Markets Weekly podcast – 18 November 2024
18 Nov 2024
What role could venture capital play in AI innovation?
29 April 2024
Please note: Barclays Private Bank does not endorse any of the companies or individuals referenced in this podcast.
Join Sumant Mandal and Jamie Montgomery of March Capital for a fascinating discussion of the key trends within the venture capital space, with a particular focus on the rise of artificial intelligence. Meanwhile, Matt Spence from our Investment Bank delves into market liquidity levels and the recent slowdown in venture investments.
Lastly, podcast host, Julien Lafargue examines US inflation and the latest releases from the first-quarter corporate earnings season.
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Julien Lafargue (JL): Welcome to a new edition of Barclays Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank, and for this kind of special edition of the podcast I will be your host. Special because we will still cover the events from last week and take a sneak peek at what we have on the agenda for this coming week, but we have two very special guests with us today to discuss an area of the market that we continue to view as very interesting for investors. And this is private equity and venture capital, in particular.
Indeed, I’m going to be joined very shortly by Jamie Montgomery and Sumant Mandal, both of them are cofounders and managing partners at March Capital. And on top of those two esteemed guests, we’re also joined by Matt Spence, who is Head of Venture Capital Banking here at Barclays Investment Bank.
But before hearing their thoughts on the private equity landscape, let me run you through the key events from last week, and it was a fairly busy one, both in terms of earnings and macroeconomic data. I’m just going to focus on what I think are the most relevant ones, and these are first-quarter GDP figure in the US as well as the PCE, personal consumption expenditure, which is the US Federal Reserve’s preferred measure of inflation. And those two pieces of data are important because the numbers that we were given last week had a whiff of stagflation to them.
Starting with the first-quarter GDP, it came in weaker than expected. The consensus was looking for Q1 GDP growth of about 2.5% in the US, and the actual number was 1.6%, so much lower than expected. At the same time, we had this PCE figure, this inflation figure. That was roughly in line with expectations, depending on whether you’re looking at the month-on-month or the year-over-year reading, but still quite elevated, north of 2.5%. The point is, just looking at this data, last week showed that the US continues to experience elevated levels of inflation, or at least higher than what the Fed would like and, at the same time, GDP growth is slowing down, which rhymes with stagflation.
Now, the reality, and that’s probably why also the market hasn’t really reacted as if stagflation was around the corner, is when looking at the Q1 GDP figure and underlying data, the reality is the US economy is slowing, but it’s still performing quite well. A lot of the negative surprise, in fact, came from inventories, as well as government spending that was lower than expected.
If you look at the underlying consumption, the underlying domestic demand, that was still very strong at 2.8%. So, we can, for now, avoid worrying about stagflation in the US, but the reality is that the 3.6% GDP growth that we saw in the fourth quarter of last year is unlikely to be repeated.
The other key datapoint from last week was earnings. That was a very busy week for earnings, with about 40% of the S&P 500 reporting a Q1 result. A lot of the attention was on the mega-cap technology names in the US, names like Meta, Microsoft, Google etc. Overall in the earnings season, we are roughly through the halfway mark, it has been good.
About 75% of US companies are delivering better-than-expected earnings per share, and when they beat consensus on aggregate, it’s by around 8.5%, so pretty solid positive surprise there. Those numbers mean a lot in the medium term, but not much in the very short term. And what I mean by that is, if I take two examples, the first being Tesla, which probably had its worst quarter on record and missed expectations on almost every single metric, that stock rallied more than 10% after the earnings release.
Contrast that with Meta, which had its most successful first quarter of any given year and, despite this strong performance, the stock sank 10% on the day of the earnings release. So, really tricky to try and position yourself ahead of earnings, and the reaction that the market has might be counterintuitive at times.
Now, it’s still good news over the medium term because, as we’ve highlighted in the past many times, earnings are the key driver of potential upside for equity markets and, as I just mentioned, the earnings are coming in better than expected in the US. And the story in Europe is somewhat similar. The picture is not complete. Not every single company is reporting full P&L, but, still, it doesn’t look like we’re going to see earnings downgrades on the back of this earnings season, which is positive.
So, that’s it for the recap of last week. Let’s now move on to our guest segment. As I said, I’m very excited to be joined by Jamie and Sumant from March Capital to explore the world of private equity and venture capital.
Maybe, Jamie, I can start with you? Thanks for joining us. Can you maybe start by sharing some insight into your journey into venture capital, into the industry and how you got started in investing?
Jamie Montgomery (JM): Well, people always say that investing is an apprentice industry, and I think that's so true. And I was always interested in technology, finance, investing even as a little kid. And after graduate school, I started my career in the Pentagon, working in intelligence. And I was looking out further, what could happen 20 years from now, and painting scenarios and trying to see what could happen, envisioning things. And people would say, well, I don't see that. I said, well, no-one can see it. It’s can you just envision it happening with the underlying trends?
And, you know, you could see in the early ‘80s, the rise of biotechnology and mobile technology. And we could foresee the collapse of the Soviet Union well before anyone else. And people would say, how do you see that? I’d say, no, I don't see it. I just envision it, you know. And people said, well, OK, you’d make a lot of money in the private sector, yeah? And I thought, well, how do you take that skillset? So, I went to work for a merchant bank. And I thought, well, this might be interesting. And then I realised, well, really what you need is you need some discipline models to work with about how to look at investing, you know, financial models, accounting and all that. But you also need to say, what makes for a good company? So, you start building your mental models. So, that was a big part of my development. And seeing lots of companies and testing those models. And, you know, we could look at thousands of companies over time. And, you know, what makes for sustainable margins over time? What makes for operating leverage? What makes for, you know, the flywheel effect in businesses? And what's good management when you see it?
And then, the third aspect was, you know, sort of, can you see something before it's obvious to everybody else? Do you have the mental models to really do the analysis? And the third part was, how do you build a network so you can access the best investment opportunities and also kind of help the companies once you're in them, right? So, that was really important. So, you know, yeah, so you end up working nights and weekends so you can network during the day. And you invest a lot in that. And people would say, well, how do you do that? Well, you know, it's work too, right? And that's part of your work. And you build this incredible, invest in that, right? You invest in the network and you invest in your relationships and you keep relationships for decades and cultivate that. And then you put the three of those together and then you've got a kind of a force that you can be effective in the venture business.
And that was sort of my insights that you needed all that. And then I was very, very, very fortunate to have some mentors along the way. Yeah, obviously, you know, I did banking for 25 years. I looked at, you know, advised hundreds of companies on strategy and finance, hundreds of companies, and took 50 companies public and, you know, sat in these boardrooms. God knows how many hours of meetings. So, all that experience, but also, you know, the settings and, you know, all these situations I'd been in. Every setting reminds me of something else I've been in.
So, I had those datasets, but a lot of it was just the, you know, the people who would take time to coach me along the way. And in the last decade, I was very fortunate to have a weekly session with Charlie Munger, you know, and, gosh, he was almost 90 when we reached out to him. His wife had passed away and I invited him to breakfast and he had really enjoyed it. He said, well, can I come every week? And I'm like, God, you know, yeah. I mean, I was like, I'm surprised you wanted to have breakfast with me once, you know, much less every week. And we did that for almost 10 years.
And he was incredibly helpful as a mentor and a role model. And his basic principles of simplicity, people overcomplicate things, and knowing what you know, and knowing what you don't know. I'm always like, I don't know, and he'd always invert and distil things down, you know, just keep inverting till you get down to the basics.
And then the quality of the people you're doing business with. People get in trouble when they do it with people they shouldn't be doing business with, you know, so character and ethical standards. So, you know, there's no reason to make this thing any more difficult than it has to be. So, you know, do business with high-quality people, high ethics, simplicity, concentration of capital, really knowing your expertise.
You lay all that over what I had before and, wow, it's really worked out well. And I have a great partner in Sumant, who's got incredible skillsets that complement my skillsets.
The insight is that you can't do it yourself. I couldn't have done this without Sumant. He probably couldn't have done it without me. Maybe he could have. I’ll let him make that call. And, you know I've been very fortunate to build this network, build these mental models and get these experiences. And then, you know, we’ve been very, very, you know, it's worked out really well for us. So, those are some of my insights along the way and it's been, you know, very fortunate. I think you have to keep giving back. And the more we give back, the more we get in return. I mean it's just, it’s a very virtuous cycle out there, you know.
JL: Well, that’s perfect, thank you. So, let’s segue into Sumant. Sumant, how do you view the role of venture capital in fostering innovation and technical and technological advancement? And I guess how has that evolved over, you know, the past couple of decades?
Sumant Mandal (SM): Yeah, you know, thanks for having me on this and I will echo Jamie's comment that I couldn't have done it without him, or at least his skills. The evolution of venture capital kind of mirrors the evolution of the world that we invest in, which is the world of technology. And when I started 25 years ago, IT was a vertical industry. It was the domain of a chief technology officer buying technology products to make an enterprise or a business operator run.
It really changed with the advent of the internet, got accelerated with the advent of mobility in the mid-2000s. And now what we invest in, what the world of technology encompasses, is almost everything. It’s everything to do with how you work, everything to do with how you live, how you play, how you make decisions, how you drive your car, how you travel. It's all technology.
So, I would say the world of technology investments is exponentially larger than it was 20 years ago. And it's also global, right? So, the world is no longer just Silicon Valley or just the Boston Corridor. It's India, it's China, it's Europe, it's Japan, it's everywhere in the world you see companies being built and, therefore, the role of the venture capitalist has also evolved. The primary role of the venture capitalist is, of course, to provide capital to innovation, capital to innovators. That has not changed.
But how you find that innovation, where you find that innovation, how you build these companies and which industries do you understand, which industries can you add value in? How can you be a good partner to your entrepreneur? All of that has evolved dramatically over the last two decades. And so I think you just have to choose your sphere of competence. You have to choose and be really diligent about and careful about where you put your time, effort and energy, and then your money, to be successful in venture capital.
What has not changed is finding those crazy entrepreneurs, those, you know, people with a mission that want to change the world, that see something is wrong and they want to make it better. That, I think, remains consistent and constant. And I hope that answers your question.
JL: Great. No, it definitely has. You know, we’ve seen that change especially over the last few years. Jamie, maybe back to you. What sectors and industries are quite interesting right now within VC? And I guess how has that, or these trends, changed over the past five years versus post the global financial crisis?
JM: It's a really, really interesting time and there's a lot of change going on and, you know, and it's easy when you read the FT or the Wall Street Journal, the Economist to digest a lot of information about tech trends and AI. But I'll distil it down. In every technology cycle, investment begins at the infrastructure layer and then investment in the application layer falls. The application layer would be software that runs business processes within companies or between companies. And this was in the client server area, then in the cloud area, and it’s now happening in the AI investment cycle. So, the cycle is repeating itself.
Over the past few years, we've seen billions, tens of billions of dollars of investment in AI infrastructure by the ‘hyperscalers’, Amazon, Google, Nvidia, AMD, IBM, Oracle, you name them, right? Microsoft, obviously. And 90% of the venture investment in AI has been by the hyperscalers themselves, and most of that's focused on infrastructure.
Our view is the next wave of value creation will be driven by intelligent automation, by AI, which is the application layer of software, across industries and within industries. And new companies will emerge which will compete with and displace prior incumbent software companies. And there'll be new software companies that will be AI native companies, like the cloud native companies, like ServiceNow and Salesforce, to be AI versions of that. You're seeing some here this week.
The second set is the stage. Series B and C valuations are down significantly. You asked about the global financial crisis. The slowdown of 2022 and 2023 was stark. And what resulted was a steep reduction in valuations that we're seeing now. Now, AI infrastructure, so the exception to the rule where the hyperscalers are investing. But the iron rule in capital markets was a 1% increase in interest rates equated to a 10% reduction in public market valuations. And that played out in the public markets very rapidly and then spread over into the private markets.
So, in 2022, private companies experienced a 58% correction valuation over three quarters, which was unprecedented. For comparison, following the GFC, private valuations corrected 42% over seven quarters. In case you're wondering, the ‘dotcom’ correction was 74% over 11 quarters. So, this correction was much sharper, much quicker, much more severe than ever before. But, what happened is a lot of companies had raised money so they didn’t, so reality didn't set in until about now. They had plenty of cash and now, finally, they need to go and raise more money and the prices have been reset.
And what else has changed? Sumant talked about venture as a much larger business. We usually come in in years two to five. Companies stay, I have to say, private longer, so there's more chances to double down before they go public. OK. Will that always be the case? Will companies go public earlier in the future? Time will tell. Maybe.
We're seeing some suggestion that the growth curves in some of these new types of Gen-AI companies are even more rapid than the fastest companies in the cloud period. So, maybe the companies will even grow more quickly and go public earlier. Who knows? I don't know. This will be interesting to see. So, I think as much as things change, they stay the same. So, I think we're in a new era, and, you know, we'll just see how it plays out over the next couple of years.
JL: Sumant, how do VCs work with founders and stakeholders in the start-up world? Can you maybe explain for our listeners how does that ecosystem work?
SM: Maybe I'll take a crack at how it should work and how we hope we work with our entrepreneurs. Look, I think when you want to build an enterprise, you want to build a business, the most important thing first, of course, is human capital. It’s who is it? Who's building it? So, people are the most important component of building a business. The next is, do you have the resources to go and build it, which is where venture capital comes into place.
Risk capital. There's a lot of belief, a common belief, that comes into investing in an entrepreneur. There's an understanding of what you're trying to achieve. You have to do it. You have to make sure that, as an entrepreneur, your vision, your opportunity, your goal matches what the investor is looking at. Oftentimes, when we see things don't work is when there's a mismatch of that.
Now, we all go in with some certain assumptions. The world changes, markets change. You want to make sure that on both sides people are open to feedback and open to being, you know, nimble, approach things in manners that the markets need and are, you know, agreeable to change. So, I think the first order of business is, is this a match, a relationship where two people or two different types of people, two different roles can work together towards a common success? Oftentimes, that's not the case. So, I would definitely say that's the most important.
What's the role of a VC? The role of a VC is to provide the capital, but then try and make it easier for the entrepreneur to achieve their goals, make their goals, make them achieve their goals, make the goals larger. How do you do that? You do that by being someone who brings some knowledge, some experience, some relationships, some pattern-matching to an entrepreneur who may or may not, may be doing it for the first time or may even have done it before, but the markets have changed, environments have changed.
So, you're really looking to find and work in an environment where you have some expertise. You've got to make sure that there's a match of that as well. And a venture, the venture investor, your new board member or shareholder has that kind of ability to impact your future in a positive way. And if you do that, you have the right sort of framework around being honest about what the reality is. You have this ability to have discussions without feeling like you are going to be threatened or if you can build that kind of trust, you can build that type of relationship, that's the best type of venture relationship that you can find. I think that would be my advice to an entrepreneur or my understanding of how this business becomes successful.
JL: Now, let me turn to you, Matt. Jamie mentioned earlier that there’s been a slowdown in venture investing. From your perspective, what are you currently seeing in the market so far this year around deal activity and the liquidity market?
Matt Spence (MS): It's a great question. And I think Jamie and Sumant really hit the nail on the head when they talked about some of the different changes. I think there are really two trends that we've seen recently.
First, a lot of the slowdown in venture investing has happened while a lot of investors have waited for valuations to still come down. And we're really living now in a world of two parts. There's the AI investment side, which, of course, is red hot, both from the seed to the growth rounds. I think by one estimation there is a 22% premium on seed rounds for AI companies compared to all other types. And so aside from AI, things haven't really come out, because the valuations haven't fully adjusted, so some of these companies are looking to raise again.
But the second big piece is that a number of LPs are looking for more liquidity. And as some venture firms have really continued to allow companies to stay private longer, the IPO market has not yet recovered. There is more pressure to start thinking about, within a portfolio, what are companies going to actually move into generating returns for the LPs? And that's something that's really different to what's happened in the past. I would call it two to four years in venture where there wasn't that same pressure and time horizon.
JL: Great. Thank you, Matt. And maybe before we let you go, can you shed some light on, you know, the current sentiment on the ground in the Bay Area? And I know you don’t have a crystal ball, but what are your thoughts on kind of the next 12 months for venture capital investing?
MS: It's a really interesting question. I mean from on the ground out in Silicon Valley, I think one trend has been that tech is no longer just a vertical that venture firms are investing in. There's a huge amount of adjacencies of tech, plus something else. It really is a horizontal that crosses into established industries. So, you're seeing, of course, a continued amount in healthcare or biology and traditional medicine intersecting with technology. I think second, you're seeing a lot of excitement now around hard tech in addition to enterprise software investments.
But there is more of an interest in what can be done around sustainability investments. There is a huge amount in defence and dual-use technology, which is exacerbated by a number of the geopolitical trends. And then the final piece that is interesting is still this strong interest in AI, but the nature of that is changing.
Barclays just put together an AI summit in Silicon Valley last week, where we had a number of conversations with leading VCs and their portfolio companies. And the question is moving in from how do you think about some of the foundational models to really what are the applications that some of the large enterprise customers will start to buy into? And then how do these companies start thinking about what their business model’s in, to get past the hype and the storytelling to really think in terms of how these will transition into successful and lasting businesses.
JL: Excellent. Great. Thank you so much, Matt. Thank you, Jamie. Thank you, Sumant. That was extremely insightful, and we’ll endeavour to have you back on podcast fairly soon.
Now, to conclude, let’s take a quick look at the week ahead. Look, the FOMC meeting, the Fed meeting, on Wednesday. Obviously, no action is expected on the part of the Fed. No hike, no cut. The entire market’s attention will be on Jerome Powell’s press conference and whether or not he decides to push back against this narrative that has been emerging in markets recently about the Fed potentially not cutting interest rates in 2024, even worse, so to speak, potentially having to hike interest rates again because inflation is stubbornly high.
Maybe the GDP figure, that we discussed earlier, will prevent them from hiking, but the market will pay very close attention as to whether Jerome Powell is actually pushing back on hike expectations, pointing to the Fed’s next move being definitely a cut, although timing is probably uncertain at this point.
And then we will, of course, conclude the week with the jobs report in the US, which is a very important macroeconomic datapoint, although somewhat lacking, and that could have the potential to reverse whatever reaction the market has on the back of the Fed. So, there will be plenty to analyse next week.
We will take a break next week, so we will review everything the week after. In the meantime, as always, we wish you the very best in the trading week ahead.
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