folks spun out to start Summit. It was phone. It was cold calling to try to build a database of interesting companies, get whatever financial metrics they could, and then sort of through all that and go chase X number of investment Opportunities. We started building that core in TCB in 1999, because originally it was Rick and myself and we were doing everything. We knew some venture guys and calling it a sourcing effort sounded much more grandiose than it actually was. We went with that people driven hordes of associates. They would come in and commit to three years and then sometimes go off to business school and come back or go off to a portfolio company and come back or just go off to another firm or another Company. But going back about 12 years, one of our associates said, we need to automate this. And it moved from phone work to email work to lots of scouring of the web and going to trade shows and all this other stuff. And so we have a data intelligence group that, and I’ll stumble on some of the metrics, that is the front end of our sourcing effort. And there’s actually AI applied here, where have massive number of data sources tracking employee growth, app downloads, various product usage measures. And it’s ingested, I think, something like 11 million technology companies, many of whom are really, really tiny, obviously, at this point. That is ingested and analyzed. We score companies. And that, in addition to all the inbound leads we get from benefit of our 30 years. If Reed Hastings sends a note saying you should check XYZ company out, we’re going to check it out. But the Data Intelligence Group is an automated tool. It just has applied to sourcing means we don’t have to hire a thousand associates to go out and try to scour the world. (Time 0:27:11)
  • Unanimous Committee Drives Conviction
    • Use a rigorous, unanimous investment committee approach to concentrate investments in highest conviction opportunities.
    • Avoid spreading bets thin; focus on doing deep diligence to select market leaders. Transcript: Patrick O’Shaughnessy What is the process like, the actual internal investment process like at TCV? Are individual investors allowed to just pick what they want? Is there some sort of committee process? Walk us through the actual process of selecting investments. And I realize we’ll probably have to couple this answer with how you win them because they’re interrelated and you’re building the relationship with the company as you evaluate it. But maybe talk us through the nuts and bolts of how that actually works inside. Jay Hoag Yeah, each of those sectors meets at least weekly and often more. That is where all that data, as well as an existing pipeline opportunities is discussed and near-term priorities, long-term priorities, company XYZ, we’ve had a tough time breaking Into how can we leverage our extended network to get in. And that’s where the initial sorting out process comes. We also have a weekly global pipe meeting where all investment professionals are involved, where we’re bubbling all that stuff up to where what might be actionable in the next six to 12 months. The reason I say six to 12 months, there’s thousands of financing that happen all the time. But what we’re really trying to do is get to know these companies over an extended period of time and be working today on what might be a 2026 investment because a young company is not yet In the growth stage. That’s part of their by design. X number of things get through the sector screening process and get presented to the IC. Say, let’s move forward with these, let’s not move forward with those. Patrick O’Shaughnessy And then we actually have a three-person final investment committee that has to be unanimous on investment. It is unanimous. At the end, it’s you and two others, presumably, that have to say yes on every single thing that you do. And how many is that a year, typically? How many new investments would you make? Jay Hoag We have a velocity fund, which is invested in expansion stage companies and the growth fund, which is big fund. We might typically invest in six to 10 a year. You start with tracking 11 million companies in an automated fashion down to six to 10. Patrick O’Shaughnessy How many do you think you like barely say no to a year? What is right outside that six to 10? Meaning like it’s on the line, you’re excited about the company probably at this stage, if you invest in six to 10, how many are on the cutting room floor right before that final approval? Jay Hoag I couldn’t cite your actual percentage, but it should be a reasonable, robust number, which may sound crazy, but early stage investor, I’ll use AI as an example, but also just in general, If an early stage investor will have many more, I’ll call them bets, but investments in a given fund, in part because they want to have as many chips on the betting table as possible to Get that one or two that really will pay off big. Missing a significant portion of those, I think for an early stage venture fund in any given vintage can be really problematic. As a growth investor, we tend to run pretty concentrated. So our typical fund might be 20 to 25 investments. And so we really have to have conviction. And we are focused on doing all that work ahead of time to say, this is the one in this category. So we’re not betting on two or three players in a given segment. So it should be hard to get to a full yes. And there should be a bunch of, we’re not sure. And then they end up being no’s. (Time 0:29:40)
  • Embrace Non-Consensus Aggressive Bets
    • Being aggressive and non-consensus with investments can yield the best returns if correct.
    • High quality technology companies sustain growth through recessions and volatile markets. Transcript: Jay Hoag More on the aggressive side as it not taking unverified bets, but I’m not turned off if it’s different because it’s non-consensus is good. Again, a quadrant, consensus, non-consensus, right, wrong. If you’re wrong and non-consensus, that’s really bad. But if you’re right, it’s often where the excess returns are. Of course, the world can come to an end and all the current macro stuff could be a decade of unpleasantness in the world. But many of the companies I mentioned earlier, they showed an ability to grow through any and all environments. If you look at churn rates for some of these subscription services during recessions, you can’t see any difference. So I have a firm believer in the best quality technology companies. One may, at different points in time, have to be aggressive on valuation and pay more, but it will be a long-term win. (Time 0:33:23)
  • Netflix Early Financing Challenge
    • Netflix survived a tough 2001 financing with TCV’s support when no investors offered equity.
    • The company traded sideways post-IPO for years, requiring patience and conviction to hold. Transcript: Jay Hoag So it was not just challenging staying with it publicly, but that predated the IPO. What made it challenging? Netflix founded in 98. It was enabled because instead of a VHS tape, which is heavy, a DVD can be mailed cost-effectively via first-class mail. But the original model was you rent one, return it. And the unit economics on that were not attractive. So subscription was what unlocked the ultimate profitability. But the company filed to go public in 2000. Market melted down. It went down 60% twice. That’s not very fun. And there was a financing in 2001, dating myself, where we had a discussion and huge supporter with Reed and conveyed, we will provide the financing, but I’m not sure how to price it. Series A through E had been up into the right. And so he went and canvassed the marketplace to see what the price of Netflix was. And there was no equity provider, zero. We did a restructuring financing in 2001 in order to get them through to the other side of profitability and free cash flow positive. And then they went public in 2002, although traded down for a while and traded sideways for like six years. But that was the tough part of the journey. Like, why are you staying with this company? Was part of the discussion at the time. I think one of the benefits of experience is we invest in these 20, 25 companies in a fund, and hopefully they’re all the next Netflix or Spotify. But after some period of time, you realize, well, they aren’t. But which ones have that decade or multi-decade growth really going to be a dominant player? And we go through that sorting process. So what’s the challenge of holding? When they go through periods of material revaluation in the public market, you get second-guessed out the wazoo. (Time 0:35:10)
  • Jay Saved Netflix CEO’s Life
    • Jay Hoag performed the Heimlich maneuver on Netflix CEO Reed Hastings to save his life in 2002.
    • This unexpected act illustrates the close relationships and unique moments in investing. Transcript: Jay Hoag Thank God I paid attention to my first aid training as a kid. I think it was in 2002, I ended up having to do the Heimlich maneuver on Reed. So if value add is you save the life of a CEO, he had a piece of meat that couldn’t get this life. Patrick O’Shaughnessy There’s two of us in a conference room. So it’s almost humorously, but pay attention to your first aid class in becoming. (Time 0:44:33)