The Bridge Ep. 03: When Markets Over-Rotate—and Innovation Doesn’t

The Bridge EP 03, Deven Parekh/Insight Partners – Transcript

Sonali Basak: (00:00:00 -> 00:00:25)
Welcome to the latest episode of The Bridge by iCapital. I’m Sonali Basak. I am the Chief Investment Strategist at iCapital, and today I am joined by Insight Partners, Deven Parekh. He was an early member of the firm that is now more than three decades old and behind a lot of the big names in venture capital that you might hear about this year, like Anthropic, like Databricks, like OpenAI. Deven, what a great time to talk to you, because this is a pretty historic year.

Deven Parekh (00:00:25 -> 00:00:26)
Sonali, Thank you for having me.

Sonali Basak (00:00:27 -> 00:00:40)
All those companies that I named might go public in the next 12 months. And so, when you think about what a big moment this is for the market, we have never seen an IPO market of that size before. How do you think about it from where you sit?

Deven Parekh (00:00:40 -> 00:01:48)
Well, look, I’ve been, I was meeting with investors this, this week and last week, and I’ve told them that so far, I’ve been wrong four of the last four years in my IPO predictions. ’cause I kind of came into every year feeling like, okay, this is the year where the IPO market is gonna finally come back. Um, and it hasn’t really happened in the last four years. We’ve gotten some companies public and there’s been some activity, but I don’t think anything relative to what people were expecting. And of course, now you’ve got these, we’ll see what the timing ends up being, but you’ve got three or four of these large companies happening at the same time and like the interesting thing about that, and it’s hard to know exactly how it’ll play out, but I think what a lot of companies are worried about that are not those four companies is what does it mean for them?
there’s a lot of growth capital, uh, in the public markets sitting on the sidelines waiting for these deals. And does it suck up all that capital? Does it make harder for that tier down, which are some really interesting companies that are tier down from these companies. Are they able to get out this year or not? And I think a lot of people are saying, okay, let, let’s steer, let’s steer clear. Let, let’s have some of these companies come out, uh, and then kind of see how they do in the markets.

Sonali Basak (00:01:48 -> 00:01:50)
Basically. Get in line.

Deven Parekh (00:01:50 -> 00:02:27)
Yeah, get in line. But I do think that there is a lot of anticipation obviously about these names. But I think the good news and the better news for the long term is there’s a long list of companies that are not the three or four that you’re talking about that also have great profiles. I think we’ve gotten spoiled, um, uh, with some of these AI companies because you’re seeing growth that we’ve never seen before. But there’s a lot of other businesses out there that are really interesting across a lot of different, um, sub-sectors of tech, both consumer and, you know, uh, enterprise, uh, that are, that are gonna be fast behind. Now, whether that’s a quarter behind or three quarters behind, I think it’s hard to predict right now.

Sonali Basak (00:02:27 -> 00:02:42)
So, it’s crazy to me is if you think about even just three of those IPOs, it would be between $50 billion or no, $150 billion, I’m sorry, 150 billion to $200 billion worth of dollars raised. Yeah. Is there enough money in the market to support all those IPOs?

Deven Parekh (00:02:42 -> 00:03:52)
Well, keep in mind that, you know, also, what what’s gonna end up happening for some of these businesses, take SpaceX, um, you know, NASDAQ has moved the rules around so that it’s gonna be in the index pretty quickly.

Sonali:
Right, right.

Deven:
So, there’s going to be demand just given what the market cap of these companies are, and they’re gonna move into indexes pretty quickly. So that’s gonna soak up kind of a lot of demand for those,

Sonali:
right.

Deven:
those names. Um, you know, what we don’t know is obviously a lot of these companies have been private, not so much Anthropic and OpenAI, but SpaceX and Databricks and others have been private for a really long time. Uh, so you do have a big cap table, uh, of investors, some of whom have gotten liquidity pre the IPO, but many have not. Um, and so you’re also gonna see unprecedented amounts of things come up out of lockup.

Sonali:
Yeah.

Deven:
Uh, you know, in six or nine months. And how does the market kind of absorb that? And we don’t really have precedence at that scale. Um, but I think my instinct, um, is there’s so much interest, uh, in those assets, uh, that de market will figure out a way to kind of absorb that size.

Sonali:
Well, you know,

Deven:
Aramco was,

Sonali:
that’s interesting.

Deven:
You can just talk about Aramco is this, this amazingly big deal and it’s tiny compared to

Sonali:
what we’re seeing,

Deven:
what we’re seeing right now.

Sonali Basak (00:03:52 -> 00:04:10)
Well, what’s wild too is that a lot of these companies have just raised money, actually. Pretty historic fundraisers that we’ve seen. And a lot of those new investor bases are two, three dozen investors into later stage rounds. How do you think about that dynamic that so many investors are able to get in before the IPO these days?

Deven Parekh (00:04:11 -> 00:05:07)
Well, let’s separate out a couple things. I mean, one, yes, these companies are raising lots of capital, but at the same time they have kind of historic, they’ve, they have kind of, they’re,

Sonali:
they need it.

Deven:
They’re consuming capital uh, you know, at rates that kind of we’ve never seen before, right. Um, and so it’s not like it was optional for them to raise that money. They need to raise that money. Um, and you can see it with, you know, Anthropic is probably growing even faster than they thought. And they’re probably running short of compute and announcing new deals with Amazon just this week. Um, so the, the, the fact of the matter is that these companies had to raise the money, um, and there was enough demand, uh, from investors, not just venture investors but I think when you look at kind of the universe of companies, uh, universe of investors in those companies, everything from sovereign wealth funds to wealth management firms, putting it through their retail channel. So, these have ended up in, on lots of different platforms, way beyond just your traditional venture and growth funds.

Sonali Basak (00:05:07 -> 00:05:54)
Well, what’s interesting, you and I were talking before we started taping about the dynamic we’re seeing in the wealth market in particular, where there’s a lot of wealth managers that want the special sauce. They wanna get in early, they wanna lean on people like us to say, where are the new Anthropics? Where are the new Databricks? Where are the next phase of AI companies that are growing going to be? But then there’s a ton of people who say, gimme some SpaceX, gimme some Anthropic. And you, it’s hard to not say to them, well, you know, why don’t you wanna get in earlier? Why are you waiting so long? You can understand why it’s so excited to get into these IPOs. I’m curious how often you get into that conversation with people. That you have to say, some of these companies have already seen the best they’re gonna see in venture, and you’ve got to look over here instead.

Deven Parekh (00:05:54 -> 00:07:21)
Well, look, our strategy, you know, is really one of investing everything from early stage to, to late stage. But if you look at where our dollars are, they’re, you know, disproportionately on the earlier kind of side of the spectrum, not primarily in kind of the pre-IPO type category. Um, and our investors are primarily institutional investors, but we have private wealth, uh, that comes into our funds as well. And I think you’ve got, look, you’ve got two different types of investors. You’ve got investors kind of want a diversified portfolio. They know that there’s gonna be Databricks within a portfolio, but there’s also gonna be ones that, you know, don’t look as good as Databricks. Um, and then you have investors who are struck by these companies that have just sparked an imagination in a way that, you know, when you’ve got somebody talking about going to Mars and you’ve got companies that are adding more revenue in a single month than enterprise software, uh, industry does in a year. Um, those are special names. Um, and so I’m not surprised that people want exposure to those names, but I think, I think what most financial advisors, uh, and wealth advisors would, you know, would tell people you, you don’t, you don’t ever want to concentrate your portfolio in a single name or in two or three names. You wanna have a diversified portfolio so I think what we’re trying to do, if you look at where we’ve had the most success, uh, in our own strategy is, you know, what we call double down, uh, which is we invest on the earlier side, uh, we write a more modest check early, earlier in the company’s life, and then double down in the winners, right.

Sonali Basak (00:07:21 -> 00:07:31)
How important is that diversification? We were looking at the data where, you know, 6% of venture bets account for 60% of the returns.

Deven:
Yeah.

Sonali:
So, you really have to go hunting for unicorns, don’t you?

Deven Parekh (00:07:31 -> 00:07:55)
Yeah. I mean, look, that, is a venture strategy, right? the reality is people talk about power law only in the con context of venture, but power law exists if you actually go look at the returns. Power law exists in buyouts, and power law exists in growth equity. The, the outlier parallel multiple is lower, right? So, in venture, the outlier might be a 100 x, uh, or 50 x,

Sonali Basak (00:07:55 -> 00:07:58)
Which means dispersion among managers is much larger than every other asset class.

Deven Parekh (00:07:58 -> 00:08:59)
Well, look, I think we’re at a particularly interesting time right now, right? Where there’s certainly funds out there with a much more concentrated, uh, concentrated strategy. Um, and they’re gonna look great, um, if the AI boom continues. And by the way, they should, they, they were willing to take a concentrated strategy. I think, you know, what we’ve basically said is this market’s changing at an incredibly fast rate. Um, innovation’s happening at an incredibly fast rate. It’s hard to assess these business models in real time, uh, because the changes are happening so quickly. Um, and so, but we believe in the innovation, but we’re saying, look, we’re gonna say let’s take a more diversified set of bets and then go try to concentrate in the winners. In what we perceive to be in the winners in our portfolio, right. Um, and I think either strategy really, which strategy is gonna look better, is gonna depend a little bit on what happens.

Sonali:
Yeah.

Deven:
Right. in the market, and there’s certainly, uh, uh, a version of the world where a very concentrated strategy where you invested in five late-stage AI companies could look great.

Sonali Basak (00:09:00 -> 00:09:30)
It’s interesting because the earlier stages, one thing we were talking about as well is this idea that the later you get, it’s not just that the companies are bigger and the growth rates are slower, it’s actually also that the premiums could be much higher that you have to pay. So, for example, there was this great pitch, PitchBook analysis that said companies that were in earlier stages in AI versus non-AI, were much less, say, 40% of a premium for AI companies versus 250%

Deven:
Yeah.

Sonali:
in those later stages.

Deven Parekh (00:09:30 -> 00:10:17)
But where I’d say something, if we were having this conversation in six months or a year.

Sonali:
Yeah.

Deven:
Um, I think we won’t be talking about AI and non-AI,

Sonali:
okay,

Deven:
as like separate categories

Sonali:
because everything is AI.

Deven:
But well, when I say everything is AI, it, it means if you’re a software company today, uh, and you are not, AI is not part of your solution, you’re just not really

Sonali:
Yeah.

Deven:
You’re, you, you’re, you’re not where you are gonna have to be. Now, there are other categories I’m not talking about saying even, but even biotechnology, right? Like, even if you look at categories, if you look at a biotech fund today, a lot of what they’re investing in is the intersection of AI and biology and next generation drug discovery, right? If you look at robotics as a huge software component to those things, an AI component to those things. So, I think this over time, this AI/non-AI thing is really not going to be that much of a thing. Everything’s gonna have an AI.

Sonali Basak (00:10:17 -> 00:10:20)
Do companies come to you without an AI strategy at all anymore.

Deven Parekh (00:10:21 -> 00:11:17)
It’s rare. In the earlier stages, yeah sure, there are companies that are a legacy software company has not yet done their repositioning. And by the way, we think that could be an interesting strategy, right? Like you, you have a company that’s got deep vertical expertise, maybe in a smaller market. So, it’s not a market that, you know, Claude or OpenAI’s gonna say, I gotta go get that market. Um, they’ve got deep customer relationships, they’ve got data modes, they’ve got integrations to backend systems, but they haven’t yet really kind of figured out what that AI strategy is. Um, well, like we can help them with that, right? So that, that is a potential investment strategy as well. But I think it’s unlikely that any of us are going through our portfolios in a year saying, oh yeah, that company doesn’t really have anything involved with AI. I think what you’re more likely seeing in these big premiums, um, is these, in today’s world, these kind of next gen AI native companies have just have had growth rates

Sonali:
Yeah.

Deven:
That we haven’t seen before.

Sonali Basak (00:11:17 -> 00:12:03)
You know, I want, I want you to get us into kind of the next generation of companies, but before that, I wanna talk about Databricks for just a second because for me at least, it was the poster child throughout the course of the end of last year into this year of what people were talking about around software. It’s like, well, wait a minute, not all software is bad. This is like the holy grail of where AI enabled software is really hitting on what this AI driven economy needs. Data, right? Um, you know, how many people recognize that? How many people around you? I’m sure, you know, in your immediate world, people are understanding the difference between the types of software. But do you think the market writ large, given what we’ve seen and the fear around software the last couple of years, I guess now brewing, it’s really exploded here

Deven Parekh (00:12:03 -> 00:13:51)
But it’s really in the last six months where you’ve seen this kind of, uh, look, I think what the market, what the market is basically saying is if you think about how do you value a software company, um, you basically say, well, I’m gonna take five years of discounted cash flows, or 10 years of discounted cash flows, and then I’m gonna look at the terminal value and I’m gonna take a terminal multiple and that’s what I’m going to do. Well, at a point in time when you believe that the company had really high gross retention and really high gross margins, um, you say, well, that, that’s almost like a utility cash flow, so I’m gonna give it a really high multiple. Uh, and now, you’re sitting there somebody saying, okay, I’m not so worried about how Salesforce or whoever it is gonna do over the next 12 months, because they’re probably fine. When I go look at that terminal multiple, I’m not sure I’m gonna give it as big a multiple because all of a sudden maybe the retention, it’s not, the moat is not what it was, right. And so, they’ve reduced that multiple, and that obviously has a big impact, right. But I think what we’re gonna find, at least this is our view, um, is that over time you’re gonna have winners and losers like you do anytime there’s technological, um, shifts and disruptions and, and, but it’s gonna require, this is also a time of execution, right? Um, and execution also matters. We always just talk about technology, but it also execution matters. So, the companies that basically take that historical moat that, that they have, and then figure out how do I take that moat and extend it? How do I add AI to it? How do I, how do I, I have the distribution advantage if I’m that incumbent

Sonali:
mm-hmm .

Deven:
How do I not lose it, right?

Sonali:
Yeah.

Deven:
Because we’re this weird time where the, the cost of a disruptor is very low in being wrong, and the cost of an incumbent is really big in being wrong. Right? So,

Sonali Basak (00:13:51 -> 00:13:54)
And incumbents aren’t historically the best innovators,

Deven Parekh (00:13:55 -> 00:15:02)
Right, but I think that you’re, you’re seeing in this case, you, you’re seeing examples of companies that are, that are moving and that are moving quickly, probably seeing examples of companies that are not moving as quickly. And, you know, you also have examples of things like if take a, a horizontal application, uh, which does not have any kind of particular industry vertical ex uh, specialization, um, maybe it has no integrations into any backend systems, um, well, that’s an easier disruption for a NextGen.AI company than somebody who’s like deep in

Sonali:
Yeah.

Deven:
Kind of a vertical market, has all the workflows, has integration debt. Now, I don’t think it’s enough. I don’t think that company can say, oh, I have all this, therefore I don’t need to do anything. You know, one of the things we’re doing in all of our kind of buyouts, kind of our later stage buyouts, and I think this gives us a little bit of a unique advantage, having early stage and late stage, is our early stage AI team is working with our buyouts on how do we create embedded AI startups in these businesses.

Sonali:
Hmm.

Deven:
Um, and, and the reality is, well, we have, we have thousands of customers in these companies.

Sonali Basak (00:15:02 -> 00:15:02)
So, what does that look like?

Deven Parekh (00:15:03 -> 00:16:30)
It looks like going in, I think if you think about the, um, you know, my partner Jeff Hoing has been talking about this for years and now I think a lot of other people are talking about it. But it’s, if you think about the way you historically thought about software from a competition standpoint is new company comes in and says, well, my software’s better. My software is cheaper, whatever it is. But you know, if you’re paying a $100,000, I’ll sell it to you $80 or sell it to you $120,000 but I’ll give you more seats. I think in an AI world, um, you’re basically going in and saying, I’m not gonna go after the software spend. I’m going after the labor spend, and I’m gonna sell you an outcome, right. Um, and you have x number of people doing this task. You don’t need as many people doing this task. I’m gonna sell you that as an outcome, and maybe I’m gonna sell it to you as a managed service using my technology, right. Um, so if you are an incumbent, uh, and you have those customer relationships, and you have the technology and you have some confidence, and you, I mean, you need to have good net promoter score, people have to believe that you can do that. Well, you have a better ability to execute on that assuming you have the right execution. Um, and you know, I think the challenge for a lot of private equity businesses are probably gonna be, if you look at the historical background, uh, of a CEO of a private equity owned firm, they came through sales and it came through finance, and now we’re in this like, very product-oriented world, right.

Sonali Basak (00:16:31 -> 00:16:56)
It’s funny, what you’re speaking to is what I’ve always imagined in my head over the next two years to be a bit of a shakeout, right. Um, the reason I brought up Databricks was to just make the point also that a lot of the greatest software companies of the future, things that are more aligned with infrastructure software rather than application software perhaps are in private markets, actually.

Deven:
Yep.

Sonali:
And so, if you wanna access to them, that’s the only real way to do so.

Deven Parekh (00:16:57 -> 00:17:48)
. Yeah. I mean, you’ve got, you’ve got a whole next generation of those type of infrastructure companies, you know, Databricks being one, there’s others as well, um, where they are accelerating because of AI, right, uh, because what’s the, what’s the fuel for AI, you know, or the oil for AI? It’s, it’s data, right? And, um, so people are, it’s more important to have that data, you know, in a single place, in an ability to be able to use that data really efficiently. Um, and you know, Ali’s an unbelievable CEO and has executed really well and has kind of gone from technology, he’s kind of done technology shift to technology shift, has done some really smart acquisitions. Um, so again, execution matters, right?

Sonali:
Yeah.

Deven:
Um, but yeah, I mean, absolutely there are, there are private software companies that are benefiting from the trends in AI.

Sonali Basak (00:17:48 -> 00:17:57)
Do you ever worry though that people might miss it because they’re so worried about what software might be in the middle of all of this AI disruption? I

Deven Parekh (00:17:57 -> 00:18:26)
Yeah, I think the baby is getting thrown out with the bath water, right.

Sonali:
Totally. Yeah.

Deven:
Uh, I think people are, people are bragging, uh, about their how little software exposure they have. All of a sudden, right? From six months ago, people were bragging about how much software exposure they had. Six months later, they’re bragging about how a little software exposure they have. And look, these things always over rotate, you know? And I think, uh, maybe there was a little too much excitement about software for a period of time, and now I think the pendulum has swung the other way. Um, and I think there’s still gonna be a lot, just so much innovation going on.

Sonali Basak (00:18:26 -> 00:18:34)
So, around the corner, the look around the corner, what really gets to you jazzed around the next generation of AI enabled companies? Where is the puck headed?

Deven Parekh (00:18:35 -> 00:21:08)
Look, I think that there are lots…so, what, let’s start with what are, what is everybody, you know, what should everybody be worried about? What are people worried about? What are, what do we spend our time thinking about when we’re looking at these new deals? Look at Anthropic, Open AI. These are pretty innovative companies. Anthropic is launching lots of new products every week. Um, there’s a risk of them continuing to move up the stack. Uh, and

Sonali:
What do you mean by that?

Deven:
So, you know, right now you think about, Anthropic as just, or people describe them as just a foundation model, right? And that they’re effectively just going to be an arms dealer, uh, and then all these applications are gonna use that intelligence and build smart applications. Um, but you’re seeing in legal and financial services and other things, that they’re trying to offer some of that functionality themselves. Um, now, today is, you know, and I’m using examples of companies we’re not investors in, but you know, you’ve got Harvey and Legora who are deep in a vertical, right? Um, and, but I think as an investor, you have to look at is, okay, how much value am I adding on top of the model, right? That’s number one. But the problem with that answer is that’s how much your value you’re adding today. Um, that doesn’t take into account where the model might go. That doesn’t take into account how it might get trained in the future. Um, and so I think one of the hardest things right now is kind of evaluating what is that moat and how durable is that moat. Um, that being said, it logically, uh, the, uh, Anthropic’s and the OpenAI’s are gonna spend their time on very large markets, uh, as they should. And there’s lots of, lots of other markets out there, uh, where I think you can offer interesting solutions. And the other thing I think is much less likely is what I talked about earlier, offering these types of solutions a service, uh, using your technology. I’ll use, you know, take Palantir as an example of an early example of that. Uh, but offering it a little bit more of a service, um, that’s less likely for somebody like, uh, an Anthropic or OpenAI to compete against, right? So, I think you just have to, there this, um, these models are offering are getting better and better by the day. Um, and I think what you wanna look for is what are applications, um, whose value to the end user customer, um, gets better as the models get better. Mm-hmm . Right? You don’t wanna be rooting for the models to not get better. You wanna be rooting for the models to get better. And if the models get better and better, you actually are still able to provide more value to your customer. That’s prob that’s probably a pretty good place to be.

Sonali Basak (00:21:08 -> 00:21:23)
It’s funny, we talk about this all the time from where we sit because it could help us with our research, but it’s incomplete. You can help, it could help us with our video, but it’s incomplete, and it does need to be better actually until we can get, you know, um, an AI employee sitting next to us,

Deven Parekh (00:21:23 -> 00:21:53)
and I think most people would agree, it’s an incredibly powerful tool.

Sonali:
Yes.

Deven:
Um, but it doesn’t get you to the end.

Sonali:
Yes, sure

Deven:
it still does hallucinate. Um, and so like, you know, there’s a lot of these applications, like if you were doing financial consolidation and you’re reporting your public numbers, you need an audit trail, you need data governance. Like, you need things that you’re not just gonna throw a spreadsheet into a model and say, you know, send me the result, right.

Sonali Basak (00:21:53 -> 00:21:57)
Okay so, give us a peek then into the next market that you think might be really interesting.

Deven Parekh (00:21:57 -> 00:22:20)
Oh, I mean, it’s, it’s, I mean it’s, that’s a really, really hard question ’cause I think the, um, the, the, the pace at which things are changing

Sonali:
Yeah.

Deven:
It’s, it is so hard. But for example, you know, I think a lot of people have been talking about, uh, uh, I asked the question a slightly different way. A lot have been, a lot of people have been talking about cyber being all these cyber stocks went down, like with Claude.

Sonali Basak (00:22:20 -> 00:22:20)
That was pretty curious.

Deven Parekh (00:22:21 -> 00:22:24)
I think cyber’s got a long way to run as an industry, right?

Sonali Basak (00:22:24 -> 00:22:30)
Well, wouldn’t you think, I mean, I thought that that was counterintuitive, right? Because on one hand, if you’re worried about AI, don’t you get more worried about cyber too?

Deven Parekh (00:22:31 -> 00:23:20)
Yes, because why, why, we can debate why, uh, philanthropic didn’t release meet those, whether it was because they had to or because they couldn’t or what, whatever. But the risks that were being discussed were cyber risks, right?

Sonali:
Right.

Deven:
Um, and I don’t believe that companies are gonna say that I’m just gonna rely on one model company or two model companies to both assess the threats, fix the threats, remediate the threats, and continue to monitor threats.

Sonali:
Right.

Deven:
Like, that’s probably not the way the market’s gonna end up going

Sonali:
, at minimum.

Deven:
So, I, I think that when you have this unbelievable technology that’s innovating, that can be used both in really positive ways

Sonali:
mm-hmm

Deven:
But it can also be used in really negative ways. Um, I think you’re gonna have, you know, more budget that’s gonna get needed, uh, to, to spend, to make sure you defense against threats.

Sonali Basak (00:23:20 -> 00:23:33)
Well, even from where I think about this a lot is what happens when agents start to work together more in terms of paying each other online.

Deven:
Yes.

Sonali:
When, when we start to envision a world where money is agentic,

Deven Parekh (00:23:33 -> 00:23:33)
Yes.

Sonali Basak (00:23:34 -> 00:23:38)
You need cyber defense to that too. And all of a sudden, it’s our dollars that,

Deven Parekh (00:23:39 -> 00:24:12)
And also keep in mind, like, you know, we talk about the world as if the only models that are gonna exist are kind of OpenAI and Anthropic but, you know, there are open-source models that are being built that are pretty competitive. Um, and we should assume that’ll continue to happen. Um, and if we ever end up with regulation or global regulation, which to me is a big if, uh, but if we did, you know, they may or may not be able, they may or may not fall within that, right. So, uh, you know, I think cyber as an example is there’ll be both new innovations, but existing vendors

Sonali:
Yeah.

Deven:
You know, are gonna continue to do well there.

Sonali Basak (00:24:12 -> 00:24:39)
So wanna talk a little bit about the history of technological cycles for a minute because if we were sitting here having this conversation last year, people kept asking, are we in a bubble? Are we in a bubble? Now, you could ask, did some of the bubble pop actually a little bit, right? Are we still worried about a bubble when we’ve seen, um, you know, a lot of rebound, but a lot of shakiness in the last six months over the AI theme. How does this cycle compare to other cycles you’ve seen?

Deven Parekh (00:24:40 -> 00:26:48)
You know, I think it depends on your frame, right? Like if you’re, if you’re worried about valuation, then people compare it to 2000. If you’re worried about, ‘well, what can happen to the macro economy because geopolitical risk’, then people compare it 2008, and people think are worried about interest rates, well then, you compare it to 1994. Like, so I think there’s a little bit of a tendency to compare it to the thing that, you know, you were most kind of concerned about and kind of worried about. But you know, you had periods, um, you know, you definitely had these periods of time where you had say, transitions from license to cloud, right? You had, and that you had transitions from cloud to mobile. Like people forget that Facebook went public, stock went down almost instantly because they didn’t have a mobile strategy, right? And they had to go create one and buy Instagram, and it ended up okay. I think that what you have here, I mean, the period of time is you, is technological shift, like we’ve had those before mainframe to, it’s just happening at a pace that those didn’t happen at, it’s happening way faster. So, the time to make, to adjust, right. And make the changes in your business. So, I think [25:46] it’s gonna be the companies are really able to, who’s able to retool really quickly, uh, in this new world. Um, and I think the thing that’s hard, and it’s hard for everybody, I think it’s hard for investors, it’s hard for CEOs, it’s hard for people within these companies is that the, you, you don’t have, you don’t have time. You don’t have a lot of time because the innovation’s happening at warp speed. Uh, and so I think it compares to a lot of those technological shifts that we’ve kind of talked about. More compressed. Um, to the bubble question, again, I think it depends on, I think if you’re, if you wake up in the morning, you think of yourself as a SaaS investor, uh, a SaaS public market investor, I don’t think you think it’s a bubble. Right, because valuations have compressed to like a 10-year low on a revenue multiple basis. I think if you’re, uh, uh, an AI investor, uh, and I said these things are coming together, but I’m just kind of talking about in the context of a bubble. Uh, if you’re a late-stage AI investor, I think you still think valuations are pretty high.

Sonali Basak (00:26:49 -> 00:26:54)
That’s the biggest question. Are we gonna look at these IPOs and say, whoa, everything was way too val, uh, overvalued in the private market.

Deven Parekh (00:26:54 -> 00:27:54)
But just, just, just to remember that like, you know, these, it’s, it’s amazing how quickly we forget things, right? Yeah. Because like 2021, valuations are really high and public markets were at 20 times revenue. 20 times revenue Uh, where software multiples where they’re now like four and a half or five times revenue, right?

Sonali:
Crazy.

Deven:
Um, but I think the thing we, we, this line we use internally, we don’t overpay companies just miss their numbers. I mean, it, it’s like, it’s a funny thing that we say, but what does it really mean? What it means is that when we’re underwriting a company, uh, we’re underwriting to a growth rate, right? Um, and if the company hits their growth rate, we generally didn’t overpay. Um, it’s when the companies don’t hit their growth rate. Um, and so let’s use a positive example. I don’t think anybody who wrote the check, uh, at Anthropic at $380 billion thought that it would, that would be effectively a 12 times revenue multiple within four months, right? So that’s a case of a company that massively beat its number and all of a sudden, the valuation didn’t seem so expensive.

Sonali Basak (00:27:54 -> 00:27:56)
Yeah, right. Nvidia has been going through this for years now.

Deven Parekh (00:27:56 -> 00:28:35)
Yeah so, I think I, I think the question I don’t have the answer, uh, are, are all these companies gonna be able to hit the projections that they’re putting out there? Yeah. Right? Um, and that’s not, that’s not a knowable. Um, because so many things are changing and the markets are changing, the competitive landscape is changing, you know, really, really quickly, you know, NVIDIA’s gonna have new competition, right? So, um, I think it’s hard to say, but I think it, it tends to be that what happens in these, you got these areas of interest. People start putting capital as areas of interest, prices get bid up, not only because the competition, but because those areas of interest have very, very high growth.

Sonali:
Yeah.

Deven:
Uh, and then the question is how sustainable.

Sonali Basak (00:28:35 -> 00:29:03)
Well, that’s the revenue growth rate, right? One thing that I think a lot of investors, I wonder if anyone’s gonna start to care, right, that the bottom line is actually quite challenged to the point you were making before, that they need to keep spending money. And most of the sell side believes that hyperscaler spend is gonna start to taper off. Um, I think I have a hard time wrapping my head around that because money is still needed to come in to finance this AI boom. So how is that spend going to taper off actually?

Deven Parekh (00:29:03 -> 00:29:50)
Yeah look, it doesn’t, you, it, you don’t see obvious reasons why that’s gonna taper off in the near term, right?

Sonali:
Right.

Deven:
You don’t, um, I think the things that you hear about in the market, you know, obviously these companies, both Anthropic and OpenAI, more OpenAI, have made, have made very big compute commitments. And that’s what people love talking about. Um, but at the end of the day, it depends on the week, right? They’re weeks where people are like, oh, OpenAI made great decisions ’cause look, Claude’s now constrained on compute, right? And other times where it’s like, oh, well, you know, they stopped doing video because they’re so, I, you know, I think these things change really quickly. but the truth of the matter is you still have a tremendous amount of growth. And you know, the other bottlenecks that we, we talk about compute, but energy’s a bottleneck, getting chips is a bottleneck,

Sonali:
Right

Deven:
All this stuff is a bottleneck.

Sonali Basak (00:29:50 -> 00:29:51)
Helium.

Deven Parekh (00:29:51 -> 00:31:51)
Yeah. All you, so you have a lot of bottlenecks, um, that that can kind of, so I think right now there’s not any obvious thing that you see that would slow the rise of demand. However, and this is the thing that it’s just hard to know, uh, is what you talked about. You talked about bottom line, and you talked about, look, there’s a lot of these companies, um, whose gross margins don’t look anything like the gross margins you would need to end up having a really profitable business, right? And you could paint the picture. Uh, you could on one hand you could paint the picture, um, that these compute costs are gonna go down. You could, you, you, you could have economies of scale, um, and you could see gross margins expand. Uh, you could see another, uh, argument that says, right, and you got open-source models that are there that are free, and the prices pricing comes down a lot.

Sonali:
Yeah.

Deven:
Uh, it’s amazing. If you look at the penultimate models, uh, of what people charge for, not the most recent model, the last model per token cost is so much lower than the current model. And I think over time, what are enterprises gonna do? They’re gonna say, well, over here I have a physics simulation, uh, that I’m doing and I need the most recent model. And over here I’m running an HR application, I could take three models to go and it’s good enough. And they’re gonna start optimizing that token spend, right? Because what’s happening in the enterprise right now, what are people being, people are being measured on just AI progress. Um, and so some of the KPIs people are using for that are things that are like kind of strange, right? Like token spend. Well, if you went to think about a marketing department, if you went to, you ran marketing and you go to the CEO and say, I’m just gonna spend another a hundred million dollars this year, and they would say, and what are we gonna get for it? That would be the question, right? That question’s not really being asked yet.

Sonali:
Yeah.

Deven:
Um, um, but eventually because of the scale of that spend,

Sonali:
yeah.

Deven:
These companies are gonna need to get productivity. Um, there’s gonna be more

Sonali:
Yeah.

Deven:
Optimization, uh, around that spend.

Sonali Basak (00:31:51 -> 00:32:02)
But in the near term, it just feels so clear to me that the technology giants of the future are not gonna be these FCF giants that the last set of technology giants had been in the public markets.

Deven Parekh (00:32:03 -> 00:32:10)
I mean, look, I I, it’s so hard to, it’s hard to know where all this is gonna, you know, play out, but like, it’s

Sonali Basak (00:32:11 -> 00:32:12)
What stops the train then?

Deven Parekh (00:32:14 -> 00:32:37)
I look generally what stops the train is somebody, some market participant, uh, missing their numbers in a really meaningful way, which causes people to have doubts about whether or not demand will continue at the same rate, which then causes capital to slow down, which then causes valuations to correct, right. I’m not gonna try to predict who that would be.

Sonali:
Yeah.

Deven:
I don’t know.

Sonali Basak (00:32:37 -> 00:32:45)
And like, let’s call it spade a spade from an investor perspective, that happening at this point is helpful to some degree given where valuations have been.

Deven Parekh (00:32:46 -> 00:32:55)
Yes. That being said, if you’re one of those three or four companies that’s, you know, trying to, you go public, uh, you know, in the next year, probably not helpful, right?

Sonali Basak (00:32:55 -> 00:32:56)
It’s not the right time for this moment

Deven Parekh (00:32:56 -> 00:35:07)
. But but I think if you’re, uh, but you know, at the market, I think if you were to talk to, we can all rationalize the valuations that we pay, right? ’cause we’re paying them, so we have to rationalize them. Uh, but I think if you had five, you know, investors around the table and you gave them growth, growth serum that all say things are expensive right now, right? Um, and but they would also say, and things are growing faster than they’ve ever seen, right? And they’d also say it’s unclear what the long-term operating margins are for these businesses. All like, all three of those are true, right? And, you know, one of the hardest things I think about this, our business, um, is, you know, we count on pattern recognition, right? Everybody counts on pattern recognition to some degree. And it could be pattern recognition on what makes a good CEO. It could be pattern recognition on what makes a good business model. Um, and we’re living this totally new world where sure, my, hopefully our pattern recognition still matters, but what works the next five or 10 years might not rhyme with what worked in the last five or 10 years. And we all have to look at this thing very differently. I, I, I’ll use again my example of Jeff Oring who’s been say, talking about like, we need to be thinking about services. Um, you know, and two years ago, I, I would be like, I’d be like, I, I don’t, I don’t really know what he means. I mean, I knew what he means, but I was like, why? Like, why is that where we should focus our time? And now it’s actually very logical. And now Sequoia and others have talked talking about that trend as well. So, you know, I think the, the markets are changing at this kind of very rapid rate and

Sonali:
speed alike.

Deven:
And, and I think the, well, we, what I think we, the best thing that we can do as investors is continuing to have high intellectual curiosity. We have to meet with as many companies as we can. I think it’s important to play with these tools ourselves, right?

Sonali:
Yeah.

Deven:
Like we’re all doing it. We did a hackathon, uh, two days ago at Insight, you know, 60 people building internally, building tools, uh, to use internally ’cause I think sometimes it’s hard to see the power of these things until you actually play with them to yourselves.

Sonali:
Totally.

Deven:
Yeah

Sonali Basak (00:35:07 -> 00:35:26)
Totally agree. Um, I vibe coded my own news app the other day to just get myself into it, um, and learn what I don’t know.

Deven:
Yeah.

Sonali:
Deven, thank you so much for joining us. We’re sitting in the middle of one of the most interesting markets. Excited to do this, uh, with you again soon when the market evolves even more at the speed of light, as we’ve been saying.

Deven Parekh (00:35:26 -> 00:35:27)
I look forward to it too. Thank you so much.

Sonali Basak (00:35:27 -> 00:35:32)
Me too. That is Deven Parekh of Insight Partners. And I’m Sonali Basak with the Bridge by iCapital.

END