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30 July 2017

Editorial: Finding an investment edge after the golden age

Microsoft is already an investor in Uber, but this deal for Ola would be in connection with an agreement that Ola switch from Amazon Web Services to Microsoft's Azure cloud services platform.

Author: James Mawson, Editor-in-chief

The latest blog by Andrew Chen, head of rider growth for US-based ride-hailing service Uber, makes the case that while it has never been cheaper to start a business, to scale it up costs far more in customer acquisition.

Chen said: “All acquisition channels are an efficient market at some point, and this means that companies that monetise better than their competitors (either with higher LTVs [life-time values] or because they enjoy shorter payback periods) will be able to afford a higher CAC [customer acquisition costs] and subsequently out-invest those competitors. In short, better monetisation is a competitive advantage for growth.”

In this light, therefore, it was interesting this past week to see US-listed software provider Microsoft is eyeing an Asian investment, and is reportedly in the early stages of discussions to provide between $50m and $100m to Indian ride hailing service Ola.

Microsoft is already an investor in Uber, but the Ola deal would be in connection with an agreement that Ola switch from Amazon Web Services to Microsoft's Azure cloud services platform. Microsoft included a similar provision when it made a huge investment in another Indian unicorn, Flipkart, in March this year.

It is an angle to look at investments as part of a strategy to win customers to support the parent’s main business while also making financial returns from the deal itself. Given the paucity of financial returns generally, such a combination is perhaps uniquely appealing.

Howard Marks, a co-founder of private equity firm Oaktree Capital, said in his latest blog: “In today’s low-return world, it’s clear that institutional investors needing 7-8% a year aren’t likely to get it from Treasurys yielding 1-2%, high grades at 3-4%, or mainstream stocks that most people expect to return 5-6%.  Heck, you can’t even get it from Ivory Coast bonds!  Where is one to turn?

“Private equity firms market double-digit return track records, and even their top-of-the-cycle 2005-07 funds now sport respectable gains.  As a result, they are attracting capital at all-time-high rates.

“Perhaps the ultimate demonstration of faith in fund managers is SoftBank’s recent raising of $93bn for its Vision Fund for technology investments – presumably on the way to $100bn.  SoftBank is a Japanese telecom company showing an 18-year annual return of 44% on investments that have included chipmakers, ride-hailing and telecom.”

“Softbank has a fantastic track record and a sweet spot in targeting companies raising at least $100m and sometimes more than $1bn but have (usually, apart from chip maker Nvidia,) yet to float on a stock exchange, such as Ola and Flipkart in which Microsoft has backed. Its Vision Fund portfolio, combined with its majority-stake purchases, acquisitions and corporate venturing deals off the balance sheet combine to give it opportunities to understand the data and chipmakers that it thinks will allow its founder, Masayoshi Son, to “rule the entire world”.

Vision Fund’s structure certainly does that. Building off an earlier Financial Times articles, Marks said: “For each 38 cents they put into the fund’s equity, outside investors are required to put 62 cents into preferred units of the fund. On the other hand, SoftBank itself invested $28bn in equity but nothing in preferred. 

“That means when the fund reaches $100bn, SoftBank will have put up only 28% of the capital but will own 50% of the equity.  Adding in management fees and carried interest, its 28% of the capital may give it 60-70% of the gains….

The willingness of investors to invest in a shockingly large fund for levered tech investing with a questionable structure is a further indication of an exuberant, unquestioning market.

Whether it is customer acquisition or faith in others to deliver returns, the golden age for corporate venture is undoubtedly over for this cycle, as noted at the end of last year, but it seems creative structures and edges, such as those shown by Microsoft and Softbank, can still be found to promise returns.

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