Invest Like the Best with Patrick O'Shaughnessy
· David George
[00:00:00] S1: There's the scene with Alec Baldwin where he's running a sales contest. A boiler room setting, and he comes in, he's running a sales contest, and he walks in and he's like, "Okay guys, new contest. Here we go. First prize gets a Cadillac. Second prize gets a set of steak knives. Third prize, you're fired." So we've adopted that as a way of describing most of the technology markets that we live in. So we happen to think, and I happen to think strongly, and my experience has been, the vast majority of market cap creation is going to go to the market leader. And this is probably underappreciated. We see this all the time with our peers in the growth investing industry where they say things like, "Yeah, even the number two player is going to be really viable." Maybe, but more often than not, that's not the case. That's obvious in network effect driven businesses, consumer internet companies, Google, Facebook, et cetera. It's less obvious in enterprise companies, but it happens just as often. There's no number two to Salesforce. Salesforce is Salesforce. Workday is Workday. ServiceNow is ServiceNow. And you'd feel a lot of pain if you did the number two, or God forbid, the number three in those markets. In early days of technological shifts, markets tend to fragment in ways that we don't foresee, and they end up being less competitive in certain areas and people settle into different areas. So on the model side, so far, the way it looks like it's played out is it will be more like the cloud industry. It's not going to be a winner take all. Certain technical advantages seem limited in timeframe. There's always this constant leapfrogging of the model industry. So I think it will look like the cloud industry in the sense that there will be multiple players. There'll be profit pools for them. Early days, we were saying, "Is this going to be aircraft manufacturing or is it going to be airlines?" Those are the two extreme ends of the spectrum. Aircraft manufacturing has high profit margins because there's really high capital intensity and it's extremely hard technically. So that would seem to mirror the model industry. Airlines, on the other hand, are horribly competitive industries and they all go bankrupt in the fullness of time. So it seems like the model industry is going to be like aircraft manufacturers or the cloud industry.
· Patrick O'Shaughnessy, David George
[00:00:00] S0: But why did cloud play out the way it did? Is it just size of market? [00:00:00] S1: I think it's size. [00:00:00] S0: Is it that simple, that if a market's big enough, you're just going to have multiple winners and not a winner take all? [00:00:00] S1: That one is all size of market. It's just so vast. And cloud is such an interesting market because if you could just independently own AWS, Microsoft, Azure, and GCP, those would be some of the most valuable companies in the world. Those would be awesome businesses to own. On the other side of it, one of my partners, Alex Rampell, has this statement that he likes to say, which is, "The best businesses in the world don't have customers. They have hostages." That's not actually the case in cloud. Sure, there are some things like egress fees. The clouds are anti-competitive with egress fees. They make it really hard to leave and get your data out and all that stuff, but that's minor. Generally speaking, the customers in that market are well served. They're happy. It's been positive sum for them. And at the same time, the clouds are really good businesses. I think the same is likely to happen in the model space. So the market is going to be so big, it will fragment in ways that we don't yet expect. And even if you're in a number two in terms of absolute revenue size or market awareness, that's okay. What's not okay, probably, I would think, is being in the number two in something like the dominant consumer chat interface.
· Patrick O'Shaughnessy
[00:00:00] S0: I want to talk about competition in our industry for investment opportunities in the market leaders led by technical terminators or others. It's become, in our collective careers, you've been in this specific business much longer than me, but across your career, it's become way more institutionalized. There's way more players, there's way more money. The people you are up against on a daily basis are probably more talented, sometimes by a lot. So you have to keep up with that. Describe the competitive dynamic when you are trying to make a big investment in a big, exciting company led by a consensus, amazing person in a big market. What does that feel like now? And I'm also interested in how it's changed over time.
· David George
[00:00:00] S1: So Marc and Ben have told the stories about the origin of starting the firm and their experience with the venture capital product and why they built the firm the way they did. And whenever they tell those stories, I'm like, "That's great. Man, wouldn't it have been fun to compete in that time?" That would've been awesome. The market is definitely more competitive now. It's become a lot more institutionalized. It's become a lot more institutionalized for good reason though. The thing that I'm telling our team and I talk about with my partners now is we're a grownup industry now. This is no longer some little bespoke asset class. When I started my career, you and I were getting out of college. There were probably one or two technology companies in the largest 10 market cap companies in the world. Now, it's eight of 10 and seven of the eight are West Coast technology venture backed companies. That realization hasn't really fully hit the finance industry. But if you look at that, tech has overtaken all of the market cap creation and is mostly driving force of the stock market and the economy. The private markets have become a real asset class. This is something I'm studying now because the venture industry was seen as this small non-scalable thing. Turns out there's 5 trillion of private market cap that is up 10X in the last 10 years. And it's honestly some of the best companies in the world. That market cap represents almost a quarter of the entire S&P 500. It's more than half of the Mag 7. So I think that we now are in the grownup in the big leagues and we need to start acting like it. So we've adapted our firm a lot to that realization. And oh, by the way, one other comment just on that industry, how it's changed. We just did this analysis. If you look at our public universe, so where do we spend most of our time? In the software consumer and FinTech stuff. The public universe in those sectors, there's less than five companies growing 30%. It's kind of staggering. That's a low number. Our portfolio on average dollar weight is growing 112%. And some of these companies are big enough to be the large companies. And if you look at the small cap universe in the public markets, first of all, public markets have shrunk by half in the last 20 years.
· David George, Patrick O'Shaughnessy
And if you look at the composition of small cap public companies, the quality I would argue is so much lower than what is available in the private markets. So the industry is real. It shouldn't be a surprise that the competition has intensified. I think about the competition similar to how our venture folks think about it, which is the market has become a barbell. So we're faced with the large multi-stage firms that have very strong venture practices on the one hand, and those are the fiercest competitors for us. I respect my peers there. They're trying to play the same game as us, which is when we have something special at the series A or the seed, we want to hold it really tightly, and they want to do the same thing. And sometimes they're effective at it, sometimes we're effective at it, but we have to battle that out. On the venture side, it's bespoke. And the retail analogy, there's the superstore like the Walmart and Amazon, which is how we would get characterized. And then the other side is like the Gucci store, the Prada store, which is like deep specialization. So Nat and Daniel would've been an example of the Elad. And then there's many others that do a really good job at what they do. So I have respect for a lot of the crossover folks who are in our world and have built private businesses, and have done a good job with it. [00:00:00] S0: So what do you do to beat these people? And I'm especially curious in the actual extreme versions of the answer, the lengths that you're willing to go to to win.
· Patrick O'Shaughnessy, David George
[00:00:00] S0: So what do you do to beat these people? And I'm especially curious in the actual extreme versions of the answer, the lengths that you're willing to go to to win. [00:00:00] S1: I think you would love to have some story that's like sensational in the moment where we did something crazy. The reality of the growth stage business is we win deals based on years of relationship building. We recently did a deal where the founder, we had worked with the founder so hard that he called us and he was like, "Hey, I'm ready to do this. I'll just talk to you." And I'm like, "Oh, wow. Okay. Fruits of my labor. Two years of this. This is good." And then at that point, it's one of the best companies in the market. And the dynamic that we are faced with is, "Okay, this is awesome. I got a clean look." I know for sure if he was going to market, he would get a higher price than what he just told me, but can I bear the price? So that's often the exercise that we have to go through as growth investors is what do we know differently about the product or the market, or what are our expectations that will allow us to do it that maybe aren't as obvious? [00:00:00] S0: What are you doing in those two years that earn you that right? Maybe that's where the extreme measures are.