Chamath Palihapitiya: It could take three years for the market to ‘accurately’ reprice late-stage cos

Former Facebook executive turned VC Chamath Palihapitiya has long been a controversial figure in the investment world. Both brilliant and combative, Palihapitiya became widely known by ushering in the era of Special Purpose Acquisition Companies, or SPACs, beginning in the fall of 2019, when he helped Virgin Galactic become a public company through the SPAC he created.

Palihapitiya went on to go public with five more companies via SPACs before the boom came to an abrupt end last year, and while investors who followed him in some SPACs lost money – as did investors in several hundred other SPACs that materialized in 2020, 2021 and most recently in 2021 – he reportedly lost money. Palihapitiya nearly doubled the $750 million he invested.

Many blame him for aggressively promoting his own interests — including during an appearance on CNBC — at the expense of less experienced investors. Others continue to heed his investment advice, considering Palihapitiya seems adept at spotting investment opportunities early. (This editor recalls an appearance in 2014 at the crowded Bitcoin conference in San Francisco where he argued that everyone should own 1% of their assets in Bitcoin. At the time, each Bitcoin was worth $520.)

Both camps may be interested in Palihapitiya’s recent appearance at an investment conference in Miami where he said he believes up to seven years of high interest rates would be good for the venture industry, and that America’s deteriorating relationship with China is a boon for the country. And where was he asked about generative AI. His comments are summarized below for length and clarity. You can check out the full interview here.

On the effect of higher interest rates:

[The tech industry] It actually built an unexpectedly better business during periods of higher pricing because there are fewer customizers coming into our part of the market because [investors] You can find better risk free rates [elsewhere]. In the absence of this surplus capital, it dictates that each individual company should be better managed. So we as an ecosystem have become more intolerant of excess, and that creates better-run businesses, and we haven’t had that cycle for probably 14 or 15 years, and we desperately need it.

There are a couple of dirty little secrets [in the venture industry]. One is that only 10% of all companies in our asset class actually generate real returns, which means that 90% are basically floundering, burning money.

The other thing is we’ve always created a high DPI of one digit [a term used to measure the capital a fund has returned thus far to its investors] – 1.7 times as much as the 30-year average – yet we’re the worst when it comes to viewing [the institutional investors who fund VCs] Paper tags or TVPI [meaning both realized profits and paper profits]. So there is a dance that this industry was able to play because the rates were at zero, [but] As investors, the asset class is challenged [because] As a result of all this capital surplus, [startups have been] Bad run more than otherwise, so we need a course correction. We need to maintain those rates for 5, 6, 7 years, frankly, hopefully, in order to really flush it through the system.

On what Palihapitiya now thinks about cryptocurrencies, SPACs, and other innovations that investors have flocked to in recent years:

Early-stage enterprise—largely in healthcare, software, deep tech, and more recently the energy transition—was our bread and butter. But sometimes we get a little off piste. In early 2011, I went off the piste and made a big bet in Bitcoin when the coin was priced at $80. It just seemed like an incredibly huge risk reward. We did the same thing in the mid-2000s. We’ve done it in SaaS and in deep tech.

[With] Speck, we stumbled across this thing because we wanted to raise money for a bunch of our companies that were very capital intensive, and we showed something that, in an instant, raised a lot of wind. We did six of them. I think there were only 650 of them in 2021, so we are [represented about] 1% of the market. I think we’ve bought good companies; I think we sold pretty well, quite frankly. But it’s one of those things where it was fueled by a moment in time of massive excess liquidity. And now I think we’re kind of back to basics.

On what he makes of the after-stage market at the moment:

At the end of last year, I looked six or seven [convertible notes]. These companies were all very well known, and they all came to me trying to raise converts to Islam. And I said, “Well, that’s the real market clearing price for these companies,” and none of them took my money. Instead, they basically converted to swerve and kicked the can down the road at the evaluation.

So we are at that point in the market where all the boards of these private companies refuse to budge on the valuation. The reason is that it meaningfully affects the DPI or TVPIs they have given to the LPs. Thus, investing in the private markets is very difficult at the moment, because you will not be allowed to discover a real price because no one wants to take the real hits.

. . . . [And for LPs] Now that’s just bad money. And when [more venture] People are leaving the market, and these companies are now more likely to re-price accurately. . . [But] I honestly think this is after three years. I thought it would be three quarters. Initially, when we were thinking about, like, how much capital are we really going to commit over this next period, we cut it by two-thirds, because we didn’t see the opportunities in the late stage anymore.

How does he think about America’s deteriorating relationship with China and the accompanying ban on technology in progress:

It is an incredible boon for America. Which is an incredible boon for America’s tech sector. The thing is, when you look inside China, they’re very good at process engineering. It is also very good at additive manufacturing. They’re very great at things like specialty chemicals, but all of those things, the precursors are coming from American, European and Australian companies that now have a lot of incentive to diversify that supply chain away from China, [and that] It benefits American companies greatly.

China’s response [so far] silent. For example, we said, “We’re going to slow the flow of very sophisticated semiconductor manufacturing equipment into China,” and China’s response was, “We’re not going to let you guys get input components into certain silicon wafers that are used in photovoltaics. I mean, if you have to arrange These things, there’s no harm in that, but we can make solar cells.The equipment you need to get to the 2-nanometer scale in chip design comes from the Dutch, the Germans and the Americans.

On ChatGPT and the generative AI craze more broadly:

What ChatGPT shows you is the incredible value of letting computers help you do the work. It’s like a calculator that replaces the abacus to replace the pen and paper. [But a] A friend of mine told me this [Warren Buffett quote] Yesterday that I love. Tell the story of refrigeration and the story he tells is that the people and the person who invented refrigeration made some money. But most of the money was made by Coca-Cola, which used refrigeration to build an empire. And I look at these large language models as cooling. Will there be some money in it? I think so. But Coca-Cola has not yet been built. And these are the companies that will work to convert it into cash.

Here’s a key thing about machine learning worth knowing: If you take 1,000 of the same inputs and give them to Facebook, Microsoft, Google, and Amazon, they’ll all come up with the same machine learning model. But if you have one more thing, one little component that all those other companies don’t have, your output can be significantly different. It’s like giving two top chefs three ingredients; When you give one additional third chef, that person has the potential to do something very special. So we are now in the world where everyone crawls the open web, [but] We’re going to move into a world where everyone becomes sophisticated enough that, when refrigeration is widely available, someone will say, “You know what? This site? I’m not going to let anyone else access it; it’s just me, just my models.” And those models will get even better. We have to let that happen for a bit.

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