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Market Musings - November 8, 2017

We continue our blog series: Market Musings, Volume 1, Edition 5, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present How Hard Is It (Really) To Raise $600,000,000 Or More?

In the course of a conversation we had recently with a friend it was remarked on how difficult it must be for a startup hedge fund to raise the $25MM to $100MM required to really open doors as a professional investment management business (as opposed to doing something on a smaller scale like separately managed accounts). It certainly seems logical that no intelligent person would just hand over a large sum of money to a stranger no questions asked, unless there was a compelling justification to do so--such as a lengthly track record of outstanding investment performance, for instance. Interestingly, though, there are several examples in recent years (perhaps because some folks are continually spellbound by the now 8-year-old bull market or the Fed's lose monetary policies, e.g., QE1, QE2, etc.) of supposed sophisticated investors literally giving obscene amounts of money to unproven (and in one case allegedly outright crooked) investors/entrepreneurs, ranging from $500MM all the way up to into the billions. So, we ponder, is raising large amounts of money in 2017 really so difficult? (Helicopter Ben says "Hell no.")

Below we present three examples illustrating our foregoing "free money mania" hypothesis:

Behind Door #1: Meet Shradha and Rishi...

These two, currently aged 33 and 32 respectively, are the founders of a privately-held outfit called OUTCOME HEALTH, started in 2006. They are young, energetic entrepreneurs, ready to take the world by storm. Who wouldn't leap at the chance to give Shradha and Rishi millions of their money to play with? In May of this year, Outcome Health was able to raise $600 million from supposedly savvy investors such as Goldman Sachs, Chicago-based Pritzker Group Venture Capital, Google parent Alphabet and an entity run by Steve Jobs' widow Laurene Powell Jobs (see sources here and here). This fundraising round valued this 10-year-old company at $5.6 billion. It turned out there was just one minor problem for these sophisticated investors who had so perspicaciously funded this promising venture--according to the WSJ, it may turn out to be a gigantic fraud. Well, what's $600 million to Goldman, the Pritzkers, Google and Steve Jobs' widow, right? Chump change--write it off as a tax loss and move on (actually, they are now suing to try to get their money back; good luck Goldman!)

Behind Door #2: Meet Vivek...

Vivek Ramaswamy, currently aged 32, is the founder of AXOVANT SCIENCES (ticker AXON). Vivek, a Harvard and Yale grad and also a former hedge fund manager, had the grand idea to buy drugs that other large pharma companies had given up on and repackage them using newly formed entities, the shares of which could then be sold at astronomical prices to gullible investors (it helps to have a multi-year raging bull market during which to conduct this business model). Vivek's first attempt was with an Alzheimers drug that had failed numerous prior Phase 3 studies, called Intepirdine. The drug was purchased from GlaxoSmithKline for a mere $5 million by Vivek and his buddies via the Axovant entity, which they subsequently listed on NASDAQ in June 2015. The valuation the underwriters assigned to this new entity with its $5 million drug, you ask? Oh, about $1,500,000,000 (yes, that's $1.5 BILLION). Huh. (See IPO Prospectus here). Incredibly, the stock price actually rose from the $15/share initial offering price to a high of nearly $28/share prior to the issuance in late September 2017 of results for the new Phase 3 Alzheimers trial conducted by the company, which (you guessed it) FAILED MISERABLY (just like all the previous Phase 3 trials with Intepirdine had). Oh, and the stock crashed about 80% in one day, leaving those suckers who bought at or subsequent to the IPO much poorer (but Vivek still gets to be on the board of directors as a major shareholder and the company is still miraculously valued over $500 million, thanks in part to equity issuances made post-IPO before the stock price crashed (evidently there IS a sucker born every minute))...

Finally, Behind Door #3: Meet Evan and Bobby...

Now call us crazy, but if we had hundreds of millions of dollars burning a hole in our pockets, we would definitely consider handing it over to...these two fellows, currently aged 27 and 29, respectively...NOT AT ALL. (Something tells us it's usually not wise to invest with people who do/say things like this.) Well, other investors sure were, because we are not talking about some fly-by-night enterprise, folks, we are talking about SNAPCHAT of course (ticker SNAP). You know, the app where you send a message disappears. Brilliant, guys! And let us not forget that these two also brought the world SPECTACLES (how they came up with such an ingenious name is truly a mystery)...

Now, to be fair, it takes a lot of entrepreneurial chops to invent an app where messages disappear, etc., and these two bros managed to (1) raise $375 million from the likes of the esteemed Fidelity Investments in funding rounds in 2016 at a valuation of $16-20 billion (source here) and (2) IPO their company at a valuation of around $22 billion earlier this year (source here). The IPO price for SNAP was $17/share and was underwritten by no less than Wall Street heavyweights Morgan Stanley, Goldman Sachs, J.P. Morgan and Deutsche Bank, among others (see IPO prospectus here). So how have SNAP investors who bought at or following the IPO faired in the 8+ months since? Yeah, not so well...

This outcome was probably do to the fact that the company incinerates tons of money regularly (already $3.1B lost in 2017!):

Evan and Bobby, however? Laughing all the way to the club in velvet pajamas, friends.

IT'S JUST THAT EASY - So we see that, despite conventional wisdom, it is really not that difficult to raise hundreds of millions (if not billions) of dollars these long as you have (A) a fake business (allegedly) showing huge revenue growth (because the accounts are fake--allegedly), (B) an ingenious way to hoodwink gullible investors, such as buying and repackaging failed drugs and doing IPOs based on the premise that the 18th Phase 3 trial will be the charm and/or (C) a silly ephemeral fad app used by millions of teenagers which causes its owner to burn gigantic amounts of cash on a regular basis.

Maybe it's just the Zeitgeist, who knows? Perhaps it is quaint to believe in such an era that our humble business model of buying things for less than they are worth could possibly be attractive to outside investors. Maybe we should instead opt for something truly awe-inspiring, like flying people from New York to Japan on a rocket, or colonizing Mars, or even digging giant holes underneath Los Angeles or San Francisco so people can avoid traffic. Heck, the crazier the idea the more money we should be able to raise. Makes sense, no?

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