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Contrarian investing in venture capital today

By Paul Asel, NGP Capital

These are heady times. Every day it seems a new unicorn is created. New vocabulary – unicorn, minicorn, decacorn, mega round, super mega round – is now common in venture parlance to describe the current investment frenzy of large rounds at high valuations.

While surely it is a great time to cover technology in the media business, prospects for venture investors are less clear.

But as many investors chase headline-grabbing deals, the highest performing investors of tomorrow are working in the shadows today finding value-overlooked sectors.

Two adages underscore this point.

“What the wise do in the beginning fools do in the end.” So says Warren Buffett in a quote highlighting the madness-of-the-crowds and advocating for contrarian investing. His residence in Oklahoma, he claims, is an antidote for the groupthink emanating from global financial hubs.

In like spirit, Jack McDonald, former vice chairman of Nasdaq parent NASD, warned of “cocktail investments.” Better to buy shares in Waste Management than the Boston Celtics, he said, because investments you like to talk about at cocktail parties tend to underperform those no one wants to admit owning.

No wonder Buffett, Charlie Munger and Philip Fisher were frequent guests in his finance classes at Stanford University.

For those chasing hot deals in hot markets, Buffett and McDonald offer timely buyer-beware warnings. Uber is a chest thumping investment, yet not all investors have fared well. Investors in the last private round in Uber are now underwater.

VCJ Venture Exits Late-Stage Growth
Paul Asel, partner, NGP Capital. Photo courtesy of the firm.

Recently, two of our NGP Capital portfolio companies, GetYourGuide and Deliveroo, together secured more than $1 billion in new funding. GetYourGuide raised $484 million in a round led by SoftBank and Deliveroo raised $575 million in a round led by Amazon.

We are delighted with the remarkable progress and performance of both GetYourGuide and Deliveroo.

Yet large financings alone do not add value. Now the hard work begins of delivering on the high expectations of its most recent investors.

Capital-efficient companies are less glamorous but often produce yeastier investment results. The best investment with which I have been associated raised a small Series A round and did not raise again before going public.

PDF Solutions, a yield management solution for chip design, received scant mention as the only IPO in the year following the stock market crash in 2000. Yet PDF produced a sexy 50x plus return for early investors and continues to trade on Nasdaq today.

In pursuit of unicorns, entrepreneurs and investors today give scant attention to capital efficiency, though this often is the best path to favorable outcomes. As Eugene Kleiner said, more companies die of indigestion than starvation.

A hot market presents numerous opportunities, but often not where one might expect to find them. Deals are systematically overpriced where investors cluster, but can be cheap in “hard,” or overlooked, sectors.

Overlooked sectors abound when attention focuses on hot markets. In 2008, NGP Capital identified an opportunity for mobile-first companies, an insight we leveraged for superior returns for five years.

We launched a Connected Car fund in 2013 well before mainstream investors saw opportunity in the transportation and logistics sector. In 2015, NGP Capital invested in WorkFusion just before artificial intelligence became buzzy. Today few investors are looking at 5G opportunities and its role in creating a more connected world.

Investing in overlooked markets is both lonely and risky. Markets are often overlooked with good reason. Investing ahead of the wave is deadly both when the wave never breaks or when it breaks on you.

And even when the wave breaks right, a fast follower may surpass the early mover. Contrarian thinking requires more careful thought but disruption and transformation do not happen without it.

Paul Asel is a partner at NGP Capital.