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Digital Health Prospects for 2Q20…

Now that the economy is in a medically induced coma, venture capital firms are scrambling through their versions of “three stages of grief”

• What is the status of each portfolio company? Which ones need to raise capital? What cost reduction steps must reluctantly be taken? Are the current reserve assumptions appropriate?
• How do we feel about all of the in-process investments that have been diligenced for the last few months?
• When do we begin to consider new investment opportunities? And how can we do that if we are not even able to meet the team? Or visit the company?

Naturally, the first two items can be assessed quite quickly, and remedial action plans are likely already being deployed. The third item is a bit trickier to predict. When the Flare Capital team members were surveyed as to when we would all be back in the office, the answers spanned from early May to mid-July.

So it was with great interest to review the 1Q20 Rock Health data released today which registered nearly $3.1 billion of new digital health investments in 107 companies. This was the second largest quarter ever, behind 3Q18. Interestingly, the average size of investment was approximately $29 million, in part reflecting that there were six financings greater than $100 million (there were more than 100 such financings across all sectors in 1Q20). Later stage investments accounted for 31% of the financings, further underscoring the maturation of this sector. Rock Health also points out that 63% of all companies financed in the quarter sell into the provider segment, which as we painfully know, is solely focused on the Covid-19 crisis now.

1Q20 Rock Health

There is a nuance buried in the monthly data this past quarter that may inform what the next few quarters might look like. The January 2020 activity was very robust: 41 companies raised $1.4 billion – but the pace started to markedly slow as the quarter unfolded. February saw 33 companies raise $898 million while March saw a further moderation with 32 companies raising $603 million, just 40% of the investment activity two months earlier. As the volume of new commitments comes down over the next few months, it certainly appears that 2020 will look more like 2016 or 2017 than 2018 or 2019 in terms of overall investment activity.

1Q20 Avg Deal Size

Arguably, healthcare technology and services investment opportunities are even more of a priority today given all of the shortcomings that have been exposed over the last few months. The profound need for innovative new clinical care models, remote management, predictive analytics to identify and manage high-risk members of our society, solutions to accelerate drug discovery and regulatory approval, novel approaches to population health management, and solutions for patient financial responsibility have never been more important. And importantly, many of the onerous regulatory frameworks that slowed adoption of novel care models have been reformed, particularly for virtual care.

Thus, the dichotomy – enormous and painfully evident market needs staring at a deeply impaired capital markets. Entrepreneurs should expect a dramatically lower level of investment activity and with that, dramatically lower valuations (a review of trailing valuation multiples shows that 2H19 may well have been a highwater mark). Round sizes are likely to be considerably smaller, often tranched to value-creating milestones as investors scramble to manage liquidity and portfolio reserves. Terms are likely to be more investor friendly, reflecting the new risk environment. In times of dislocation, many corporate venture funds significantly pull back or leave the market altogether. Obviously, prospects of near-term compelling exits just evaporated. Management teams will be pushed to extend operating runways with the cash on-hand, as syndicate members nervously look around the board table to assess which funds will struggle to support the company.

And the cruel irony is that the healthcare needs are overwhelming. Axios recently reported that quarantined Americans are reverting back to many bad health habits:

Nielsen data for the week ending March 21 showed alcohol sales spiked 55%; online alcohol sales jumped 243%
Evidation Health data from 68k fitness trackers shows over the course of March activity dropped 39%
Marijuana sales are increasing dramatically – up 56% on California alone

With some epidemiologists estimating that the death total could ultimately be as high as 500k, a second order concern may well be acute malaise that sets in over the next few quarters as we collectively process such a catastrophe. Nearly 7,700 Americans pass away every day in this country which starts to put daily death tolls of a few thousand into some context. Inevitably, many of us will be personally touched by this virus, either will get sick or know someone who was sick or even died from this. There will also be third and fourth order effects as delayed attention to other chronic diseases catches up or a resurgence of Covid-19 returns.

Covid Cycles

While of little solace in this moment, the healthcare system is quite resilient and there are great entrepreneurs who already envisioning solutions to address many of the systemic issues we now are confronting.

Stay healthy…six feet apart.

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Whistling Past the Graveyard…

As we are now all expert on surge capacity and what it means for the U.S. healthcare system, we have tragically come to learn how woefully unprepared we are for a crisis of this magnitude. Shortcomings in supply chain are now frighteningly evident. Hell, even the lack of adequate labor is alarming as we now start to envision scenarios where some of the essential staff are taken offline. The New York Times recently highlighted that healthcare workers (orange dots) are literally in close proximity to disease daily. At the end of the supply chain is the Death Care industry which is also likely to be overwhelmed given how it is structured.

Risk Exposure

Within weeks (or less), U.S. hospitals will be overwhelmed with COVID-19 cases. The healthcare system is mobilizing, setting up ancillary care units, recognizing the expected inability to house all of those people. With approximately 2.4 beds per 1,000 residents, the U.S. is nearly one-third the per person capacity of countries like South Korea, which appears to have more effectively managed this crisis. If half of the 330 million Americans are infected, and if 5-10% of those cases are critical, it is near-impossible to see how 8 – 16 million people will fit in ~100k ICU beds.

Beds

According to the Centers for Disease Control and Prevention (CDC), more than 2.8 million people die each year in the U.S. (in 2017, 56 million people died globally or 150k per day). On average, 7.7k people die in the U.S. every day which puts the current crisis in such stark relief. About 2.5 million people live in nursing homes and long-term care facilities in the U.S. – 380k already die from infections in those facilities annually.

Dr. Neil Ferguson at the Imperial College in London, a prominent English epidemiologist, recently published models which estimated a range from best to worst case scenarios for deaths due to COVID-19 in the U.S. of 1.1 – 2.2 million people. Think about that. This pandemic has the potential to increase the annual number of deaths in the U.S. by 35 – 80% this year. Thus, the question now is what is the surge capacity of the Death Care industry?

There were an estimated 2.7 million funerals last year. The Death Care industry employs 123k people and is forecasted to be approximately $68 billion in 2023, after a long period of very modest growth according to Research & Markets, Inc. It is principally comprised of three sectors: funeral homes, cemeteries, and memorial products. According to the National Funeral Directors Association (NFDA), there are nearly 19.3k funeral homes (11k of which are members of the NFDA). Funeral home revenues are estimated to be $16.8 billion per IBIS World, with the six largest companies controlling nearly 30% market share. The dominant player is Service Corporation International (NYSE: SCI) with $3.2 billion in revenues, operating margins around 20%, and a market capitalization of $6.8 billion (~2x revenues).

There are over 115k cemeteries in the U.S., which is actually a difficult number to determine given many are not actively managed. SCI estimates that “for profit” cemeteries generate around $4.0 billion in annual revenues with “healthy” operating margins of nearly 30%.

The third significant sector of the Death Care industry is something called memorial products and includes items such as funeral planning, cremation, body preparation, transportation and other assorted merchandise. There are over 300 brands of caskets. While the cost of a funeral may be $8k – $10k, all the additional add-ons likely make these ceremonies meaningfully more expensive. It is estimated that Michael Jackson’s funeral cost well over $1.0 million.

Innovation, believe it or not, is an important recent industry development as issues like brand and environmentally sensitive procedures are becoming much more relevant. And now grieving-at-a-distance. It has also been an industry that has had to gently navigate cultural and religious norms and peculiarities. Now other powerful forces are at work. In 1970, 5% of all funerals involved cremation, but with increasing environmental concerns of placing so much steel and embalming fluid in the ground, cremation is now approximately 56% of all funerals (annually, enough embalming fluid is used to fill eight Olympic-size pools and enough steel is used to build the Golden Gate Bridge). Now that there is a new emerging concern about greenhouse gases as over 600 million pounds of “pollutants” are released, alternative procedures such as alkaline hydrolysis or “green burials” are becoming more prevalent. Cremation is thought to be much less profitable than traditional burials.

Interestingly, until recently, industry analysts had warned that with the dramatic decrease in tobacco usage and increased life expectancy, the Death Care industry was in for relatively difficult times. In 1882 in Rochester, NY, presumably given the needs highlighted by the 620k Civil War fatalities, the first ever National Funeral Directors convention was held. One cannot help but wonder how the industry now will navigate this expected surge, particularly when groups no larger than 10 can congregate. Hopefully, as McKinsey & Co. underscores below, necessary steps can be taken to dramatically reduce the mortality rate and viral reproduction dynamics in the population otherwise this surge will be devastating even to the Death Care industry.

COVID

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Pandemic Bonds and Peru…

It certainly appears that I missed some extraordinary events while in Peru last week. While every week now feels quite extraordinary, the across-the-board asset price correction was deeply unsettling. Equities plunged into “correction” territory. Investors sought security as government bond prices hit historic highs, driving yields to 0.7%, alongside accelerated withdrawals from riskier high-yield bond funds. Price of gold soared 6.8% just last week alone. OPEC, unable to agree to proposed 4.0% production cuts, saw Brent crude prices drop 9.4% (and another 30% in early-morning trading in Asia!). In light of the unfolding coronavirus crisis, analysts up and down Wall Street were “adjusting” U.S. GDP growth projections. For example, Deutsche Bank revised 1Q and 2Q growth rates from 1.7% and 2.2% to 0.6% and negative 0.6%, respectively; a net 2.8% change in 2Q is staggering. All of this has created volatility not often seen in the capital markets.

Trump Volatility
One other recent announcement merits highlighting and that is the federal government’s $8.3 billion coronavirus relief package (~$25/person), of which $3.1 billion is for public health and social services. A further $2.2 billion was directed to the Center for Disease Control and Prevention of which $1.0 billion is to go to local facilities and interestingly $0.3 billion was for international needs (more on that shortly). With global reported cases now exceeding 100k and nearly 4k deaths, challenging questions about U.S. preparedness are being pressed. Shockingly, a recently leaked presentation used by the American Hospital Association to prepare for worst case scenarios estimated that there could be as many as 96 million cases of coronavirus with 460k deaths in the U.S. alone.

Peru, a country of 32.8 million people nestled comfortably on 500 million square miles of some of the most staggeringly beautiful vistas in the world, would certainly be runover by a coronavirus outbreak. According to the World Health Organization (2017), Peru spent just 3.7% of its $505 billion in GDP on healthcare, and has run consistently 50% of what most Latin American countries spend. Over half  of the population is indigenous, while 19% of the country is below the poverty level and 79% live in urban settings. Across many of the leading healthcare indicators, Peru compares poorly to its peers. Life expectancy is 77 years (74.5 for men, 80.2 for women), ranking 65th in the world according to the United Nations Population Division (50 years ago, life expectancy was 54 years). The obesity rate is 19.7%, putting it #109 globally (interestingly, Vietnam is #1 with 2.1% while tiny Nauru in the Australian Ocean waddles in last place with 61% of its 13k residents deemed obese).

Today Peru is a democracy spanning across 25 regions. For a dozen years starting in 1980, the country suffered through a terrible period of bloody insurrection led by the Shining Path, a communist organization determined to overthrow the government. The end of the twentieth century also saw periods of hyperinflation, which occasionally reoccur as much of its economy is tied to prices of important commodity exports such copper, gold and zinc. The boom and bust cycles are very evident as most houses look mid-construction with rebar poking through first floor walls, waiting for additional floors to be built. And rarely was there construction work being done.

Peru Building

The last decade saw relative economic prosperity and fostered a greater commitment to improve public health (similar dynamic I saw in Colombia last year). In 2009, a universal health insurance law was passed which now effectively covers 80% of Peruvians. There was a significant investment in primary care infrastructure (there are now 1,078 hospitals in Peru) and outreach to rural communities (36% of all births are still outside of hospitals). Half of the population is indigenous and still quite reliant on “traditional” medicines and shamans which is readily apparent given how often one is offered coca tea. It is somewhat unsettling to see hanging in the markets alpaca fetuses which are considered spiritually beneficial. Unfortunately, today it is estimated that the top 20% spend ~4.5x more on healthcare than the bottom 20%. Thus, my concerns as I watched the pandemic unfold (fortunately, Peru still does not have a reported case). Peru is also hosting 860k Venezuelan refugees, per Financial Times estimates, further stressing local healthcare infrastructure.

In 2017, as the Ebola crisis was winding down with “only” 11k deaths and at an estimated $53 billion economic cost, the World Bank developed a novel (controversial?) financing instrument affectionally called “Pandemic Bonds.” Up until that point, there had not been a structure to allow institutional investors to participate in such events. Insurance and the derivative markets are very sophisticated in underwriting most other risks (flood or fire insurance, natural disaster insurance, etc) but had yet to create an instrument for investors to mitigate pandemic risks we see emerging today. Financial instruments are meant to spread risk while rewarding investors who take on those risks.

Technically called the Pandemic Emergency Financing Facility (PEF), the World Bank heralded the creation of these super complex $500 million specialized bonds, as they were 2x oversubscribed. At its essence, the bonds were designed to assist poor countries to finance a response to a healthcare crisis, while offering investors attractive returns. Structured across two-tranches (Class A and B), payouts were based on predetermined mortality rates (number of deaths over certain time frames). Class B investors were paid LIBOR +11.1% but faced complete loss of principal, while Class A investors earned LIBOR +6.5% with losses capped at ~16% of principal.

Naturally with complexity and given the exposure to catastrophic loss of life, there is now controversy as to how these bonds really work. Have enough people died, fast enough? Is this a “qualifying” pandemic? Most analysts expect that the bonds (which do not trade publicly) should start to payout in April 2020, which likely accounts for the rumored discounted private market pricing of $0.64 on the dollar. Obviously, the complexity is bad, but importantly, the returns are actually correlated to broader capital markets. Ideally, these types of financial instruments should be more valuable as the health crisis unfolds, attracting additional capital to support these poorer countries.
The reality is that these pandemic bonds will at most pay approximately $195 million to just the poorest countries, a relative pittance given the overall costs to contain and treat.

Unfortunately, these are also the countries (like Peru) with the weakest healthcare systems, least likely to capture accurate and timely data to even begin to assess the severity of an outbreak. Iran has already run out of hospital beds in the hardest hit northern provinces. The only public health signage I saw all week in Peru was as I was boarding the flight back. This starts to explain the World Bank announcement on March 3 of a $12 billion coronavirus aid package.

Peru Public Health.jpeg

Since early February 150 Chinese companies have issued $34 billion of “coronavirus bonds.” State-owned banks were the principal buyers and at what was deemed to be below market rates, certainly not priced to reflect the true economic risk. These issuances allowed many of these companies to fund accumulating losses associated with the global disruption caused by the epidemic. Chinese exports have already tumbled 17% in the first two months of 2020. For instance, Didi Chuxing (“China’s Uber”) just spent $14.3 million to install plastic sheeting between the driver and passengers in all of its vehicles and in the face of dramatically reduced ride volumes. Passenger car sales fell 80% in February in China, according to Reuters.

At least the sun was out at Machu (“Ma-a-achoo”) Picchu which was breathtaking but in a good way…

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Chocolate Mess…

As we now languish in the chocolate void between Valentine’s Day and Easter, it was with great sadness that I learned that the formation of the “Chocolate OPEC” (“COPEC”) by the Ivory Coast and Ghana, which together account for 60% of global cocoa production, is expected to cause the price of chocolate to increase significantly. While most commodities have experienced notable price declines with continued global trade concerns and the spread of Covid-19, cocoa prices have risen, spiking nearly 7% just in the first two weeks of 2020 alone. Cocoa is (obviously) the principal ingredient in chocolate.

Chocolate Prices

Data: FactSet; Chart: Axios Visuals

Over the last five years, cocoa prices have swung wildly from highs around $3,400 per metric ton to lows of $1,800 just two years ago. While prices today are closer to $2,900, a few years ago “COPEC” initially considered instituting a price floor but later determined that adding a $400 per ton premium was more beneficial to cocoa farmers. The goal was to ensure that farmers would realize at least $1,800 per ton, which is challenging given the complexity of the supply chain with local government squatting right in the middle. According to the International Cocoa Organization, last year 4.8 million metric tons of cocoa were milled. The World Bank goes on to observe that 80% of all cocoa farmers, which equates to 4 million people, subsist on an income of $3 per day. Forty-five 141-pound bags of cocoa generate $3 to a farmer.

 

Cocoa Prices (2)

The chocolate industry is estimated to be over $107 billion. The National Confectioners Association estimated that $21.1 billion of chocolate was sold in the US last year (of the $34.5 billion of total candy sales). Global consumption rose 5.7% over the five years from 2012 – 2017. With premium craft chocolate bars now retailing for more than $8, one would to expect to see continued strong growth.

In fact, the industry has worked hard to promote the health benefits of dark chocolate with its cocktail of antioxidants that, in moderation, may prevent cardiac disease and type 2 diabetes, as well as being a mild sexual stimulant – true story. Obviously, in excess, chocolate is quite likely to be unhealthy. It is rich in caffeine (20 mg per 100 grams) and theobromine, which has several toxic side effects. It is believed that as earlier as 1750 B.C. Mexicans enjoyed chocolate drinks as a source of healthy nutrition. Undoubtedly, though, chocolate (and other refined sugars) have contributed directly to the fattening of Americans over the last half century.

Average Weight

In addition to weight gain, there are other elements of the chocolate industry which are unhealthy. “COPEC” is in part a response to the very difficult labor conditions and poor wages facing cocoa farmers. It is also an industry that is fraught with child labor issues, as it is estimated to “employ” upwards of 2 million children.

This is largely due to the intensity of developing this crop. It takes 3 – 5 years for a cacao tree (which grow cocoa beans) to begin to bear fruit. It takes 4,000 cocoa beans to produce one pound of chocolate (which is about 10 Hershey bars). One cacao tree can produce between 1 – 3 pounds of chocolate per year (or between 4 – 12k beans). This begins to put the scale of human labor required into proper context. With global climate change, producers in “COPEC” are worried about the ability for cacao trees to continue to be as productive so in 2010, after the cacao tree genome was sequenced, scientists started to bioengineer new strains of cacao trees.

There is another constituent which finds chocolate quite unhealthy: dogs. According to the American Society for the Prevention of Cruelty to Animals, there were 20,865 calls for something called “canine chocolate exposure” in 2018 (versus 33,486 calls for prescription pills). In fact, 11% of all calls to the ASPCA were for eating chocolate with the monthly rate doubling in December as dogs found their way to Advent calendars and other holiday gifts. It turns out that as little as 3.5 ounces of chocolate can kill a 20-pound dog. Each treatment cost approximately $450, mostly to induce vomiting.

And on the brighter side, there appears to be a very strong correlation for countries with high (excessive?) per capita chocolate consumption and the number of Nobel Laureates. Evidently, Switzerland has a high number of really smart but fat people jacked up on caffeine.

Chocolate vs Noble Prizes

Mark your calendars: National Chocolate Day is November 29.

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Another Terrific Healthcare Technology Year in the Books…

The underlying fundamentals in the healthcare technology sector continue to be strong and supported by important transformative forces. Some observers were anxious exiting 2018 that perhaps the sector had entered into a “bubble” phase with too much capital being invested in wobbly business models. That certainly does not appear to be the case at all. And while the $7.4 billion invested in 2019 (Rock Health data) was a decrease from the high-water mark of $8.2 billion in 2018, the number of funded companies has been relatively consistent over the last handful of years.

Health Funding Rock Health

As a point of comparison, StartUp Health which includes global data and has a more expansive definition of “digital health,” tallied $13.7 billion invested in 727 companies in 2019 which also was somewhat down from 2018’s level of $14.7 billion. The sectors that saw the most investment activity in their data were Patient Empowerment ($2.7 billion), Clinical Worflow ($1.9 billion) and Wellness ($1.7 billion). Interestingly, StartUp calculated that there has been over $70 billion invested in the healthcare technology sector since 2010.

Arguably, this sector may be poised for some rationalization as “emerging winners” become more evident and investors drive larger, later stage financings. Per Pitchbook data, median early stage round sizes were consistently in the $5 – $7 million range, and when compared to median early stage round valuations in the $15 – $17 million, this suggests that entrepreneurs were incurring ~33% dilution (see charts below). While 30% – 40% dilution was incurred all stages, there was a notable drop in valuations for late stage rounds from $325 million in 2018 to $185 million last year.

HC 2019 Round Sizes (2)

The other important barometer of industry health is the step-up between post-money valuations and the pre-money valuations of the successor round. Meaningful step-ups strongly suggest that companies are executing well and hitting important commercial and product milestones. To set context, financing rounds tend to provide around 12 – 18 months of runway. Essentially, the median data suggest that early stage round investors were realizing ~2x step-ups from one round to the next, while there may well be some multiple compression at later stage rounds; that is, the step-ups are not nearly as significant given the size of the rounds. This is something investors watch closely, particularly given there were only 112 M&A transactions, and that was down 40% from 2018. The ability to privately finance growth is critical.

HC 2019 Valuations (2)

Some of this enthusiasm may be due to a belief that the IPO market was opening, at least for successful healthcare technology companies that had reached a sufficient commercial scale and were either profitable or converging on profitability. There were six successful IPOs in this sector in 2019 which today trade at a cumulative market capitalization $17.5 billion. This is even more impressive given those companies collectively raised $1.8 billion (admittedly does not include Change Healthcare data, which was spin-off). Rock Health’s “digital healthcare” IPO index increased 31% in 2019, right in line with the 30% increase for the S&P 500 index. Additionally, One Medical had a very successful IPO in 1Q20.

At its essence, the investment strategy of our firm (Flare Capital Partners) is informed by the observation that as other industry verticals (financial services, adverting, commerce, etc) were re-architected over the last twenty years, profoundly disruptive venture-backed companies emerged generating enormous shareholder value. For instance, the U.S. advertising market is estimated to be $240 billion (Statista) and attracted $1.9 billion of venture capital investment in 2019 ($4.5 billion in 2018). The U.S. healthcare industry is nearly 15x larger and arguably has the potential to create several hundred (if not thousands) of valuable companies over the next few decades. The complexity and numerous sub-specialties provide no shortage of markets to reinvent.

HC 2017 (2)

Bruce Broussard, CEO of Humana (Flare Capital Industry Advisory Board member), recently observed that the core issue healthcare needs to solve is one of affordability. In order to make progress against this goal, there were three paths forward: significant investment in technology, payment model reform, and change the role of the consumer. Improved analytics will assist in delegating decisions and allow novel entities to more effectively take on outcomes risk. Broussard is excited about transforming data to be more clinically oriented versus claims oriented. Increased consumer centricity implies a much greater reliance of effective primary care services and improving access into the member/patient’s home.

All of this implies that one should see continued convergence of technology and services to create novel offerings in 2020 – neither component alone is enough to drive down costs and improve outcomes. Specifically, “digital front-ends” to manage members/patients more effectively over time and over their healthcare journeys will be more prevalent. In parallel, the convergence of payor and provider business models will increase. Expect to see investors continue to embrace healthcare services, notwithstanding the capital intensity implied. Notably, the number of Medicare Advantage members grew by 9.4% in 2019 to 24.4 million people.

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2019 – Groundhog Year…

Rinse and repeat. In many important ways this past year felt very much like 2018. Many pundits had expected that the great bull market would finally come to an end, interest rates would rise, inflation would kick in, and unemployment rates would start to increase. None of that happened.

While there was a notable shift in investor sentiment on profitability over growth at all costs, particularly in light of the failed WeWork IPO, the $136.5 billion of venture capital investments in 2019 nearly hit the all-time high of $140.2 billion registered in 2018. Ten years ago, coming out of the Great Recession, venture capitalists invested just over $31 billion, less than a quarter of the current activity. Quite clearly this robust pace was driven by an extraordinary year for exit activity. For all of 2019, there were 882 liquidity events which totaled $256.4 billion in exit value, a high-water mark nearly doubling any prior year and perhaps not likely to be seen again.

But be forewarned: 2019 was the first year in nearly 20 years that 40% of all public companies lost money (negative net income) and yet the Dow raced to 29,000, now trading at 25x P/E ratio for the S&P 500 index.

As with any headline, there are nuances beneath the surface which make the story somewhat more complicated. As shown below, even the quarterly investment pace slowed significantly in the number of financings and likely suggests growing concerns among VCs to make new commitments heading into an election year with an impeached President and the Dow now marching to 30,000. Even the exit activity was heavily weighted to the first half of 2019 and skewed by the $75 billion valuation of the 2Q19 Uber IPO. In fact, this past quarter saw only 174 exits valued at $18.8 billion.

 

4Q19 VC

 

Notwithstanding that the 4Q19 pace is more than $13 billion less than what was registered in 4Q18, for the entire year the amount invested and number of deals across all stages were relatively consistent between 2018 and 2019. This past year there were 4,556 angel and seed deals which raised a total of $9.1 billion as compared to 4,541 and $9.2 billion in 2018, respectively. For early stage investments the amount invested and number of deals were $42.3 billion and 3,624 in 2019 and $43.3 billion and 3,722 in 2018, respectively. The same holds true for late stage activity: $85.1 billion and 2,597 in 2019 and $87.7 billion and 2,279 in 2018, respectively.

More than 62% of all capital invested in 2019 was in late stage deals, suggesting that investors may be focusing on less risky, more mature opportunities. In point of fact, 181 deals in 2019 were larger than $100 million; 53 of those 181 deals were for early stage companies, raising $9.7 billion (or 23% of early stage deals were larger than $100 million).

According to Crunchbase, globally there were 455 financings in 2019 that were greater than $100 million in size, raising in total $108 billion. Given the increased scrutiny on IPOs (and the possible emergence of direct listings which largely side-step Wall Street), it is noteworthy that of all of the “mega rounds” greater than $100 million between 2008 – 2015, 19% of those companies went public – a rate far greater than companies that did not raise such a round.

All of this robust investment activity in the late stage marketplace has clearly put upward pressure on valuations as shown below. A mere five years ago median late stage valuations were just over $50 million and now are close to $90 million (average late stage valuation in 2019 was $488 million, clearly skewed by the 155 unicorn financings) as shown below. Median late stage round size was up slightly over the last five years from $9.0 million to $10.4 million in 2019, suggesting that investors now are owning a far smaller percentage of these companies. Another implication is that early stage investors are showing dramatic unrealized mark-ups in their portfolios.

2019 Valuations

The real story in 2019 was about exit activity. Of the 882 exit events, 627 were acquisitions and 80 were venture-backed IPOs. Interestingly, the investments to exit ratio was 12.2x in 2019, a level not seen before (2018 was 10.4x) indicating a growing backlog of private companies. While the $256.4 billion of exit values last year somewhat masks a relatively weak 4Q19 for exits, undoubtedly significant liquidity to LPs will be recycled as new commitments to new funds. Fundraising last year hit $46.3 billion across 259 funds which was the second strongest year behind the $58 billion raised in 2018. The median fund size was $79 million while the average fund size was $182 million, highlighting that the venture industry continues to see a “barbell” phenomenon with a handful of mega funds co-existing with many small micro funds; 93 funds were less than $50 million in size.

According to Preqin, there is $276 billion of “dry powder” held by US venture funds, which is ~3x the level in 2012. Preqin also estimates that there is $365 billion held by Asian venture capital firms, of which $100 billion is uninvested “dry powder.”

Elsewhere, the level of U.S.-based venture capital investment in China is estimated to have dropped to less than $4 billion last year from an extraordinary level of $17.4 billion in 2018, according to an analysis by the Rhodium Group. Obviously, this reflects the grinding trade war with the U.S. but also may be impacted by China’s 6.1% GDP growth rate in 2019, meaningfully below 7.0% – 10.0% over the past decade. The level of venture capital invested in the U.K. hit a record of $13.2 billion in 2019, an annual increase of 44%. Germany and France venture capital activity increased 41% and 37%, respectively. Clearly in an economic environment with near-zero interest rates and uncertain GDP and trade growth rates, investors appear to be seeking return investing in innovation in relatively stable jurisdictions.

 

2019 Growth

 

Extraordinary levels of raised capital was not just for venture capitalists. Preqin also flagged that the private equity industry has $772 billion of “dry powder” and raised $595 billion globally last year. Perhaps signaling investor desperation for yield, more than 25% of all IPOs last year were by special purpose acquisition companies (SPACs) which do not have any operations and are “blank check” companies whereby the issuer then has two years to acquire an asset. Over $13.6 billion was raised in 59 SPAC IPOs last year. And all of this against a backdrop of lower rates and a Federal Reserve that injected a few hundred billion dollars into the financial system this past fall. Hmmm.

So, this will close with a word of caution and that involves global debt levels, which hit a record of $253 trillion (with a “T”) in 3Q19 according to the Institute of International Finance. The debt to global GDP ratio of 332% is also a record and cause for significant alarm. While much of this debt are obligations of governments and non-financial corporations, the risk for systemic instability is real and very present should interest rtes spike or global economic growth continues to slow.

 

2019 Debt

 

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Flare Capital Team Upgrade…

Last week we made two somewhat related announcements, both of which look to further deepen the Flare Capital bench.

Parth Desai, who joined us as a Senior Associate in March 2019, was promoted to Principal, largely in recognition of his tremendous contributions to the investment activities of the firm. Parth has identified a number of compelling new investment opportunities, and more importantly, has introduced us to extraordinary entrepreneurial talent. Venture capital is all about working with the best entrepreneurs and Parth has made a significant impact there. It was quickly evident to us that his industry insights and strength of network were viewed as real assets by many people we wanted to back. In addition to terrific investment judgement and being a lightning rod for great people, he is an absolute delight to have around.

Notably, Parth has also taken on the oversight of the Flare Scholars program, which is a five-year old initiative offering professional development for people who are earlier in their careers, excited about healthcare technology innovation and want to learn about venture capital. With the Class of 2020, which will be announced shortly, there are nearly 150 current and former Flare Scholars. Many of them have gone on to either start exciting new companies, join leading healthcare technology companies, or join other healthcare investment firms. Scholars either come from leading schools around the country or innovative healthcare companies. Parth was a Scholar himself.

Concurrent with the new Scholar class, we are excited to announce the formation of Flare Scholar Ventures, whereby we have allocated a portion of our newest fund to invest in Scholar-backed opportunities. Many of our Scholars are looking to start companies and only need a small amount of capital to knock down early technical or commercial milestones. Our hope is that Scholar Ventures may help stand up as many as a few dozen companies backed by what we have come to believe are some of the most compelling young entrepreneurs in the healthcare technology sector. Scholar Ventures
According to Rock Health, $7.4 billion was invested in the digital health sector in 2019, which while modestly down from the $8.2 billion invested in 2018, still suggests that there is plenty of capital available but much of it was for more mature companies (average deal size in 2019 was $19.8 million). Working with many of our Scholars, we determined that the market opportunity was to provide “pre-seed” financing to get them started. As roughly half the Scholar classes are academics, we expect to see a number of very novel, super technical projects where we would look to connect them with strong commercial and product leaders from our network. Conversely, the other half of the Scholar classes are from industry and see firsthand where the healthcare system needs to be re-invented.

If Parth’s trajectory is any indication, we have plenty of reasons to be excited about what Scholar Ventures spins up.

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