Cautious Optimism in Venture Capital Amid Technology Sector Gains
The past three months have seen some of the most volatile and uncertain markets in our memory. Throughout this period, after ensuring the health and safety of our teams, our efforts have been primarily directed to value preservation: cost cutting, revising budgets, raising financing and completing strategic transactions, all designed to ensure that our companies have ample cash resources to ride out the storm. But as we now approach 100 days under the COVID-19 pandemic, it is time to consider the unfolding environment from a new perspective: opportunity.
Online Everything: The Pandemic is Accelerating the Technology Sector
After living on zoom calls for the past few months, we all see the growth in video conferencing first-hand. Most of us have increased our online shopping amid the restrictions on physical stores, including increased use of digital payments. Our children are taking online classes, while we stream as much video and music as we can. Industrial manufacturing is turning to more robotic automation to ensure business continuity, while enhancing safety and productivity. Even our social gatherings are virtual. And of course, in each case, we face a growing need to enhance our cybersecurity.
While all of this was happening in our own lives, we watched a remarkable recovery — following the initial shock — across the public market technology sector. Many of the leading tech companies are now reaching new all-time highs. These are not limited to the Zoom Video and Peloton virtual upstarts capitalizing directly on the lockdown, but include industry leaders Apple, Microsoft, Amazon, Netflix and Shopify, with the Nasdaq index as a whole closing at an all-time record high just last week.
Initial reactions were full of skepticism, but the momentum in the sector is growing. Now everyone asks if this trend can continue. Is it another mini-bubble based on the psychology of being stuck at home? Or is it for real.
Some of these recent growth trends may well be temporary, as the world ultimately returns to a more normalized time. But generally, we are of the view that the broad technology sector as a whole is accelerating as a result of the pandemic. Step changes in online activity levels are increasing the customers for all of these products and services at much faster rates than before: think of three years of expected steady linear growth occurring in just three months!
A Stealth Market Boom
What if there was a market boom that nobody noticed: most people today remain focused on the pandemic health issues, and the ongoing risks and stresses to the economy as a whole. Massive new unemployment has left no doubt that we are in a very real and deep recession. Tremendous fiscal intervention has been required, and significant uncertainty remains across all industries. But the tech sector is starting to feel different, as more and more new customers arrive, and their increased spending leads to surprising financial strength for many companies.
The capital markets remain very cautious, focused largely on the macroeconomic risks. Most venture firms are increasing their reserves to support their existing portfolios and reducing numbers for new investments. Few entrepreneurs and fund managers are raising new capital today, as the number of new transactions slows and new start-ups choose to defer their launch. This is the pattern from prior slowdowns, and it is the playbook we have been following in our Kensington portfolios as well. Our first priority is to protect the value that we have created: increase our reserves and extend the runway for our companies.
But this is only the first part of the story. As noted above, many technology companies are directly benefiting from the broad lockdown and stay-at-home policies being imposed to battle the health crisis, seeing significant new growth creating increased value. In many cases, we believe this new value creation is not a temporary blip, but a more lasting shift in customer behavior likely to drive continued growth into the future. This view is consistent with public market sentiment driving stock prices to new highs. As some investors take a more cautious approach in this market, our deal flow remains strong.
But Still Cautious for Now
The risks in this market remain high and the opportunities do not apply to all. There are many tech companies hit hard by the pandemic in subsectors that will not quickly recover, such as the travel industry and all of the software supporting it. Another market shock could erase recent gains overnight. We are well aware of these risks and closely watching for new signs of trouble.
But we are once again starting to invest — in new opportunities with companies positioned to win.