A new wave of
technologies is about to change the world...
As investors,
it's a window of opportunity we're unlikely see again in our lifetimes… the
kind that leads to extraordinary profits.
Investing in
up-and-coming technologies, or growth stocks, might seem counterintuitive
today. Government debts are at record highs. The Federal Reserve, the European
Central Bank, and the Bank of Japan are all printing ridiculous amounts of
money. Economic growth is weak the world over.
But few people
understand two underlying trends…
The first is the
accelerating rate of technological change, propelled by the impact of
"exponential technologies." Artificial intelligence ("AI"),
robotics, network sensors, synthetic biology, 3D printing – these technologies
are all advancing at exponential rates.
At the core of
exponential technologies is the microprocessor, the "brain" of any
computing device. For the last 45 years, the power of these microprocessors has
been doubling every 18 to 24 months. As a result, we have progressed from the
most basic forms of computing (like addition and subtraction) to completing
complex algorithms at speeds far faster than the human brain.
At the same
time, the costs for this processing power have been dropping exponentially.
Computing power that used to cost tens or hundreds of millions of dollars is
now less than $1,000 and accessible to the average consumer.
Today's average
smartphone is more than 32,000 times more powerful than all of the computing
power used for the Apollo missions to send astronauts to the moon. And it fits
in your pocket.
Some of today's
cars are "smart" enough to drive by themselves. In just a few years,
millions of self-driving cars will be shuttling people around more safely, more
efficiently, and more cost-effectively than any human driver could do.
Artificial
intelligence capabilities are also improving by the day.
Tesla cars, for
example, use AI for their self-driving technologies. This allows the cars to
learn, improve, and deploy their new skills via automatic software downloads to
the fleet of Tesla vehicles. Every iteration delivers more safety to Tesla's
customers. The company collects data from a million consumer miles… every 10
hours!
The laws of
accelerating returns and exponential growth are firmly entrenched, and will
impact every aspect of our lives.
Consider this…
Over the last
few decades, it took the average Fortune 500 company almost 20 years to reach a
$1 billion market capitalization. Compare that to social media giant Facebook
(FB), which reached a $1 billion market cap in a little more than five years.
Today, Facebook has a $321 billion market cap. It took in $18 billion in
revenue over the past 12 months alone.
Online
transportation company Uber hit a market cap of $1 billion in about three
years. Uber is still private, but it's estimated to reach $26 billion in gross
bookings this year.
Slack, a
workplace-productivity software platform, reached a $1 billion valuation in a
mere eight months. (It, too, is a private company.)
How is this
possible?
In short, it is
simply easier, cheaper, and faster than ever before for companies with a
fantastic product or service to bring them to market.
Cheap computing
power, simple-to-use development tools, Internet infrastructure, and more than
3 billion smartphones deployed around the world all contribute to this
acceleration in innovation.
These are all
very real businesses generating extraordinary revenues, thanks to exponential
technologies.
Another
contributing factor is the rate of technology adoption. When the first personal
computers came out 25 years ago, the cost was prohibitive – from $3,000 to
$5,000 (in 1990 dollars). Today, you can buy the latest technology for less
than $1,000. And many services provided via smartphone applications are often
offered for free (at least, initially). Dramatically improved distribution
platforms, highly automated manufacturing, and affordability have been catalysts
for more rapid technology adoption.
The chart below
shows the time it took for certain technologies to reach widespread
adoption...
It took the
telephone about 60 years to reach a 75% adoption rate. Electricity took about
35 years. The radio and color television took about 20 years. The cellphone and
the Internet reached 75% adoption in only about 15 years.
The time to
adoption will become even shorter with new technologies. The positive impact on
society will be faster… and the profits made from investing in the right
technology companies will be greater than ever before.
Thanks to this
acceleration in innovation, the average company lifespan on the S&P 500
index is plummeting.
Back in the
1960s, the average company remained on the S&P 500 index for 60 years. By
1980, it had dropped to about 35 years. By 1990, less than 20 years. And by
2010, it had dropped all the way down to about 15 years. Current projections
for 2030 are even less than that.
This is because
most leading-edge technological development is happening in private,
venture-capital-backed companies, not the ones that have been around for the
last 30 years. Slow-moving, incumbent companies find themselves out of business
(like Kodak) or having to sell themselves to another large company before they
die naturally (like AOL).
Exponential
technologies, coupled with exponentially decreasing costs to use those
technologies, has created the perfect environment for rapid innovation.
Just 16 years
ago, it cost $5 million to launch an internet technology company and bring a
product to market.
It was even more
for those that made computer hardware (like semiconductors) – typically $15
million to $20 million.
However, with
the development of free, easy-to-use development tools, and cheap, ubiquitous
computer processing resources, you can launch a company and a product today for
a mere $5,000.
That leads me to
the second underlying trend that few people realize…
Over the last
five years, the financing of technology companies has changed dramatically.
Fairly modest sums of capital can now create billion-dollar companies.
Back in the late
1990s or early 2000s, if a private technology company had $20 million to $50
million in revenues and was generating free cash flow (i.e., its cash balance was
growing, not shrinking), it was time to go public. By selling shares via an
initial public offering (IPO), companies received the capital they needed to
reach the next stage of growth.
Today, more and
more technology companies are using angel investors (funds from private
individuals) and venture capital (VC) dollars (funds from private investment
groups) to bring their products to market. They are able to fund research,
development, and revenue growth without the scrutiny and expense of being a
publicly traded company.
Venture-capital
financing in the U.S. has been on a strong uptrend over the last 10 years. The
graphic below shows $77 billion in VC financing in 2015… the highest level of
funding in the last decade. That's a 13% increase over 2014, and about double
the level invested in 2012.
It is also
important to note that while the amount of VC capital is increasing, the number
of deals is decreasing… indicating a larger number of large deals. 2015 had
only about 86% of the deals closed in 2014.
For the past
five years or so, large banks, hedge funds, and other institutions – such as
mutual funds, hedge funds, family offices, and asset managers – have been
allocating larger percentages of their investment portfolios to private
companies, primarily technology companies with the potential for exponential
returns. Hundreds of billions, in fact, have flowed into venture-capital-backed
firms.
In 2009, the
investments by non-VC entities were mostly in the single digits. By 2015, the
number of investments being made by these entities went through the roof...
By a factor of
15 for hedge funds
By a factor of
11 for mutual funds
By a factor of
30 for family offices
By a factor of
eight for asset management firms
In fact, by
September of 2015, 78% of the billion-plus financings were led by non-VCs, up
from 60% a year before.
With so much
money at play from non-VC sources, it was necessary for VC firms to invest in
larger and larger private deals. Each deal takes a lot of effort. For example,
if a fund has $1 billion to invest in a given year, will it do 100 deals of $10
million, or 10 deals of $100 million? The answer is that it tends to gravitate
toward a smaller number of larger deals.
This explains
financing deals like Uber. In August 2015, the company received $1.2 billion
from several Chinese companies. Uber was valued at around $50 billion at the
time. It has since raised funds with a valuation of $62.5 billion.
The private
financing of technology companies has caused the entire technology IPO market to
dry up over the last few years.
In 2015, only 24
technology companies went public, representing only 14% of the total IPOs for
the entire year. These are the lowest levels seen since the 2008-2009 financial
crisis. In 2007, or pre-crisis, 60 tech companies went public, responsible for
28% of total funds raised in the public markets.
New companies
with fantastic, leading-edge technologies have been able to raise private
capital in the hundreds of millions or even billions… giving them time to
develop their products and business models before going public.
And this dynamic
– the ability to stay in the private sector longer – is creating the most
exciting investment opportunity of our lifetimes.
Once a company
goes public, it is typically under much more scrutiny. It's subject to
reporting requirements that can be distracting to a quick-growing business.
Hence the desire to delay the IPO process.
This has led to
a huge backlog of companies waiting to go public… And some are among the
greatest technology companies in history.
Think of it like
a massive bottleneck… a dam ready to explode.
VC investors,
investment banks, hedge funds, and institutional investors put money into
private technology companies for one reason: to make outsized profits. They are
willing to be patient… to a point. Eventually, the investors expect more… they
demand an exit.
Exits sometimes
come in the form of an acquisition by another technology company. But the
really massive gains come from taking these companies public via an IPO.
And you have a
chance to get in on these next generation technology stocks ahead of the crowd.
My Exponential
Tech Investor subscribers have already had a number of big IPO winners,
including gains of 97%, 100%, and 239%.
And these are
only the first of many companies that will go public over the next two years.
As the "dam breaks," these companies will access the public markets,
raise billions of dollars, make fortunes for investors, and replace slow,
outdated companies on the S&P 500 index.
Unless you've
been part of the senior management team of a private company that has had an
IPO, or you're in the world of investment banking helping companies go public,
the IPO process is likely a bit of a mystery.
It's a
well-defined procedure that thousands of companies have followed over the
years. But about three years ago, something interesting happened… The process
became secretive and much less transparent.
But on April 5,
2012, the "Jumpstart Our Business Startups Act" (JOBS Act – H.R.
3606) was signed into law. Buried within the act in section 106, entitled
"other matters," is the following clause:
Any emerging
growth company, prior to its initial public offering date, may confidentially
submit to the Commission a draft registration statement, for confidential
nonpublic review by the staff of the Commission prior to public filing,
provided that the initial confidential submission and all amendments thereto
shall be publicly filed with the Commission not later than 21 days before the
date on which the issuer conducts a road show…
Thanks to this
clause, companies can submit confidential IPO filings. This allows them to do a
lot of the leg work for going public many months in advance, without making its
intentions known to the public.
Being able to
file confidentially has significant advantages. The IPO prospectus – known as
"S-1 filings" – are very detailed. They provide specific information
about the health of the business, strategy, products, revenue, costs, key
contracts, etc. If this document is public, it means that the competition will
also have access to all of this information. It also means that investment
banks will be contacting the company nonstop to sell their services and help
the company IPO. Keeping the details of the company confidential prevents any
competitive disadvantage, as well as unwanted distractions.
The JOBS Act
defined an "emerging growth company" as one with annual gross
revenues less than $1 billion U.S. in its last fiscal year. The vast majority
of companies aspiring to go public meet this criterion. And they're taking
advantage of it…
By the second
year of the JOBS Act, about 87% of all companies filing for IPOs did it
confidentially. The Wall Street Journal recently referred to these confidential
filings as the "Dark Pipeline."
The ability to
fly under the IPO radar might be great for businesses, but it's frustrating for
investors and investment banks. They can longer see what companies may be
preparing to IPO.
An S-1 filing
used to be the only way investors and investment banks could know which
companies were preparing to IPO. Now that companies have the ability to file
their S-1s confidentially, an S-1/A and a road show are the first publicly
available signs that going public is imminent.
And when I say
"public," I mean public only to those scouring SEC filings and
tracking news on any road shows that might be taking place. At best, you might
have two or three weeks' notice on whether or not to invest in an IPO. The
average investor only becomes aware of these new companies months or years
after they have gone public… often missing the largest potential profits.
The only way to
know about these opportunities is to have done a tremendous amount of research
and analysis well in advance.
Over the last
five years, I've been studying the most interesting exponential technologies
and the key private companies working in that space. This is critical
preparation for determining whether or not an IPO will be a worthy investment
for us. I've also been looking at each company's sequence of financings, the
size of each round, and the actual entities that are making the investments.
This kind of information signals whether a company is getting ready to go
public.
Time is short
once we know a company will IPO. Those days are spent analyzing any updated
information about the company, the S-1 and S-1/A filings, the pricing and
valuation of the IPO, and any updates about the products, industry, and
competition.
To that end, I
have "shortlisted" 20 companies that could IPO within the next 24
months. Many of these companies will make fantastic investment opportunities
for my Exponential Tech Investor subscribers.
Some of these
companies will likely be acquired before an IPO by larger technology companies.
That doesn't necessarily mean that the investment opportunity has been missed.
In fact, the acquiring company might become an interesting investment as a
result.
Either way,
we're preparing to take advantage of these exciting opportunities. This is
critical to being a successful small-cap, high technology investor.
The most
transformative and disruptive technologies and business models are most often
driven by small, secretive, venture-capital-backed companies that almost no one
has heard about.
And we want to
get in on the ground floor of these companies as early as possible.
Here's how we're
going to do it.
Regards,
Jeff Brown
