On this episode of Okay, Computer, Dan and FirstMark Capital’s Rick Heitzmann have a chat at the iConnections Global Alts Conference in Miami about the reckoning for poor due diligence in public and private markets (2:00), the VC industry’s biggest lessons from recent excesses (8:00), the record amount of VC dry powder and how Rick is deploying capital (17:00), why Rick is most excited about opportunities in healthcare & AI in 2023 (21:00), and how a reopening of the IPO market will be a key signal to confidently invest again (26:00).
And later, Dan talks with Chamath Palihapitiya, founder & CEO of Social Capital, about the macro climate for investing and why it’s the start of a new phase of sobriety (28:00), what will survive the crash of risk assets (36:00), the problem with growth investing & where to look for signs of a bottom in private tech (42:00), why mounting geopolitical tensions between the U.S. and China will likely be a boon for American companies (46:00), and the rise of large language models in AI and how it may spark the next wave of M&A from big tech (49:00).
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Show transcript:
Dan Nathan: [00:00:38] Welcome to Okay, Computer. I’m Dan Nathan. I am down in South Beach at the iConnections Global Alternatives Conference. Yesterday on stage I had two great conversations with VCs that you know and probably love. The first with Rick Heitzmann of FirstMark Capital. The second were Chamath Palihapitiya of Social Capital. We covered a wide range of issues, basically how these guys are deploying capital right now, some tech trends that really excited about and if and when we are going to come out of this VC tech winter that we might be in. So stick around for both of those conversations. Great to be here at the iConnections Global Alternatives Conference. Thanks for being at this. This is my good friend Rick Heitzmann. He’s the founder and CEO of FirstMark Capital. This is one of the New York City VC OGs. Welcome Rick. [00:01:25][46.4]
Rick Heitzmann: [00:01:25] Thanks Dan. Thanks for having me. Thanks everyone from iConnections for having me. And you know, at this point in the cycle, it’s really interesting conversation to have of what we’re seeing in a very different world from what you just heard about. But in venture capital and that facet of the private market. [00:01:42][17.1]
Dan Nathan: [00:01:42] Yeah, no doubt. I mean, listen, that was a really great conversation we just listened to hear I mean, he’s co-host of a podcast that he and I do together it’s called Okay, Computer. And we’ve been talking about some of the themes over the last year and a half as some things have been kind of coming unwound in the private investment world a little bit. And a lot of it has to do with the fact of we’re all dealing with this kind of rising rate environment and the other side of the pandemic and some of the dislocations that we saw because of that. And so we really want to start out talking about, again, you know, we’re calling this panel a reckoning for poor due diligence. Rick and I had a podcast, I think it was almost a year ago we were talking about like this kind of the Nasdaq had just kind of topped out. People didn’t know it was the top. You never know it’s the top when it’s the top. Right. But the fact is that the Fed was saying that they’re going to raise interest rates aggressively to tamp down or battle inflation, and nobody knew how long and how high they would go. And Rick’s point was like, oh, baby, watch out, because there was a lot of really bad due diligence in the private sectors and the lags. So let’s talk about that, the lag that you see from and you’ve been doing this now over multiple cycles. What is the lag from from public markets to private markets? And then, you know, it’s that Buffett conversation or that comment about when the tide goes out, you see who’s swimming naked sort of thing. [00:02:59][76.4]
Rick Heitzmann: [00:02:59] That’s exactly true. So, you know, as we’ve talked about on Okay, Computer, what we saw was, you know, even 18 months ago that things were moving very fast with very light due diligence and very large checks and probably valuations that were unsustainable. And for those of us who had seen cycles that made us very scared, you know, there was probably folks who were feeling FOMO or fear of missing out when things were moving that quickly. Yeah, we probably took to quote Buffet again, You know, when other people are greedy, be scared. And they felt like there was a lot of greed and that made us very scared. And we said, hey, our normal process of deep diligence getting know the founders, understanding our process and wanting a thoughtful way to invest, you know, is going to work. It’s going to work in the long term. And therefore, hopefully we could avoid some of these disasters. But, you know, we said that we saw that happen. And then answer the second part of your question and then even and as the public markets turned and the public markets turned probably in October, November, December of 2020, 2021, and being in New York, you know, I think the conversation might be different than being in Silicon Valley. You’re much closer to the to the to the financial markets. You’ve a lot of friends who are deep in the financial markets, and therefore you have the ability to kind of be more market aware. We saw a lot more fear and a lot more presence and a lot more concern over rising interest rates than what maybe some of our colleagues that we served on boards with as venture capitalists saw. And we said, hey, this is going to happen and it’s not going to be short term. This is going to be a long, hard process. And we think it’s going to take 2 to 3 quarters because that’s what we had seen historically for, you know, the news on Wall Street to get to the boardrooms of a lot of earlier stage venture capital companies. And so that lag we were going to see and I think we saw that of what we saw market cracking on the public side in October due to largely interest rate speculation that, you know, you really were seeing a kind of a bottoming out in probably Q2 or over the summer of 2022. That in that memo filtered through the system. On the flip side, though, I think the private market is going to lag the public market leading us out. And, you know, I think then we’re going to have to turn to guys like Dan who really understand that and trying to figure out, therefore, where do we go from here? [00:05:32][153.2]
Dan Nathan: [00:05:33] Yeah, you know, one of the things I think is really interesting, you know, you’ve been on this Midas list. You guys are very early stage, your seed stage. And so you were on the board of Pinterest. You were the first institutional money there. You saw something about DraftKings. You had a path forward. It wasn’t just fantasy was towards sports betting. Talk to us a little bit again, going back to business model, and I think that’s a big part of your theme as it relates to due diligence. You know, those business models were exposed after years of kind of VC, I guess you would call subsidizing those models for consumers. So let’s talk a little bit about that and why were you able to look at a Pinterest or a DraftKings or a Shopify or an Airbnb early on? How much did it have to do with just, you know, an easy money environment or versus really kind of getting to know what the business model was and wasn’t going to be able to kind of deal with a changing economic environment? I think that’s a really big part of it because that’s when this thing started to turn, when interest rates started going up last year. [00:06:34][61.6]
Rick Heitzmann: [00:06:35] So, you know, as we think about doing diligence, you’re not only looking at the founders and doing reference checks and background screens on them, but you’re thinking holistically more about the market. And one of the things we think about is what’s the end state business model of this business, and do the founders understand where they need to go? And then just to contrast some of the things that you just said, Dan, if you look at Airbnb and what’s the end state business model there, they’re incremental, each additional dollar of revenue drives about 75% incremental dollars of cash flow. So they’re driving meaningful. They did over $1,000,000,000 of EBITDA in the third quarter of last year. We invested when the model was completely upside down and they were growing, they were investing in both the fixed costs as well as market expansion. But we were able to see five or seven years ago when we first invested, hey, when this business expands due to the nature of the marketplace, to the capital efficiency of of being virtual and, you know, being a lodging company that doesn’t own anything, that that’s going to be a great business model over time and will generate material earnings and cash flow. Conversely, we didn’t get involved in any of the quick service delivery companies where we said, well, all right, we understand you’re investing now and you’re losing a massive amount of money to give somebody a pint of Ben Jerry’s ice cream that they could buy at the store for $5 and giving it to him for $4 to be able to do it, which didn’t make a tremendous amount of sense to us. But we listened to that part of the conversation. But what’s your end state if you still have to go to the store, buy the ice cream, have a human being, take that ice cream, get it on a bike, drive into someone’s house that you know and what does that mean for the consumer? And, you know, in order to drive a 50 plus percent margin business when you’re doubling prices and what does that mean when that venture subsidy goes away? And what is your business look like? Shockingly, even some of the founders hadn’t really thought through that because it was pretty easy to raise money from people who weren’t asking the questions. But what we saw was the best founders or the most thoughtful about not only where their business is, but where their business is going. And you look at Chesky and Nate from Airbnb and they have been able to lay out that whole path and where exactly they were going, as opposed to folks who were dismissing diligence in in the search for easy money that could provide the supplement. [00:09:07][152.8]
Dan Nathan: [00:09:08] You know, it’s funny when you think about some of the companies just named in some of the businesses and how they were affected over the last few years, just obviously, first, by the pandemic, you think about an Airbnb, we know what happened to their revenue during that, not their fault there. But if you have the wrong business model and you know what I mean, like it’s that much harder to come out of this other thing and take advantage of maybe some of the new trends that exist. Talk to us a little bit about like some of these founders that you invested in when they were, you know, obviously seed and Pre-series A and the period in time which they have just gone through, some of these guys became wartime generals, right? Are we likely to see some of these guys, are they the next thunder patches and Satya Nadella is are we is there a crop that are going to make it out of this period and end up being know the next CEO of $1,000,000,000,000 company in ten years? [00:09:52][43.4]
Rick Heitzmann: [00:09:52] Yeah I think this is going to be a crucible no different than yeah with Jeff Bezos phase or even the Steve Jobs phase to a certain extent faced in other downturns. And if you could be a good peacetime general and you were able to understand how to motivate customers, motivate employees, build a good business during the good times, and can then also be a good wartime general of, hey, here’s how we control costs, here’s how we change still a positive message for internal external communications. But temper that message to be sensitive to the environment. And you could do both of those things incredibly, incredibly rare. Yeah, we saw some founders who were great at raising money and up in upsides. We’ve seen some founders who have been ruthless cost cutters and downside. But the Venn diagram overlap is very rare, but I think that’s when you see those special people who’ll be able to manage those businesses over several cycles into the public markets and be the exceptional people that we’ll talk about like the Bezos is in ten, 20 years [00:10:52][59.7]
Dan Nathan: [00:10:52] What do you think VC has learned from this period again? So like, obviously we all know, you know, Rick has been in the business, he’s been in multiple cycles. And again, one of the things that I think is really unique about this cycle is that, you know, when we came out of the dot com implosion 20 years ago, when we came out of the financial crisis, interest rates were at zero and they stayed really accommodative for a long time. Right now we have a Fed meeting tomorrow and Fed funds is going to go to 4.75%. The strong likelihood it will be 5% in March. And whatever your estimates are for when they start coming down, they’re still going to be much higher than they were at the bottom of other cycles. Will we continue to see the lessons that we just talked about? Poor due diligence? Right. Will we see better practices among investors in the private markets on the way out over the next couple of years? [00:11:42][50.2]
Rick Heitzmann: [00:11:43] I think you’re already starting to see it. I mean, I think deal velocity has slowed down. You’ve seen an absence of people. You know, it was almost a daily event in the press to say, hey, this was char.com we just minted a new unicorn yesterday. And so that’s going away. Billion dollar valuations are going away. We’re probably net down unicorns in 2022, especially if people are being honest with themselves. And then you’re seeing net down $100 million rounds and even some of the market participants who are driving that behavior or out are not in the business anymore. So I think you’re going to see a return to diligence where I think, as we said almost a year ago on one of the first Okay, Computers out there, the revenge of diligence and the return of business models as rationality and sobriety have re entred the ecosystem. And, you know, I think that’s going to be important and I think, as you say, is interest rates. Everyone expects them to continue to rise, at least getting to 5%. You all as capital allocators are going to say, hey, I could be an almost in and be able to drive returns in a risk free environment. What’s the risk premium? I’m going to need to be able to invest in the riskiest part of the curve in venture capital. So I think you’re going to see less capital in the market. I think you’ll see more dollars go to people who were thoughtful and cautious and sober during the 2021 period. And, you know, we’ve even seen a lot of people who have go or are looking for here are people who have been there in the long term. And I originally got into venture capital in 98, almost 25 years ago. And then people who will stay for this next cycle and the ability to understand cycles, we’re not only seeing it from the capital providers, but very interestingly, we’re really starting to see it from entrepreneurs who want someone like that on their board, who has seen cycles and can give really good advice both in the ups and the downs. [00:13:40][117.0]
Dan Nathan: [00:13:40] All right. So if you’re an allocator and you say to yourself you want to kind of get more into privates, you want to get more into V.C., what would some of the signs be that this is bottoming out, that we’re seeing the bottoming out of a cycle? Like what are we we want you just said that net unicorns are probably going lower. Are we going to see consolidation? Are we going to see some major pivots of some companies that you thought were meant to do this? And they were the next thing of this, the next Uber of this, you know, that sort of thing. What are some of the signs? I think some of these people, you get a sense for that we might be two quarters away from this being over at this point. [00:14:14][33.5]
Rick Heitzmann: [00:14:14] I think I think you’re right. I think we’re we’re probably bouncing along the bottom. I think the question is going to be how long are we going to bounce along the bottom? And I think we’re probably 2 to 4 quarters out. You know, from a macro perspective, you know, interest rate stabilization. So as you all are thinking about, you know, how am I going to deploy my capital dollars, you know, what am I going to put in different sectors? You know what, therefore, what’s my view on interest rates? What’s my view on a risk premium? How is that going? I think that’s going to be the macro concern from a market concern, what you’re what you’re seeing and you know, there is a big thing on secondaries, both fund secondaries as well as individual companies that’s been bouncing around the news over the last month or so. As you know, folks are trying to rebalance their portfolio, especially people who have gotten way over their skis on privates and how do you rebalance your portfolio. So you’re seeing all right, the market is starting to become more efficient. It’s still jagged with a lot of volatility in the privates for all the obvious reasons. But you’re seeing the market kind of rese there. Already seeing largely the market reset in founders minds. And it took over a year for that to happen. But we’re able to see a return to classic valuations after spending most of last year telling founders that most of 2020 and 2021 was fairy tale land. That was any benchmarks that you have in terms of capital raising, cost of capital, and maybe even some business model things are irrelevant to the way the world has worked historically and will work. So let’s go back to looking at benchmarks historically over the last 20 years and taking out that period. And that’ll reset valuations, reset expectations, reset everything from cost of capital to return on capital. And we’re seeing that happen in the primary trades. And then I think you’re seeing almost a washing out. We call them the tourists, people who got into venture capital or private equity or growth capital in the 2020, 2021 period that were in some kind of other business. You know, they were in real estate, but they thought they they they become seed investors. They were public market investors that were kind of going earlier in the cycle because, you know, you’re in a 12 year bull market run. One of the lessons people seem to learn, though it’s not true, is the earlier you go, the more money you’ll make. That’s true as long as the bull market continues to go, if it doesn’t go on forever. So, you know, tourists from other asset classes, tourists who haven’t done that or have kind of left. And I think you’re seeing some of this capitulation in the secondary markets saying, hey, I was a tourist, I got burned, I’m going to leave this asset class return to my core focus and you’re going to see, you know, multidecade providers of capital and partners of entrepreneurs return to setting price at reasonable levels and having a functioning market. You know, it might take the better part of this year, but I think that, you know, we’re well down the path of all three of those things happening. [00:17:15][181.2]
Dan Nathan: [00:17:16] All right. Let’s talk about dry powder. You raised two funds last year. You raised in early stage in a growth stage fund, over $1,000,000,000. Talk to us how you’re thinking about it. Like, how much is the macro when you think about deploying it, I guess all the things that you just kind of mentioned, the kind of inputs that that are important to you and having the perspective of multiple cycles, how are you deploying that capital? Are you sitting on your hands a little bit? Can all go back to 2008, 2009. Some of the most innovative companies that we interact with every day in our iPhones were all founded in and around that. Times are some of the kind of multi hundred billion dollar market cap companies in the public markets. You know, they were founded or really hit a stride during that time. How are you thinking about, I guess, the timing of the capital raise? And it’s not just FirstMark. There’s a lot of capital that was raised at the end of 2021, early 2022, and it’s waiting to be deployed in the private markets here. [00:18:08][52.0]
Rick Heitzmann: [00:18:08] So there is a lot of capital. We tend not to look around too much where other people are doing, but really focus on on us. And, you know, one of our premises is taking the longest view in the room. So as we think about our investments, we were investor in Pinterest for, you know, 12, 13 years from seed stage to being a public company and coming off of lockup, you know, DraftKings, Airbnb, we were in seven or eight years. So, you know, who knows what part of the cycle we’re going to exit in. But we can control entry price, so we can control the mentality of how founders build the business. So we raise capital and we’re very fortunate to have some great LPs, probably including some people in the audience here. So thank you. And then what we’ve seen is as the markets reset is that we’ve been able to, you know, wait for our picks and we’re pretty simple firm. We’re generally, you know, small and we view ourselves as bespoke, you know, looking at how we think about look about the market, especially the New York market. So each partner has to do two or three deals a year. We did a little bit less last year as entrepreneurs expectations had to reset. We feel like they have reset. We’re back on a normal deployment cycle. But, you know, our job is to find a couple companies that we believe can be great billion dollar companies with founders we believe could lead them there a year each and do that. And I think we’ve been excited of what we saw probably fourth quarter of last year in terms of expectations being we said, you know, there’s a whole group of founders who had golden handcuffs from that time that have faded away as public stock prices have have dropped. And therefore, you know, they couldn’t leave Google or SNAP or whatever it was because they leave all this option money on the table. But they really want to start a company. And now is that is that embedded golden handcuffs has disappeared. You know, they feel more free to go out and start a business and they’re excited to do it. So I think this is going to be similar to 08 or nine or when I was an entrepreneur and in in 2000, 2001. It’s a great time to start a business. There’s more people who want to do it. You know, there’s going to be a better way to aggregate talent as the you know, you’re seeing more layoffs and less less irrational pricing on hiring. And, you know, and there’s a sense of a sense of thrift out there in the. Market people might have gone away from in the last couple of years. And we think that, you know, having a culture of thrift is a core part of any startup by startups. [00:20:46][157.7]
Dan Nathan: [00:20:46] Yeah, last one here we had that 2008 2009, this kind of confluence of events as mobile, social broadband, that sort of thing. What excites you guys at FirstMark right now? What do you guys see as something ten years from now we’re going to be talking about, which was really a seed change for technology. And again, I think, you know, a lot of us have been looking at this Chat GPT, you know, some of these language models and some of these AI applications for a whole host of different industries. I’m just curious what what are you guys focused on? Because they sound like buzzwords right now, some of them are going to be the next unicorns. [00:21:18][31.4]
Rick Heitzmann: [00:21:18] You know, on the consumer side, there tends to be a platform shift. And one of the things that was interesting, you know, building businesses 20, 25 years ago was, you know, the growing install base of broadband and what was broadband going to do to enable the next generation of applications via the Internet. And then, you know, in that downturn was also a confluence of the iPhone. What is a smartphone by having a computer in your pocket enable you to do. And that ushered in a whole next generation of companies. We haven’t seen a real platform transition or something that we’ve seen great disruption on the consumer side. But what we have seen is vertical, very, very large verticals being disrupted, which which is fascinating. So on the consumer side, I’m going to say health care biggest part of our GDP has not been disrupted digitally yet, but we believe that a whole bunch whole areas of health care are going to be disrupted by having a more digital first, more bespoke experience with companies like Roman Health that are that are leading the way of how to create a higher quality, more personalized, more value focused health care by having a doctor in your pocket. On the flip or the other side. On the enterprise side, I think you’re right. The AI is really something to be excited about. You know, their horizontal platforms of being able to do workflow, being able to have computers, process things. There’s vertical platforms like Chat GPT or Lensa that could do everything from, you know, turn you into a space superhero from a selfie to write a term paper for you if you’re in the seventh grade. I think that that’s the toy element of it. But we’re seeing things generative AI that’s doing synthetic media creation. We’re seeing elements even in verticals like health care of scanning bodies to be able to understand, you know, what happens in terms of cancer growth or even cardiac calcium within within your heart. So that this AI, both horizontally and vertically, I think is something that we’re probably underappreciated today, although it is getting too much, maybe almost too much buzz now, but something that will be very, very large. [00:23:34][136.0]
Dan Nathan: [00:23:34] All right. So that’s a great question. I mean, does that make you a little nervous? Like so we just went through this period. Again, we’ve been talking about due diligence. Now, you and I have been talking about it on CNBC and on our Pod and in venues like this for a while. And everyone knew that it was getting kind of lazy. It was that sort of environment over the last few years. You know, I think a lot of what just happened with this whole FTX situation was really kind of the exploration point on the thing. But then you see a headline and you just said you thought that like some of these, you know, language model, some of the stuff is getting a lot of hype. You know, I just saw a headline the other day that the company I can’t speak to it. I don’t know who the founders are, but the headline was character two Ex-google guys were working on a machine learning thing, are looking to raise $250 million at $1,000,000,000 valuation for a company they just started. So I’m like, how can it be that? And I’m not saying these guys may be they may be the next Google for all I know. But what I’m saying is, how can it be that that much capital could be thrown at something that we just don’t know about yet? [00:24:31][56.5]
Rick Heitzmann: [00:24:32] Well, I mean we you talk to and broad basis of these macro bubbles and bubbles bursting and there’s always small bubbles and there’s always there’s always things that are overly inflated, overly hyped. I think, you know, tech on the whole, especially Silicon Valley, has their own echo chamber and bubble factor. So I think generative AI might be might be having its moment for better or worse now. But I think the why diligence matters is because, you know, we’re not trying to play a sector bet on AI, We’re AI thematic. It’s, you know, hey, there’s AI, which, which is something really interesting and something that might be transformative. But we really like this AI company who’s able to detect cancer and say, I company who’s able to process fields informatics that is at 1% of the cost of a human being. There’s AI out there doing real jobs that have real customers. Those customers are, they’re driving real ROI, they’re sharing that ROI . And if you could find and and the team’s great. So if you could find those entrepreneurs, you could diligence that model. You’re able to you’re able to pick your your individual companies in what might be a bubble. [00:25:49][77.3]
Dan Nathan: [00:25:50] Yeah, What might be a bubble? Again, one last thing I guess we’ll just focus on this is that, you know, you being in New York, we started this conversation close to Wall Street. You know, when you think about again, at some point, you know, we’ve seen the US dollar come in. We’ve seen interest rates, at least the ten year U.S. Treasury come in. We’ve seen inflation inputs come in. We’ve seen high yield credit kind of hold up. You know, a lot of measures that I would look at and say, you know, is the equity market at least public? Is it safe to get back in the water. They’re at least kind of telling you in a relatively stable macro environment that we’re probably not that far away? Okay. So I’m curious, you know, for you, we just talked about you have this capital you have is dry powder. What are some signs that you might take from the public markets that would give you greater confidence in deploying this capital sooner than later? [00:26:42][52.1]
Rick Heitzmann: [00:26:42] Well, the number one sign is the reopening of the IPO market. So, you know, nothing gives you more confidence in deploying capital than having proof that your prior capital you deployed was smart and therefore, you know, and reopening of an IPO market. We probably have a dozen companies that, you know, are hoping to go public in the next 18 to 24 months, assuming the market opens around Labor Day, which is conventional wisdom at this point, reopening and having a healthy IPO market after what’s been, I think, the second worst IPO market ever over the last 15 months. Then the second piece would be, you know, what is what is a re inflation or even just a normalization of the market mean for M&A. So you’re seeing some of this some M&A deals get done. But in general, you know, the the large companies who are going to be the buyers in this situation have said, hey, we just laid off a whole lot of people our our investors are telling us we should be risk off. You know, you know, how are we going to buy a company for $1,000,000,000 if we just laid off a whole bunch of people or risk off? Should we change that up? So, you know, a stabilization of the market will kind of start to reopen the M&A markets. The long term stabilization will open the IPO markets, and therefore, they’ll be a much healthier movement of capital in and out of venture funds in the privates. [00:28:05][82.9]
Dan Nathan: [00:28:06] All right. We’ll call our time is up here. We really appreciate you guys being here. Rick Heitzmann of FirstMark Capital. Thank you so much. Thank you, guys. Thanks a lot to Rick Heitzmann. Stick around for my conversation with Chamath Palihapitiya. [00:28:16][10.3]
Dan Nathan: [00:29:05] Thank you guys for being here. It’s been a great day of content and thanks Chamath here. I’ve had the fortunate opportunity to interview Chamath on many occasions. We’ve had a lot of private conversations over the course of the last, I think five years or so. It’s been crazy time for investors, for entrepreneurs. You know, you as a former operator, I think you have a lot of opinions how businesses should be built and operated and all that sort of stuff. But then as an investor, you’ve had some crazy returns, too, right? So thank you for being here to this audience here. And, you know, speaking to this audience, I think it’s really important, right? Because it’s like allocators, you got all that dough and then you got to find the right people to invest it. So, Chamath, welcome back. [00:29:47][42.3]
Chamath Palihapitiya: [00:29:47] Thanks so much, Dan. [00:29:48][0.5]
Dan Nathan: [00:29:48] Let’s talk about the macro. You know, I feel like there are very few people that I know, so I’ve been doing CNBC for a long time, have been an investor myself. I’m just kind of the sole operator now. But Guy and I, was just up here, we run a little bit of a media company here. You know, there’s very few people that I come across that have I don’t know, man. The knowledge of both the public and the private markets the way you do the finger on the pulse. You know, you’ve had some videos, some interviews on CNBC with our friend Scott Wapner that have gone absolutely viral, talking about, you know, public markets, talk about what’s going on right now because it feels like we are in a little bit of a exuberant period in the public markets. [00:30:24][35.5]
Chamath Palihapitiya: [00:30:24] Yeah, I mean, I think that we’re dealing with two things. One is just that if you really think about it, if I had said 13 months ago that we would be sitting here today and the Fed would have hiked, you know, 500 basis points in nine months plus or minus, you would have thought it was crazy. So we’re sort of like coming into this phase of sobriety, trying to figure out how do we all do our jobs differently and what does it mean for the investments that we’ve already put in the ground. And for me personally, I think it really the setup is that it amplifies tail risk. And so right now I’m sort of somewhat quite cautious because I think there’s a left tail risk and I think Mike Wilson is here. But, you know, if you listen to Mike, who’s been really right so far, you know, the risk is that the S&P earnings are sort of with a one handle, 180 185, and all of a sudden the S&P is, you know, 3200 3300. But then there’s this right tail risk, which is that the Fed becomes dovish, everybody capitulates because it looks like things are slowing down. And now all of a sudden, though, you will have to deal with terminal rates that are going to be 4 to 5% on a more consistent basis, because if he lets off the gas now, then inflation kind of sticks around. So both roads lead to repriced assets just in very different path dependency. And those risks to me are a little heightened. And so I’ve tried to kind of be quite conservative and just, you know, be down the fairway. [00:31:49][84.2]
Dan Nathan: [00:31:49] One who has capital invest can be conservative if they want. When you look at where the two year Treasury note is right now. Right. And so I think it’s kind of interesting. For the first time in a long time, there is an alternative to equities, for instance. And so talk to me a little bit about that barbell, because I think the biggest risk right now is not that the market or investors come around to the fact that maybe Mike Wilson’s right and maybe that S&P earnings are going to be down 10% this year to $180, and therefore there needs to be a lower S&P 500. I think the risk is that for whatever reason, we just reignite the risk asset bubble right here, because if we don’t learn anything from the period that we were just in and you’ve written about this, we’re going to hit this substack that you wrote last week here. If we don’t have a reset, it just sets us up for the same sort of mistakes that we make again and again. [00:32:40][50.6]
Chamath Palihapitiya: [00:32:41] There’s a lot to learn when you look at the past, which is that a high rate environment, at least in the area in which I operate, which is technology businesses, we’ve actually counterintuitively built better businesses during periods of high rates. And the reason is because there are fewer allocators that come to our part of the market, because you can find better risk free rates. As you said, the two year, you know, even down to T-bills and repo, quite honestly. So that’s one thing. And then the second thing is that in the absence of the surfeit of capital, it forces each individual company to frankly just be better managed because there’s less money. And so we become as an ecosystem, more intolerant of excess. And all of that just creates better run businesses. And so we haven’t had that cycle for probably 14 or 15 years. And so we desperately need it because if you look inside a lot of technology companies, they’re unfortunately rotting from the inside out, right? They’ve had a period where they’ve been able to raise successive amounts of capital to fund a valuation creep that frankly won’t translate into what the actual money is you’re going to get back. In our industry you know, there’s a couple of dirty little secrets are like the dirty, soft underbelly. One of them is that only 10% of all of the firms in our asset class actually generate real returns, 10%, which means 90% are basically founding around burning money. The other thing is, is that we have always consistently generated a high single digit DPI. So like 1.7 X is like the 30 year average on distributions, yet we are the worst offender when it comes to showing people like you guys, paper markups or TDPI. So there is this dance that that this industry has been able to play because rates have been at zero. As investors, the asset class, I think, is very challenged in order to generate real returns now. The companies that we funded have, as a result of all this excess capital, been more poorly run than otherwise. And so we need to course correct. So we need these rates to be sustained for, you know, five, six, seven years, frankly, hopefully in order to really flush it through the system. [00:34:58][137.2]
Dan Nathan: [00:34:58] What did you see back in 2018 it was Fed Chair Powell first year there, and he started raising interest rates right off that zero interest rate band that had been there since the financial crisis. And they were kind of I think they use the term on autopilot, raising like 25 basis point every other meeting. They got to, I think three and a quarter percent. And you remember what happened in Q4 of 2018, the S&P 500 went down 20% in a straight line and then they pivoted. And I think so talk to me about like, what were you seeing in the private markets then and how did that rate increase and the pace of which was much steadier? You know what I mean? It was not the way that they went up this year. Like, what were the impacts on venture back then? [00:35:40][41.3]
Chamath Palihapitiya: [00:35:40] There was none. And the reason is that in that time, the narrative was that China was turning over and so people needed to reestablish some amount of baseline global growth. And so they thought if China turns over in the US now all of a sudden raises too much, we’re going to be in a lot of headwinds. And so Powell capitulated, but it turned out that China actually faded, that perceived theoretical recession risk. And so all of a sudden the floodgates opened because rates were low here, you couldn’t find any real growth anywhere. And we were at that period of the market where so many people had been sitting on the sidelines and effectively on the outside looking in that they ran into the riskiest assets. And so, you know, technology ripped, crypto ripped, SPACs ripped. Everything that was on the far edges of the risk curve were really well bid to a point that now, looking back, clearly was unsustainable. But it’s explainable in the sense that we gave folks no real other recourse because they were in the eighth or ninth year of no returns anywhere else. [00:36:50][70.1]
Dan Nathan: [00:36:51] Yeah. Do you think as investors, we just kept on looking for new things to invest in. So you just mentioned SPACs. Obviously you were a prominent player in that. And you know, when I first met you, it’s not like you were some Johnny come lately. I mean, you were bringing company, the SPAC, Virgin Galactic, right, in 2017. And so talk to me a little bit about that, because there was also obviously crypto. There was, you know, SNAP went public in 2017. It was wildly unprofitable then. It’s still unprofitable now, all these years later. What’s the postmortem on some of these things? And obviously, crypto had this huge retail move, you know, that started obviously it crashed in 2018 but started to reflate in 2020. What’s your like look back on those risk assets right now and what survives out of that? [00:37:35][44.2]
Chamath Palihapitiya: [00:37:35] In our history from founding, we’ve had these things where we’ve had these major themes that we’ve always invested in, which is early stage venture, largely in health care and software and deep tech. And so that’s been a consistent theme. And recently energy transition, that’s been our bread and butter. But every few years it has turned out that we sometimes go a little off piece. And, you know, in the early 2011 I went off piece and I made a huge bet in Bitcoin when it was 80 bucks a coin. It just seemed like just an unbelievably massive risk reward. We did the same thing in the mid 2000, we did it in SAS, we did it in deep tech and SPACs. You know, we stumbled into this thing because we wanted to raise money for a bunch of our companies that were extremely capital intensive. And we demonstrated something that in a moment just caught a lot of wind. So, yeah, as you mentioned, you know, we did six of them. I think there were 650 of them just in 2021. So we’re, you know, about 1% of the market. I think we bought good companies well, I think we sold well, quite honestly. But it’s one of these things where it was fueled by a moment in time of just enormous excess liquidity. And now I think we’re sort of back to basics. So for us as an institution, we’re kind of back to early stage venture. Who knows? We may go off piece at some point to really try to turn it. That’s our job as investors, right, is like we allocate risk well, we maintain top quartile returns, but when there’s a window, you know, I have you know, I’m the largest LP in my fund, so when there’s a window, I go for it. And that was a moment where we tried to go for it. [00:39:11][96.1]
Dan Nathan: [00:39:12] So as a largest LP in Social, I mean, when you think about this, refocus on early stage, talk to me about is it is it just the environment is about some things that you’ve learned over the last few years? Is that where you think that you can have the most impact on these companies? And then to your point, if things get back rolling again in a couple of years, maybe that’s when when the growth investing comes back a little bit. [00:39:32][20.2]
Chamath Palihapitiya: [00:39:32] Yeah. I think the problem with growth investing, just to give you some anecdotal data, like at the end of last year, I looked at six or seven converts and these were all extremely well known companies that all of you would know on a first name basis. And they all came to me trying to raise, convert. And I said, well, here’s the real market clearing price of these companies. And none of them took my money and instead they did a convert to basically deflect and kick the can down the road on valuation. So we’re in that point in the market where all the boards of these private companies refused to budge on valuation. And the reason is because it impacts meaningfully their TDPIs that they’ve given to LPs. And so it’s a very difficult part of the private markets right now to invest in because you will not be allowed to do true price discovery because nobody wants to take the real hits. The best companies will do it. I mean, I think you saw today that Stripe may take a 50% down round. That’s probably the best technology company in Silicon Valley proper being built right now. So they’ll do it. Klarna did it. In fact, it’s so interesting that it’s all, you know, the through line there is Sequoia, which is an extremely disciplined and incredible organization. So they’re able to enforce that discipline. But other companies, other venture funds, they don’t want to look at the TDPI decay and so it’s UN investable, quite honestly. On the other end, early stage venture has always been where the real growth dollar profits are made. And if you overlay that with a rising rate environment and you regress that back 30 or 40 years, in fact we did it looking back 60 years, the most incredible opportunities to make money are actually when rates are rising in early stage venture. That’s just the historical artifact if you look at public companies in size. So, you know, we said very explicitly, okay, no more growth. The default answer right now is going to be, no, we’re not going to touch it, but we’re going to continue to sort of overindex into early stage and do as many good deals as we can see. And, you know, let the chips fall where they may. [00:41:39][126.4]
Dan Nathan: [00:41:39] If you just think about public markets, for instance, you know, some of these high valuation names without profits, they started correcting, you know, early 2021. Right. So by the time that the Nasdaq topped out in late 2021, the S&P topped out the first week of January, in 2022, there were there were bear markets all over the place. Right. And so because a lot of people were looking at the indices, they were masks, you know, some of the devastation crypto had already turned over. What do you think some of the signs of the bottom in in private tech will be? Because to your point, if you’re seeing some of the leadership, the stripes take these big hits, there’s got to be some devastation to happen under much smaller names that are out there at big valuations. [00:42:19][40.0]
Chamath Palihapitiya: [00:42:20] I think when limited partners really become disciplined about keeping people honest about distributions, because in a moment like this, when your asset allocation goes upside down, the most important thing are who can generate DPI? Who actually gets money back into your pocket? Forget paper markups because they’re kind of not really worth the paper that they’re printed on. Where are the distribution so that my my actual assets can be more right sized. They are the ones that I think start this trend of bottoming, because what’ll happen is you’ll go to the organizations that have had the most consistent TVPIs with the most inconsistent KPIs and say, I can’t work with you anymore because this is now just money bad. And when those folks leave the market, those companies now become more prone to get repriced accurately because that set of GP’s will say I need to return money. And that’s where guys like us can step in with clean balance sheets and lots of money to go and say, okay, let’s go and reprice these. I honestly think that’s like three years away. I thought it was going to be three quarters away. You know, at first when we were thinking about like how much capital are we really going to be allocating over this next period, we cut it by two thirds because we just didn’t see the opportunities in the late stage anymore. [00:43:40][79.7]
Dan Nathan: [00:43:40] But you’re excited about some stuff. You tweeted this the other day. Two most important drivers of the next decade, the marginal cost of energy and the marginal cost of compute will both go to zero. And you said over the next decade. So this is at early stage. You’re looking for opportunities to invest in and around these themes. Talk to us a little bit about that. [00:43:57][16.7]
Chamath Palihapitiya: [00:43:57] These are multitrillion dollar shifts in how the information economy and and as a result, the economy itself is going to work. You know right now today you can generate using solar and wind energy that’s effectively approaching zero and it’s cheaper than nat gas. And it’s not just at the residential level, but it’s also at the baseload power generation level. And so as a totality, you have the ability for 100 million U.S. homeowners to effectively displace 1700 utilities and all of that monopolistic behavior and regulatory capture. And so if all of a sudden you have free, abundant energy that you can collect from the sky and store in your garage and direct anywhere you want, you all of a sudden have the ability to solve problems via brute force that before you couldn’t because they were boundaries of energy. Separately, we have found a way to transition away Moore’s Law away from CPU’s into these application specific chipsets now that operate in a realm of machine learning and AI, and the cost of that is effectively going to zero because these reference designs now are so well understood. The software is so powerful now, and when you multiply these two things together, if you wanted to brute force reverse engineer every single theoretical protein that binds to every other protein in your body, what was a multibillion dollar compute and energy problem is now effectively a few tens of millions of dollars. If you actually wanted an infrastructure that could actually detect in real time how to give true autonomous self-driving, make extremely complicated decisions and stop on a dime, those were compute problems that you can now basically make, render, cost less. And so when those two things come together, it’s one of these really transformational moments in our society where you can go after some very big problems that we didn’t think were tractable before. And so I’m very excited about that intersection and finding companies that play on those themes. [00:45:56][119.3]
Dan Nathan: [00:45:57] How does this sort of economic I was going to say Cold War with China, but it seems pretty hot. How does that affect some of the ways you think about these transformative technologies? Because again, you know, our government is banning advanced technology sales to China. It just seems like we’re going to be in this bipolar tech world and [00:46:15][17.7]
Chamath Palihapitiya: [00:46:18] It’s great for America. It’s an unbelievable boon for America and it’s unbelievable boon from America’s technology sector. Yet, you know, the thing is, when you look inside of China, they are extremely good at process engineering. They’re also extremely good at additive manufacturing. You know, they’re extremely great in things like specialty chemicals. But all of those things, when you think about the precursors, come from American, European, Australian companies that now have a huge incentive to diversify that supply chain away from China that benefits American companies in a massive way. And so China’s response is muted. So, for example, we said we are going to slow down the flow of extremely advanced semiconductor manufacturing equipment into China. China’s response said, We are not going to allow you guys to get the input components to certain silicon wafers that are used in PV cells. I mean, if you had to rank these things, no offense, but we can make solar cells, the equipment that you need to get to two nanometer scale in chip design comes from the Dutch, the Germans and the Americans. And so it’s a really interesting moment where the game theory, optimal view is that China’s cost advantages actually get moved over, right? So the margin decay in China gets replaced by margin expansion in these businesses here, but now allow them to operate in parity. So it’s a really unique moment. [00:47:41][82.2]
Dan Nathan: [00:47:41] To do some of these geopolitical kind of issues, maybe call them disconnects do they present unusual opportunities for somebody who’s doing early stage [00:47:49][7.5]
Chamath Palihapitiya: [00:47:50] I’ll give you one thing that I can’t totally talk about but kind of can talk about. But like, you know, there is an extremely large government that we partnered with to create a specialty chemical that’s using the battery supply chain. And this is a 49 51 joint venture between us and them where, you know, they’re giving us discounted pricing. We’re building the entire supply chain. It benefits from the BIL and the IRA and the CHIPS Act in the United States. That deal would not have been possible three or four years ago. A that an organization like ours would partner with the government, B that that deal would be reliable. And these are the kinds of opportunities now that have been unleashed because people want to diversify away from the Chinese supply chain. I think China will do well. I think that they have an incredibly vibrant internal ecosystem, but wherever sort of the G7 can put pressure on the criticality of these supply chains and diversify and force them through subsidies or other things to just be North America or, you know, a different set of allies, it’s going to create a lot of economic tailwinds for those people that plan that. [00:48:58][68.4]
Dan Nathan: [00:48:59] I mean, this seems like everyone in this room is you know, you’ve heard of this Chat GPT, and I know this is stuff that interests you, and you’re probably the sort of guy who’s been on top of this stuff for years. And it just kind of bubbles up for a lot of people like us. It seems like I haven’t seen the technology that’s kind of captivated the public, you know, in a while. Talk to us a little about these large language models. I mean, you just talked a little bit about how transformative AI is going to be in all these different industries. What about it from an investment standpoint? Because you and I were just chatting about this, you know, I saw a headline, the company I’ve never heard of them two guys leave Google chapter or, you know, chapter dot AI, and they’re looking to raise $250 million at $1,000,000,000 valuation. You know, maybe. What did we Llearn here? Because it seems like a big round for something that is probably be a handful of engineers kind of banging away at a chat bot right now. [00:49:46][47.5]
Chamath Palihapitiya: [00:49:47] You know, when I was at Facebook, my team and I were probably the first folks that really commercialize machine learning in the wild. You know, when our first versions of Newsfeed and some other technologies that you guys probably interact with every day essentially was about using machines to guess and to guess better and better over time. So that’s basically what this is just on steroids. And you know, what Chat GPT shows you is just the amazing value in allowing computers to assist you in doing work. It’s like a calculator replacing the abacus, replacing a pen and paper. What’s important, though, is this Buffett, quote, friend of mine told me this yesterday, which I loved. He told the story about refrigeration. And the story he tells is that the people and the person that invented refrigeration made some money. But most of the money was made by Coca-Cola, who used refrigeration to build an empire. And I view these large language models as refrigeration. Will there be some money made in it? I think so. But the Coca-Cola has yet to be built, and those are the companies that are really going to monetize it. And in order to monetize it well, here’s a basic thing about machine learning that’s worth knowing, which is if you take 1000 of the same inputs and give it to Facebook and Microsoft and Google and Amazon, they’ll all come up with the same machine learning model. But if you have one extra thing, one little ingredient that all of those other companies don’t have, your output can be markedly different. It’s like giving two great chefs three ingredients, but you give the third chef one extra one. That person has the ability to do something very special. So right now we’re in the world where everybody is crawling the open web. We’re going to move to a world where as everybody gets sophisticated enough, where when refrigeration is widely available, somebody is going to say, you know what, this site, I’m not going to allow anybody else to access. It’s only me, only for my models. And those models will become better. And so we have to let that play out a little bit. And so it’s going to be a little bit of a really interesting arms race. So the next wave of M&A, for example, could be companies like Google and Microsoft and Facebook looking at these companies saying, can they be viable inputs to my large language models or to my other machine learning and AI models? So you could see M&A activity that drives that differentiation before anything else. So lots of really. So then as a result, for guys like us early stage investors, we may want to invest in companies that have zero viable public market potential whatsoever, but is building a data repository that’s so unique that we know that it will feed one of these bigger companies in their efforts in AI, and that could very well justify making an investment that we would otherwise not make today, knowing what we know. [00:52:33][165.7]
Dan Nathan: [00:52:33] And on that front, I mean, some regulatory really quickly, because we only have a couple of minutes here. I mean, you know, you know, ten years ago, Facebook would just buy the next thing, right? They’d pay $1,000,000,000. You know, the fact that Microsoft made $1,000,000,000 investment open, AI, you know, in a different regulatory environment, they might have just bought it. They couldn’t buy open AI. But, you know, does this also excite you about early stage tech investing in this environment? Does the regulatory environment actually help your cause to let some of these companies bubble up a bit further than they might if they were just kind of taken over by the incumbents? [00:53:03][29.8]
Chamath Palihapitiya: [00:53:04] Yeah, I mean, I think the incumbents are going to have to veer into adjacent M&A that it’s non-obvious that will pass regulatory muster. And then separately, it’ll allow people who build the Coca-Colas of the world, who use refrigeration properly to actually emerge with a lot less threat, where the cross bundling and the cross-selling and upselling that the big tech companies use to basically eliminate a lot of competition will be very difficult. I mean, the classic example, look at the emergence of reels and what reels has done, and maybe it’s not as obvious to everybody here to the enterprise value of TikTok. I mean, I think we’ve all thought that Bytedance was going to be a two or $300 billion company. There’s all this, you know, value tied up in it. All these folks have these big stakes in it. But if you look at the growth of reels, it’s probably had the enterprise value of TikTok before the regulatory stuff has happened. So that kind of stuff I think allows when all the big folks are fighting amongst each other, it allows the little folks to kind of hit the seam and actually build something. [00:54:07][63.4]
Dan Nathan: [00:54:07] All right. Before we get out of here, a lot of you guys are probably All In podcast fans, you know, that he has, you know, the tendency for a little hot take. Give me something, man. I’m going on fast money in an hour here. What do you got? What’s what’s a hot take to leave this audience with. [00:54:20][13.0]
Chamath Palihapitiya: [00:54:21] Wow. What’s a hot take? Well, you know, my my, my most interesting thing right now is I have looked at and Mike Wilson inspired me to do this. I basically went back and I looked at Google’s P&L and just for shits and giggles, I took all the TAC, the traffic acquisition costs that they pay and I put it back into COGS and I capitalized it and I’m like, What’s the true p e if you did that? And then I did the same thing for Facebook because, you know, you hear this constant thing which is like, Oh, this thing trades at 20 times. It’s so cheap. Oh, Facebook trades it, you know, eight times it’s so cheap. And it turns out Facebook trades at 19 times and Google have traded 31 times. And then all of a sudden it’s not so cheap. So there is it hot take. There you go. Which is when you look at software businesses and you actually capitalize some of these costs and look at true EBITA, true EBITDA. They’re not nearly as interesting on a implied yield basis. [00:55:13][52.0]
Dan Nathan: [00:55:13] As you know, you sound like a good friend of mine, Jim Chanos, just, you know. . Yeah. All right. Listen, on that note, thank you guys all for being here. Chamath thank you for being here, it’s great, man. [00:55:21][8.1]
Chamath Palihapitiya: [00:55:22] Thank you so much [00:55:22][0.0]
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