Daily Musings

Evening all

some call it crazy. I prefer to call it widening the circle of competence. Nintendo calls it Alarmo—a USD 100 alarm clock. My phone's alarms do a fine job of startling me out of bed. But perhaps I wouldn't need three alarms, if I had a morning alarm with the sound effects of Mario to evoke infuriating memories of failing the underwater level for the 100th time.

Alas, as I contemplate buying a GameBoy to finally beat that underwater level, I share today's musings.

Cheers
Philip

Today’s Stories

• UK's tech scene just got another dose of stardust with Harry Stebbings – think the Robbie Williams of venture capital – closing his second fund at USD 400m, following the USD 140m vintage from 2021. The LP roster features MIT’s endowment, Mubadala, Thrive Capital’s Josh Kushner (Yes - the same Thrive that led OpenAI’s latest round), and a who's who rollodex of tech founders.

  Stebbings' podcast network, 20VC, has amassed a cult-like following, with episodes regularly featuring big names like Sam Altman, Reid Hoffman, and Donald Tang. It's another chunky fund for the UK ecosystem. Right on track with HSBC’s expected USD 12bn fundraising for UK VC this year. Atomico, Index, and Balderton have all been putting in the work to make HSBC’s expectation a reality and raised sizeable UK vehicles this year.

  20VC's backings include AI coding startup Poolside, social presence tool Linktree, and game developer Tripledot. Yet Stebbings hasn't been immune to the valuation froth of 2021 and 2022. He was for instance seen on the cap table of Hopin – the virtual events darling once valued at USD 7.8bn, which later sold most of its assets for tens of millions in 2023.

• Adams Street raised USD 1.2bn for its fourth set of VC fund-of-funds and direct investing vehicles

• GA and Inisght partners both raise capital for continuation funds. Insight raised USD 1.5bn. GA filed with the SEC but declined to disclose - perhaps the last continuation vintage of USD 3bn raised in 2021 provides some indication.

Chart Art

Public software players are providing a gloomy read-across: 2024 is shaping up to be a tough year for software and cloud. Net Dollar Retention has slipped an average of 5ppts, dropping from 113% to 108%. Has me wondering—what’s the bigger drag: Adding or retaining customers? Looking further into the data: Payback periods tell a similar story. Stretching out by 9 months on average. The sector-wide norm comes in just shy of 4 years (44 months) to recoup CAC.

With payback horizons creeping up, you have to question whether LTVs are high enough for some companies to keep the lights on sustainably. I have since coined the following term: CAC Zombies—businesses limping along with payback periods dangerously close to their LTV. Imagine an LTV of 45 vs. a payback period of 40. A few months of positive contribution margins (mind you this is a far cry from net margins) isn’t going to have investors showering these companies with money.

PEs are diving headfirst into European carve-outs, with activity levels well above historical norms. In today’s murky economic waters—where liquidity isn’t the free-for-all it was during ZIRP—companies are shedding underperforming or noncore units. A fan favorite for PEs that enjoy a bit of complexity. Carve-outs, especially in the industrials I’ve seen, are often riddled with operational, political, and administrative headaches—never mind the financial chaos. Alas for those investors that do not shy away from lengthy nights these deals can offer a chance to scoop up assets for pennies on the dollar, capitalizing on opportunities where standalone units often outperform compared to when they were buried in a conglomerate. Dissynergies are common for noncore BUs that don’t get the resources or focus to grow. As standalone entities, they can finally thrive.

Some notable carve-out plays:

• KKR's EUR 22bn buyout of Telecom Italia’s fixed-line network

• Siemens offloading their EV charging business as part of the continued portfolio streamlining that has been year’s in the making

• PAI snagging a majority stake in Vamed’s pan-European rehabilitation unit for EUR 853m

European fertility rates are on the decline. An early stress warning for the socioeconomic structures that build on the assumption of perpetual population growth. Think: empty housing in the future, pension schemes running dry, and a labor shortage cliff. The looming problems are clear. Cultural shifts are certainly at play, but the rise of companies tackling fertility treatment, family planning, and related corporate benefits suggests there’s more to the story—namely, a healthcare and family planning gap. Some companies come to mind that are looking to solve this challenge:

• Apryl

• Ava

• Levy Health

• Bea Fertility

• Fertifa

• Carrot Fertility

• Gaia Family

• Clue

• Ovom Care

• Progyny

• Flo Health

BofA signals market-wide margin compression, with earnings expected to grow by 4.0% against a 4.7% increase in top-line growth. Some specific sectors caught my eye, particularly those that serve as eye-candy:

• Consumer Discretionary: Earnings are shrinking while sales outpace overall market growth. Increased marketing spend and the prevalence of brick-and-mortar stores (labor, rent and mortgage costs = relatively fixed cost stack). Intriguing that despite depressed consumer sentiment regarding the US economy, discretionary spending is still popping - albeit much less so in Q3 than staples. Logically so.

• Tech and Communication Services: Both sectors are riding the scale wave. Operating leverage and network effects contribute to stronger margins relative to growth. Marginal returns on capital employed remain positive—though, of course, cash flow might tell a different story.

• Financials: This sector mirrors the discretionary pattern, albeit for different reasons. Consumer saving rates have risen in H1, while Q3 retailers may look for other safe havens to save them from inflation. The compressed spread Instis can earn in a lower rate environment is working against the margin profile.