(Click here to subscribe to the new Delivering Alpha newsletter.)
Lux Capital invests in emerging science and technology companies, making long-term bets on contrarians in the space. Over two decades, the firm has grown to manage $4 billion in assets.
Josh Wolfe is the futurist fund manager leading the charge at Lux Capital. He has an acute read on scientific innovation and technological breakthroughs to which investors should be paying close attention. Wolfe sat down with CNBC’s Delivering Alpha newsletter to discuss his investing outlook, along with where he sees the most promising opportunities right now.
(The below has been edited for length and clarity. See above for full video.)
Leslie Picker: I just wanted to start first with your broader read on the markets right now. Do you think that especially in some of the key pockets of tech, and growth, is this just some air coming out of the tires a bit or a full revaluation of the sector?
Josh Wolfe: I think in some sectors, it’s a mix. I think you’ve got a flat tire in some sectors. We’re looking at probably, in my estimation, a greater than 60% chance that we are in March of 2000 for a broad segment of the market that has been very overvalued. And that means that we’re probably going to, for an 18 month period till, say October 2001, where you saw about an 80% decline in some of the most popular names. And that 80% decline happened by 50 basis points, 1% drops over a long period of time, which was a measure of people’s belief, clinging, that this was going to continue. You’ve had five, six years where buy the dip has been the mantra and it has worked. And I think it’s no longer going to work and you’re going to see revaluation across specifically some segments of the market, but largely across high-growth tech and speculation and the stuff that we specialize in.
Picker: What are you telling your portfolio companies to do in light of this?
Wolfe: Three words: husband your cash. Hold on to the cash that you’ve raised. We’ve had companies that have gone public through SPACs, we’ve had companies that have done direct listings, companies that have gone public through traditional IPOs – the amount of cash that was delivered to balance sheets of Lux portfolio companies, and many companies around the world, is unprecedented. You’ve got hundreds of millions of dollars for companies that are burning, maybe $10 million a quarter, something like that. So you’ve got maybe a decade of cash. What you do with that cash now is the most important capital allocation decision that a management team and a board can make. And in our judgment, the most important thing you can do is husband that cash. Investing now, if we’re going into any kind of recessionary times, is going to be like spitting against the wind, where that cash is going to be ill served going after growth. Instead, make sure you have a fortress balance sheet, look at your weaker competitors, consolidate customers, technologies, positions, I think you’re going to see a huge M&A boom over the next year.
Picker: One of the big aspects of valuation growth in Silicon Valley has just been the amount of capital that’s been circulating over the last, five, six, seven years. Do you see that slowing down anytime soon, given what we’re seeing in the public markets? And will that impact the valuations that companies are able to get as well as the capital that they’re able to get moving forward?
Wolfe: And emphatic yes, yes and yes. Now the way that I think about this, there’s going to be some segments of the market, again, that are flush with cash. A lot of funds have been raised. We closed a billion and a half just six months ago, with a lot of dry powder to deploy. Now the speed with which we’re doing that is going to be much slower than it was say, a year ago or two years ago…So I think that the next year you’re going to see LP indigestion, GPs slowing their pace, companies in the private markets seeing valuations come down, akin to what you are seeing predictably in the public markets.
Picker: Because typically, there is a lag. Only recently have we started seeing reports come out that companies are willing to take lower valuations as a result of what’s going on right now. But at least over the last few years, and especially during – surprisingly – during COVID, many private companies still were able to maintain pretty decent valuations and a lot of them were able to double or triple their valuation. So you think this time is actually different and we will see sort of that 2002 period where startups really have to kind of bootstrap it for a while.
Wolfe: In the private markets, the latest valuation is set by the marginal price setter. And in many cases, historically, that might have been SoftBank. That might be some of the large crossover hedge funds that are doing private deals. And they were basically saying relatively indiscriminately, “We’re gonna’ buy the winner in the company. Does it really matter what price we pay? No, particularly if we have great terms.” … If you’re senior preferred in the capital structure of these companies, you’re in a great position. So I do think that you’re going to see a situation where private companies are going to go through a discriminating narrowing, meaning the crossover hedge funds, the late-stage growth investors and even the early stage investors are going to be way more discriminating. And [it’s] going to be dominated by, I’ll give you an acronym, instead of FOMO, Fear Of Missing Out, It’s what I call SOBS, the shame of being suckered. People do not want to be suckered in this current moment.
Picker: I do like that acronym. I wonder if it will ultimately take hold, because I think a lot of investors have been waiting, especially those that have been in Silicon Valley for a while, I’ve heard the term tourist investors for some of the public-private investors that do both sides, crossover investors, that they don’t expect them to be around for a while. Do you agree with that? Do you think that ultimately we do see people kind of just exit this part of the market entirely?
Wolfe: I think it’s true of every industry through time, right? You see a huge number of entrants then a precipitous pruning as the numbers decline over time. What the wise person does in the beginning, the fool does in the end. This happens within sectors, it happens within investment sub sectors. So you saw this, you know, 2002 to 2007, with the rise of activist hedge funds or active long short hedge funds, then there was a pruning post-crisis…There will be survivors. There will be great investors that come out of this market, there will be great new firms that form, and there will be a significant culling of the herd. I would predict that between 50% and 75% of the active investors in private markets today will disappear within the next few years.
Picker: Are you putting capital to work right now? Are you kind of hunkered down to see how this all shakes out? Or are you really just looking to sit this out for the long term?
Wolfe: Well, for our existing companies, we’ve got fortress balance sheets and we’re telling them, “Consolidate your position, do it as quietly as you can, do it as loudly as you can, but just do it.” For new investments, we’re becoming more discriminating on price. We’re not participating in any auctions. We’re not doing deals that are closing because of this FOMO in a day or two, because you got 40 competing term sheets. We’re playing the long game. Now the beautiful thing about the long game is you can invest in deep science and deep technology in these cutting edge areas where there are few investors and few companies. We’re not investing in areas where there’s 500 or even 50 competitors. In many cases, we’re investing in a sector where there might be only one, two, or three companies. You capitalize that company, you bet on the right management team and you can withstand whatever’s happening in the macro for five, six, seven years and make sure these companies are well capitalized. At the end of the day, we’re not buying indexes. We’re not passive investors, we’re active investors, we’re sitting on boards. We’re helping grow these companies from inception, providing them talent and competitive intelligence and future financing, risk reduction.
I always say that it’s sort of like in our business, trying to pick the best meal on a menu after you’ve selected the best menu in the best restaurant in the best city in the best state in the best country and you’re about to eat a morsel of that delicious bite that you’ve selected, and all of a sudden Godzilla comes and steps on the on the restaurant. Ignorance of the macro is no virtue. You have to pay attention to what is going on in the context of capital markets, inflows, price setting where money is flowing, what the Fed is doing. A lot of people are not focused on that kind of stuff. We historically always pair a little bit of macro understanding and the global situation into our micro investments and security selection on the entrepreneurs we’re betting and the companies that we’re building.
Picker: Do you see any specific opportunities right now that you’re excited about?
Wolfe: You know, there are two big themes that we’re really capitalizing on. And we broadly say we’re prepared to pounce. So one of them is in hard power and one of them is in soft power. Both of these relate to geopolitical instability. In the geopolitical stage, you’ve got a revanchist Russia, you’ve got a rising China, you have a cold war really between these two powers, a bifurcation of financial systems, surveillance systems, internet technology. And so on the hard power side, every facet of aerospace and defense is something that we think the U.S. and its allies needs cutting edge technology. You’ve had 20 years of Zeitgeist where people have really been loath in this military industrial complex to want to provide cutting edge technology to the women and men that are on the frontlines of war, whether that’s Special Operations, Air Force, Space, Force, Army, etc. And so we are very focused on providing technology through many of our investments, to the defense industry.
And I think you’re going to see a resurgence and reemergence of some of the next gen primes and people that are going to compete with Lockheed and Raytheon and General Atomics, et al. in air, space, land and sea – autonomous systems, artificial intelligence, machine learning, cutting edge tools and technologies that are very expensive, very risky and in many cases, people have been loath to only focus on a government customer like the Department of Defense or the Pentagon, or allies. We’re entirely comfortable doing it and we think it’s geopolitically important…You’ve got north of 14 sovereigns that are now racing to get to space…and so there’s a lot of competition to launch things into space, have satellites, antennas, communication, lots of technologies that were invested in across [those] platforms from literally launch all the way up through space.
On the soft power piece….we’re convinced, and people have not really picked up on the steam yet, but what we call the tech of science, there’s going to be a huge boom and demand globally, but particularly for the U.S. pharma companies, biotech companies, academics, U.S. government labs, for the technologies that improve science and give us a competitive advantage to win on the global stage, what is really prestige, globally.