Private Shares – Christian Munafo

What were the major recent events and what were the impacts on your asset class?

Unlike in the first quarter when we had the bank failures, including notably Silicon Valley Bank, there wasn't a singular event, I think, in the second quarter. It was more, I think, of a continuation of what we've seen over the past several quarters. And so while, you know, the bank failures, again referencing Silicon Valley Bank, and some other institutions clearly had and continue having an impact on certain parts of the economy, which includes the area we focus on, which is the venture capital and growth equity segment of the private markets. The overall markets have broadly shaken it off, which is quite interesting. Now, I think it's fair to say that banks and operating companies continue taking a closer look at their balance sheets, at their spending habits, their liquidity and risk management practices, et cetera. But all things considered, you know, these bank failures we think have been well tolerated. And you can see signals of this.

So if you look at, you know, setting aside the more specific economic indicators, if you just look at the number of publicly listed companies and specifically technology companies and growth-oriented companies in the US in particular, and see how they've traded up year to date. Despite these, the aforementioned shock to the system right through these bank failures, you know, they've continued to report fairly resilient growth and earnings performance, particularly those companies, as we've mentioned in the past, that exhibit strong differentiation, healthy balance sheets and profitability. And we see similar examples of this where we focus in the late-stage venture and growth segment of the private market, where many of those companies also continue to exhibit their resilience. But obviously we continue monitoring the ecosystem.

And I think it's fair to say that growth estimates and earnings estimates have in some situations been pulled back in lieu of this looming recession. And also, to be fair, you know, I think in balance, it's important to point out that these broader market rallies have largely hinged on some of the largest market cap companies. So you haven't seen this significant outperformance, I think, across the entire market. It has been more isolated in some of the larger businesses. And again, we also see that extend into the private market. Along those lines I guess I would also point out that despite this public market rally, if you look at the valuation multiples of high growth software companies in the public market, which is akin to the types of companies and multiples and growth rates that our portfolio and the companies we target in the private market exhibit, they're actually still only valued in aggregate at roughly half of where they were at pre-Covid, and 40% of where they were over the five-year average as of the end of the second quarter. So, in other words, the broader markets are still valued well below peak levels. And so someone that looks at the landscape with more of a half glass full perspective might anticipate attractive upside from here. Of course, barring, you know, another significant shock to the system. And I would add, you know, the caveat for private market strategies like ours is that there is a lag effect. So there's a lag effect that's normal between what happens in the public market and when that actually comes in to the private market. We can argue about how that lag effect may have decreased over time, which, you know, we think it has. But if you look at the secondary pricing of transactions involving private company securities, so this is another indicator that we look at, the pricing of those assets in the secondary market have actually fallen to a median discount of 52% to the most recent round of funding at the end of the second quarter. So to say differently, this lag effect, you can actually see because while the public markets have largely recovered, you're seeing a lag in private markets where there's still these dislocations. Now that affords sophisticated investors, right, who are well capitalised and have a long-term perspective to take advantage of those types of lag dynamics. And that's exactly what we've been doing.

And I would just say the last point in terms of developments is this generative artificial intelligence boom. I think we hit on that last time. I mean, this largely is continued across both the public and private markets. While we believe these technological advancements and computational processing speeds are really significant developments and are going to provide meaningful benefits in a variety of capacities, as we've previously stated, and try to remind our investors, it is very important to remain disciplined and to avoid hyped up overvalued assets where we might not yet be fully able to understand the use case and strong product market fits. But again, it is encouraging to see this development. And as always, we're seeing most of that innovation coming from the private market.

What can your asset class offer in the current environment?

As we've previously stated, if you look just in the US at companies that are generating more than USD 100 million in revenue, which is quite meaningful in the current market environment, more than 70% of those companies are private today. And again, that's just based on information that's publicly available because a lot of private companies clearly don't make all of their operating performance publicly available. So we can actually argue that that 70% might be haircutting the real number. But whether it's 70%, 80% or 90%, I think the point is that investors who only focus on, you know, public equities, for example, in this day and age are missing out on a significant segment of the economy. And so, you know, we fundamentally think that as a matter of portfolio construction, that investors would be well served at least to spend some time learning more about the benefits that private market securities can provide, particularly where we focus. And so, you know, where we focus again, by investing in these later stage large, highly differentiated private companies and areas such as, as I mentioned, artificial intelligence and machine learning, big data analytics, cybersecurity, robotics, you know, fintech, et cetera. You know, companies like this that have generated significant revenue traction and that have strong balance sheets.

What is your outlook in the near and medium term?

There's a few things that we monitor. So one of the things that I mentioned is exit activity, and I'll come back to that. Another one is valuations. And I also touched on that, you know, a couple questions ago. So if we look at the valuations of late-stage venture backed companies, we continue to believe that the market where you have best of breed assets that will continue exhibiting their resilience. While lower calibre companies are going to continue facing increased pressure. And so we've seen that over the past few quarters. We think that's going to continue over the near term. The capital raising environment is showing signs of loosening up. It has certainly been challenging again, but the best in class companies with good balance sheets and strong operating metrics have largely been raising either up rounds or flat rounds. So they really haven't been getting penalised. It's the companies that are lower calibre that may be burning too much, that may not be as differentiated, that are facing tighter conditions, and some of them may be sold on the cheap. Some of them may be forced to shut down. So that's one of the areas we focus on, like valuation and capital raising. Another one that we see that we monitor, as I said earlier, is exit activity. And we have seen a pickup in mergers and acquisitions, which is a signal that suitors are getting a little bit more comfortable and optimistic about the path forward, despite the fact that there's ongoing regulatory pressure that's trying to dissuade some of these potential monopolistic situations. Again, there's two arguments on both sides of that. But there is pressure from a regulatory standpoint. And then the public markets, as I stated, are showing some signs of improvement. We're seeing a growing sentiment that IPO activity is likely going to pick up over the next couple quarters. And why do we say that? Well, one, you know, the public market environment is improving. We're seeing more risk-taking appetite by public market investors. We're seeing an incredibly deep, high-quality pipeline of private companies that probably would have already been public had we not gone through this recent market correction. And so there's a pent-up supply of really interesting companies. And we're hearing from public market investors and seeing in some of the IPOs that have recently gone out, that public market investors are demanding and looking for interesting public ideas. So, you know, along those lines, again, you can see that in some of the recent IPOs.

So while we're seeing, you know, these signs of sentiment shifting, we also remain keenly aware, again, of the risks and challenges that exist in this market. So you have to be patient and disciplined. But again, it's important to remember that historically investments made during periods like this where there is this bifurcation, there is this dislocation in the markets. They tend to generate strong performance in subsequent years, largely due to price dislocations and the ability for investors, buyers, etcetera, to negotiate more favourable terms. But again, I'll say it for the last time, investors must be patient and disciplined and share a longer-term perspective like we have to benefit from these types of private market strategies. And I would just add, we remain concerned for the near term about strategies that involve, you know, a high dependency of debt and leverage to operate their investment strategy or their business. So, you know, capital-intensive businesses, you know, debt-laden businesses, lending businesses. You know, we think the significant rise in interest rates is going to continue having a bit of a negative impact and creating challenges for those areas.