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General Commentary
October 23, 2016

Class of 2020

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Market Snapshot

Indices Week YTD
GSV 300 1.80% 42.10%
S&P 500 0.70% 9.10%
Dow 0.60% 10.40%
NASDAQ 0.80% 16.40%
Russell 2000 1.40% 1.50%
MSCI P/E Fwd P/E/G
Valuations 25.8x 0.7x
GSV 300 17.6x 2.3x
S&P 500 Now YTD
I-Rates 2.17% -11.40%
10-Year Note 1.03% 102.00%
3-Month Bill - Current
Sentiment - 28.1-38.3
Bull-Bear - 0.97
Put-Call - 11.28
Vix Now YTD
Inflation $1 12.50%
Gold $47.86 -11.10%
Oil - Week
Mutual Funds - -$3.40
Fund Flows (bil) 00-09 09-Now
Growth-Value -34% 218%
Growth 87% 133%
Value

This fall, the class of 2020 showed up on college campuses across the United States. They don’t know what a Walkman is and would be shocked to learn that people used to smoke in bars. They were three-years-old during 9/11 and have spent more than 80% of their lives in a country at war.

If you go back 18 years, the class of 2020 shares its birthday with Google, which was launched in 1998. Today, there are over four trillion searches per year. This group grew up in a world where information is free and at your fingertips. For me, the is opposite of the world I grew up in when information was expensive and water was free. But this is just the beginning of how different the class of 2020 is than the world I grew up in.

Think how much things have changed.

Just a year before Google’s launch, Steve Jobs returned to Apple for a second tour with the goal of putting a personal computer in every home. The launch of the iPhone in 2007 ultimately put a super computer in every pocket.

For the class of 2020, the smartphone is just a phone… they expect it to be “smart” as they do with other technology. And that’s just table stakes. They want to access everything on demand — from transportation, to food, retail products, and media.

Source: GSV Asset Management

If you think about entertainment, services like Netflix, Hulu, and YouTube enable you to access anything you want to watch, whenever and however you want to watch it. It’s no wonder that the Class of 2020 thinks that going to a movie theater at a set time to buy overpriced popcorn and soda is ridiculous.

Over the last decade, movie admissions in the United States and Canada peaked at 4.4 million in 2006 and 2007, dropping to 3.8 million in 2015. Nearly all of the major film studios — including Paramount, Sony, Universal, 20th Century Fox, and Warner Bros. reported losses in Q2 2016.

Not coincidentally, over 50% of the Class of 2020 thinks that online courses are as good or better than the classroom. It’s absurd to have go to a commodity Econ 101 class on Thursday morning at 8:00AM if you can access it on demand.

The class of 2020 loves technology but has no recollection of the Dotcom Bubble. They were three-years-old when it burst. But what’s etched in their memory forever is their family, or friends of their family, losing a home to foreclosure during the financial crisis of 2007. Not surprisingly, a decade later, Millennial home ownership is down nearly 20%. They also have no memory of the AOL Time Warner merger, the “worst merger of the century,” and think that the pending AT&T Time Warner merger is genius and conceptually gets you the most content for compelling value.

DotCom Bubble vs. Great Recession?
The Class of 2020 can’t remember the Dotcom bubble… but the home foreclosures and job losses of the Great Recession still ring fresh.

Source: GSV Asset Management
Decline in Millennial Home Ownership, 2007 vs. Today
Home Ownership Among People Aged 25-34

Source: Forbes

Also etched across the collective memory of the Class of 2020 is parents losing jobs they had for an entire career — and pensions along with it. Not surprisingly, the Department of Labor estimates that the latest crop of graduating Millennials will have over 15 lifetime careers — up from four in 2010. While a number of factors are driving this dynamic, including accelerating digital disruption and globalization, a simple aversion to career commitment has a lot to do with it.

Increasingly, many of these lifetime careers will be a part of the emerging “Gig Economy.” Anyone can become an entrepreneur in 60 seconds by monetizing their home, their car, or even their spare cash, by selling services through digital Peer-to-Peer Marketplaces like Uber, Lyft, and Airbnb. Currently, the Financial Times estimates that over 20% of Americans are employed as freelancers, up from 6% in 1989. The freelance marketplace Upwork pegs the number at 54 million part time workers in the United States. (Disclosure: GSV owns shares in Lyft and Upwork).

Interestingly, as ride-sharing platforms have surged — Uber raced past two billion rides delivered in 2016 — the demand for car ownership among Millennials has plummeted. According to Bloomberg industry research, last year, more automobiles were sold to people aged 75 and older than 18-24-year-olds.

The precarious new dynamics in the auto industry drive home the disruptive and deeply intertwined elements of the Class of 2020. Powerful, ubiquitous mobile devices enable on-demand services and Peer-to-Peer Marketplaces. Broad demand for these services, in turn, has created widespread part-time work opportunities for a generation that is increasingly unlikely to commit to a single career. And sharing platforms have further reduced the need and desire to purchase physical assets, like houses or cars.

Understanding the Class of 2020, and the profound impact this generation is having on the World, is about thinking outside boundaries and connecting dots.

HOW MANY DOTS DO YOU SEE?
There are 12… Your brain just won’t let you see them all at once.

Source: Mashable

It is fitting that the most recent Nobel Prize for Literature was awarded to Bob Dylan. Now in the company of T.S. Eliot, Samuel Beckett, and Gabriel García Márquez, Dylan is the first musician to win the award. The Swedish Academy decided to think differently (It’s about time — even the Oxford Book of American Poetry included his song “Desolation Row,” in its 2006 edition, and Cambridge University Press released “The Cambridge Companion to Bob Dylan” in 2009.)

Dylan once observed that, “Some people feel the rain… others just get wet.” He has also said that, “Colleges are like old-age homes, except for the fact that more people die in colleges,” which may be of particular interest to the Class of 2020.

Source: New York Times, GSV Asset Management

At GSV Capital, we’re focused on “seeing the rain” when it comes to understanding the the profound global transformations that are taking place — particularly embodied in the Class of 2020.

GSV’s research and investment process is structured to accomplish the identification of large, open-ended growth opportunities, as well as individual companies that possess the critical elements necessary to capture meaningful market share in these opportunities

Our top-down perspective focuses on the intersection of Megatrends (technological, economic, and social forces that disrupt the status quo) across growth sectors of the economy to identify game-changing businesses with innovative technologies and

services. GSV’s bottom-up analysis is centered on the Four Ps — People, Product, Potential, and Predictability — an objective framework to assess a company’s potential to

realize sustained long-term growth resulting from market Megatrends.

The convergence of Megatrends and growth sectors is how we develop investment themes focused on identifying the “Stars of Tomorrow”… the fastest-growing, most dynamic companies in the world. We have identified five themes that we believe are the most fertile for investments in companies with the greatest potential.

1. CLOUD + BIG DATA: Over 90% of the world’s data has been created in the last two years. According to the MIT Technology Review, by 2020, 1.7 megabytes of new information will be created every second for every human being on the planet. To put that in perspective, in 1969, we sent astronauts to the moon and back using computers with only 2 kilobytes (0.002 megabytes) of memory.

At the same time, organizations are struggling to make use of abundant new sources of information. EMC projects that less than 5% of target-rich data is analyzed today, let alone used. Powerful software analytics are creating massive opportunities for innovative companies that are attacking a global Big Data services market that surpassed $125 billion in 2015.

2. EDUCATION TECHNOLOGY: In a Knowledge Economy and Global Marketplace, education makes the difference in terms of how well an individual does, how well a company does, and for that matter, how well a country does. The Internet, combined with ubiquitous smartphones, democratizes education access by lowering cost, and now, improving quality. We are starting to see the rise of what we call “Weapons of Mass Instruction” — rapidly scaling education companies attracting millions of students in a short period of time.

3. SOCIAL-MOBILE: In 2008, the average American spent 2.7 hours per day on digital media. In 2015, we spent 2.8 hours per day on smartphones alone — more time than we used to spend on desktops, laptops, mobile, and other connected devices combined. Over 87% of Millennials sleep with their smartphones and 97% U.S. high school and college students would rather lose every other possession before giving up their smartphone.

Facebook-owned WhatsApp processes a mind-bending 60 billion messages per day while Snapchat (Snap) users upload 9,000 photos per second. Social everything — communication, collaboration, photography, music, shopping, education, and healthcare — is the future and it is going to be done anytime, anywhere on mobile devices. (Disclosure: GSV owns shares in Snap).

4. MARKETPLACES: The foundation of modern economics is Adam Smith’s “invisible hand.” As people make economic decisions in their own self-interest, it ultimately brings economic benefits to others. But the rise of modern information technology and ubiquitous mobile computing has made the invisible hand a lot more collaborative.

On any given night, roughly one million travelers who would have typically checked into a hotel are instead using Airbnb’s marketplace to rent unused houses, apartments, and bedrooms for a better price — and a more unique experience. Millions more are saving time and money by ditching taxis for rides with services like Uber and Lyft. The Internet is exceptionally suited to aggregate supply and demand within an industry, and smartphones amplify the tremendous network effects that can be created. (Disclosure: GSV owns shares in Lyft)

5. SUSTAINABILITY: The good news is that the world’s middle class will more than double to five billion over the next 15 years. The bad news is that the strain this will put on the environment will be extreme, with wealthier people traveling more, consuming more, and using more electricity for everything — from air conditioning to lighting larger homes. Sustainability is not just green technology — it is water and wellness. There is no longer a debate between being “green” or “growing” — both are important.

Bubblin'

by Luben Pampoulov

Slacking Growth

The best companies of all times have one common characteristic — they produce healthy growth rates (revenue and earnings) for the longest. Naturally, as companies grow in size, the growth rate decreases. At some point, you can’t keep on growing if you’ve hit your total addressable market. That’s why a company like Apple, which was growing its revenue by 20-30% even at a $500, $600 or even a $700 billion market cap, finally hit a wall and posted two consecutive quarters of revenue declines. There just aren’t that many more people they can sell iPhones to.

At an early stage, things are different. A disruptive new company can experience revenue growth rates of 200%+ for years. Some of the best companies can even produce such growth at levels above $100 million of revenue. Currently, Lyft is such an example and is on track to have another 200%+ revenue growth year. Another one is Snap, which will likely grow over 500% this year. What’s impressive with Snap is that it is seeing accelerating user growth, even at the scale of 150+ million daily active users (DAU). (Disclosure: GSV owns shares in Lyft).

Slack is another example of a very dynamic growth business. In February, its year-over-year DAU growth rate was +360%, and in May it was still a very strong +260%. But it is decelerating at a faster pace now. Last week, the company announced it hit 4 million DAUs, which implies YoY growth rate of +142%. It’s still a very strong pace, but the deceleration shows signs of difficulties.

Slack is a social collaboration platform that has replaced email for a majority of small and medium sized businesses. It is highly effective for internal communication, and it has been adopted by the majority of tech startups across North America and Western Europe. Even larger customers such as Harvard, eBay, Samsung, Airbnb, or Time Magazine have adopted Slack.

But the competitive landscape is heating up. Other large platforms are launching their own business communication tools and are entering Slack’s turf. Dropbox recently launched Paper, Salesforce has Chatter and RelateIQ, Google has River, Atlassian has HipChat, and since last week, Facebook has Workplace. Many big players are moving in quickly, and Slack will have to maintain a superior service in order to stay at the top. (Disclosure: GSV owns shares in Dropbox).

Slack also announced it has hit 1.25 million paying users. This implies its current conversion ratio of daily active users to paying users is 31%. While this is up from the 28% conversion ratio a year ago, it is flat compared to May 2016.

At its last round, Slack was valued at $3.8 billion. This values a Slack paying user at $3,040 (or about $800 per monthly active user), while the average revenue per paying user is approximately $100 per year. While there is a long way to justify this valuation, Slack’s leverage is in its high growth rate and its pricing power. If it can stabilize and maintain strong user growth, everything will take care of itself. Additionally, with the on boarding of larger customers, Slack is increasing its ARPU, which is balancing off some of the user growth deceleration.

We estimate that Slack’s last twelve month revenue is approximately $90 million. With an estimated +120% paying user growth next year, and with ARPU going from $8 to $10, 2017 revenue could be in the $360 million level. This would value Slack at 11x ’17 price to sales.

Value per MAU*

Source: Public announcements, GSV estimates

We continue to keep Slack high on our priority list, but are also monitoring its growth closely with competition heating up. 

Pioneer Notes

by Li Jiang

Founders Are From Mars; VCs Are From Venus

While many people in the Global Silicon Valley have played both the roles of a founder and a venture capitalist, these two positions actually are quite distinct and requires different personalities.

The theory de jour is that having operating experience makes one a better investor. I certainly agree to some extent. Yet some people are built to be entrepreneurs — they enjoy the day to day action. Others are built to be venture capitalists—they enjoy coaching and observing higher level trends.

I’ll generalize, but here are some ways why Founders are from Mars and VCs are from Venus.

1. Founders are at War and VCs are at Peace

VCs operate in peacetime, founders operate mostly in wartime. Founders are often fighting for the life of their companies. They have to fend off the competition from taking their customers and their employees. The phrase “always on” was truly created for founders who are constantly worrying about the next move and whether there are unforeseen Achilles’ heel in their company.

While VCs compete to invest in the best founders, very few great companies are built with only one venture firm backing it. VCs collaborate with each other to support the same company and it has become the industry expectation. There is no need to constantly fight the competition because we can all participate in expanding the pie.

It’s true what they say:

Well behaved founders rarely make history.

2. Founders are Precise and VCs are In Range

VCs don’t actually have to be exactly right, as long as they are generally in the right range. Founders have to make every hire great, make sure every detail in the product works, debug every bug. If the team doesn’t execute on a product and a plan precisely accurately, they may not survive.

VCs have more room for error with any one company and with a broader portfolio in general. Venture capitalists can build a broadly diversified portfolio of great companies and hope that enough of them turn out to be mega-winners. Frequently the best investments were controversial and not the ones that the venture firm originally thought were clear winners.

It’s also true what they say:

Half of great venture investments are lucky, we just don’t know which half.

3. Founders play Football and VCs run Track

Startups are heavily team oriented, VCs are more about personal relationships.

As a VC, you could be one gal or guy and still be very successful investing in a couple of the right founders. No startup has ever been built by one person. And like football, a startup needs to have everyone running the same play, in the right places at exactly the right time.

In fact most venture firms remain small, often fewer than a dozen general partners. Highly valuable startups often grow to a few hundred of even thousands of people within a couple of years of founding. Since communication challenges grows exponentially not linearly as a company grows, startups have to be extraordinarily vigilant about teamwork and clear organizational structure.

In Conclusion

It’s harder to be a Martian than a Venusian. The life of a founder is constant capitalistic warfare in which not only does she have to build an incredible team that works well together but also make almost all of the right moves.

My hats off to the founders.

Market Update

Week ending October 23, 2016

World Indices

America Index 9/20/2017 YTD Week
U.S. GSV 300 107.4 42.1% 1.8%
NYSE 11812.0 6.8% 1.0%
Dow 21813.7 10.4% 0.6%
NASDAQ 6265.6 16.4% 0.8%
NASDAQ-100 5822.5 19.7% 0.5%
Russell 2000 1377.5 1.5% 1.4%
S&P 500 2443.1 9.1% 0.7%
Brazil Bovespa 71073.7 18.0% 3.4%
Mexico IPC 51373.2 12.6% 0.6%
Canada S&P TSX 15056.0 (1.5%) 0.7%
Euro-Asia Index 9/20/2017 YTD Week
China SSE 3331.5 7.3% 1.9%
Heng Seng 27848.2 26.6% 3.0%
Singapore Straits Times 3259.6 13.1% 0.2%
Indonesia JKSE 5915.4 11.7% 0.4%
Japan Nikkei 225 19452.6 1.8% (0.1%)
India Sensex 31596.1 18.7% 0.2%
Russia RTS 1979.1 (11.4%) 2.5%
France CAC 40 5104.3 5.0% (0.2%)
Germany DAX 12167.9 6.0% 0.0%
U.K. FTSE 100 7401.5 3.6% 1.1%



U.S. Indices Snapshot

Valuation P/E Est. P/E/G Price/Sales
LTM NTM Growth LTM NTM LTM NTM
S&P 500 24.2x 17.6x 7.60% 3.2x 2.3x 2.4x 2.1x
NASDAQ 25.2x 17.5x 7.90% 3.2x 2.2x 2.6x 2.2x
Russell 2000 24.7x 17.6x 6.30% 3.9x 2.8x 1.9x 1.6x
GSV 300 50.6x 25.8x 38.40% 1.3x 0.7x 5.5x 4.0x

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