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Venture Capital and Innovative Banking

In this week's episode of Industry Focus: Financials, host Jason Moser talks with Motley Fool Ventures Brendan Mathews about the venture-capital life. Brendan updates listeners on some recent investments MFV has made and what makes those companies so exciting, two public banks that work heavily with the private world and stand to benefit from it, how investing in the VC world is critically different from investing in public companies, and what we know about the We Company debacle and how much blame SoftBank should get for it. Plus, stay tuned for "What's the last stock you bought and why," a vent session about things that really grind our gears, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Nov. 11, 2019.

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Monday, Nov. 11. It's Veterans Day, so we'd like to offer our deepest thanks and gratitude to all of those who've served this great country of ours. Listen, folks, it's our country. We're all in this together, so be kind to one another.

I'm your host, Jason Moser. Joining me in the studio this week from Motley Fool Ventures, he's back, yeah, I'm talking about Mr. Brendan Mathews. Brendan, good to have you back in here!

Brendan Mathews: Hello, Jason!

Moser: So, on today's Financials show, we've got a lot to talk about. We're going to get into what's been going on with Motley Fool Ventures and some of the latest on the investments that you guys have made. We got a couple of banks that listeners should get familiar with. We've got opinions on SoftBank's troubles. We've got more of the last stock you bought and why. And, well, we got a couple of things to get off our chest, too.

But first, let's go ahead and kick it off here with Motley Fool Ventures. Brendan, you've been with Motley Fool Ventures now over a year?

Mathews: It has been over a year.

Moser: Yeah, well, you were last in here three or four months ago, and we were talking about how things had gotten going. Let's talk a little bit about how things are faring toward the end of this year here with some of the investments that you guys have made over there at Motley Fool Ventures. For those who aren't familiar, Motley Fool Ventures, it's our venture capital wing of the business here at The Motley Fool. You're in the business of making investments in smaller, privately held companies that haven't had a chance to make it to the public market yet.

Matthew: Yeah, exactly. We're playing the long game, just like The Fool does in public markets. Our fund is a 10-year fund. We're continuing to support the companies that we've invested in previously. We've talked about HomeCare, a healthcare staffing agency. We continue to support them. Upskill, an augmented reality tool for industrial workers. We've continued to support them. We only actually have made one new investment in the past quarter. It's actually a super interesting one, though. It's called Blokable. It's a vertically integrated manufacturer of manufactured homes. Basically, they have what's called Bloks. It's a cube of walls that they slap together on-site. It's higher-quality housing, and they can combine them in multiple configurations to have better, cheaper housing, built faster. They do all of the design themselves. They actually build the houses, and then, depending on the model, they often own part of the actual real estate development.

Moser: We talk about businesses that we're familiar with, can understand, you can relate to, I'm only half kidding here, this is a business probably a five-year-old can understand, just playing with blocks, right? You're just putting these blocks together and there you go. The name seems like it says it all.

Mathews: Yeah. It's going to be interesting to see how they develop. It's a new company with a big vision. We're part of a $23 million series A led by Vulcan Capital, which is Paul Allen's investment vehicle. They have a factory in Vancouver, Washington, they're building one in Sacramento. The idea is to take traditional piece-by-piece construction and replace it with modular, more efficient housing.

Moser: When you talk about vertical integration, I want to talk a little bit about that with our listeners who may not fully understand what you mean by that. When we talk about a company that's vertical, we're talking about a company that controls all aspects of that product or that service that they're offering. You mentioned how they do their own designing and their own manufacturing. Basically, what you're saying is, Blokable owns the process from start to finish.

Mathews: Yeah. They're in it from the beginning to the end. Part of it is, real estate, housing, especially big developments for residential, can be a complicated, slow process. They want to be there every step of the way to make sure things get done right, and ideally faster and more efficiently.

Moser: It can be a little bit more expensive on the front end to build a business like that. But typically, the longer a business goes on with that vertical integration, I mean, we've seen a lot of that in some of our favorite investments over the years here. The companies that have that vertical integration, it becomes a bit of a competitive advantage to an extent. I would imagine that Blokable would be no exception there.

You mentioned you've only made one investment lately. I want to dig in there a little --

Mathews: One new investment.

Moser: One new investment, I'm sorry. Do you and the team feel like you're coming into a time where it's more difficult to find good ideas? Or, is it valuations? Or is it a little bit of both?

Mathews: We continue to find good ideas. What we're trying to do is stick to a pace of about two new companies per quarter. We want to over five years invest in about 45 to 50 companies. We're right at the pace that we want to be at. We have to manage our time internally between supporting our existing company, so, that means additional rounds of funding for companies already within the portfolio, against looking for new ideas. It's the same with a portfolio of public stock. Sometimes you'll find you're spending a lot of time looking at your existing companies for more dollars and more reinvestment. For us, it's a little bit different because we're providing primary capital vs. secondary capital. A lot of it is driven by, companies need more money, which is oftentimes why we'll be funding them, vs., this is our favorite company at the moment. We're still continuing to find lots of great ideas.

Moser: Probably one of the luxuries that we have as public market investors, that you don't get so much of now, but I have to imagine it's very valuable, you're having that experience on both sides there. Information is a lot tougher to come by there when it comes to these smaller private companies, isn't it?

Mathews: Yeah. We have a lot of things hamstring us. A lot of times, we don't get to decide when we invest. If a company's raising capital, that's the time at which we invest. We can't sell anytime we want. We have to be invited to invest. We can't just pick out a company and send them a check. We need to talk to management and make sure they want us on board. But, yeah, information is a lot harder to find. You have to work harder to find it. It's a lot easier to have an information advantage in private venture markets. They're just a lot less efficient.

Moser: Let's switch gears here and talk a little bit about a couple of banks that we've talked about before. One of them has been in our Foolish universe here for a little while. One is a relative newcomer. We have Silicon Valley Bank (NASDAQ: SIVB) and Live Oak Bank (NASDAQ: LOB). These are a couple of companies that you, I know, continue to follow. Small banks, but making big investments on the tech side. Wanted to talk a little bit more about where you see these banks going, and how we're in this age of fintech, and technology, as it's done with everything, it's certainly changing the face of finance as well. Talk to us a little bit about Silicon Valley Bank and Live Oak Bank, and some of the things that you like seeing coming out of those two companies.

Mathews: Sure. These are two banks I came across in the day-to-day ventures business world. Sometimes I like to come talk to you about the companies that I see out there in actual real life. That's probably where most of my public market research or knowledge is generated these days, by things I come across in the venture world. Silicon Valley Bank, we've definitely known about that one for a while. It's actually been a partner bank of The Motley Fool as a corporation for quite a while. It's also been a recommendation in a couple of our services for quite a few years. What I've found is, being out in the venture world is complete validation of our earlier thesis that they're really everywhere in the early growth company ecosystem. We look at our portfolio of companies, there's quite a few of them that use Silicon Valley Bank, either for their operating account, their bank account, some of them have lines of credit. Everywhere you go, you hear SVB. If somebody is looking to take a loan, it's SVB. They have a powerful, dominant franchise with early growth companies, and then also people who invest in them.

Moser: The name says it all, right? Silicon Valley. We talk about information being tough to find sometimes. I would imagine they have some pretty good channels to some information that is very relevant in this quickly developing tech space.

Mathews: They do. Also, this is what I've heard from our corporate side, they're great to work with as a growth company. Corporate bankers will loan money to companies, traditionally aren't set up to loan to growth companies. They want to loan collateral, they want your assets, you want to be a well-established business. So, they're not the best to work with newer, growing companies. Silicon Valley Bank, SVB, really is. One of the things you see if you look at their numbers is, they have a super low cost of funds. Most of their deposits are actually non-interest-bearing. That's companies who are holding their cash balance with them just because they like and value the services provided by SVB, and they're not getting paid any interest.

Moser: That means that basically, Silicon Valley's not having to pay for access to that capital.

Mathews: Right. They have a very cheap cost of funds. Their overall cost of deposits is 38 basis points. There's a great opportunity -- if you're borrowing at 38 basis points, and you can go out to lend to companies at even a prime rate of 5% or 10%, there's a great spread for you. It's allowed SVB to be super profitable. Looking at some of the headline numbers. Return on equity, for a bank, we like to see 10% to 15%-plus. They're at 21%-plus, which is pretty impressive. They've continued to grow. Over the past five years, their earnings per share are up 32% at a compound rate. Now, of course, we have to keep in mind, they're pretty heavily tied to the venture cycle, which we're a little bit deep in. I guess, I just wanted to bring forward how powerful that franchise is.

Moser: We're talking about Silicon Valley Bank, we're actually talking about --

Mathews: SVB Financial.

Moser: The ticker there, for those interested, is SIVB.

Let's pivot over to Live Oak. This is a company that I've recently started digging into. Hopefully going to be having an interview with the president of the bank here soon to talk more about his experience with the bank, his history at Goldman Sachs. Always interesting to talk with insiders within the banking space. Live Oak, a small bank based out of North Carolina. Seems like they see a big opportunity and that SBA, that Small Business Administration world. I wanted to see if you could talk a little bit more about the opportunity that a little bank like Live Oak might open up for investors.

Mathews: Sure. Live Oak is a small bank. Let me put that in numbers. J.P. Morgan is the biggest bank out there -- $2.7 trillion in assets, market cap of $400 billion. SVB, you could say, is solidly a medium-sized bank with a $12 billion market cap and $68 billion in assets. Live Oak is a small bank. Their market cap is under $1 billion, and they've got under $4 billion in assets. What they're specialized to do -- they don't have a branch. They're just lending to small businesses. I came across them because they have some interest in lending to venture-based businesses. But so far, it's mostly been SBA loans, Small Business Administration loans. These loans, it's a government program, the government will more or less backstop you if you lose more than 25% of the loans. The government is stepping in to spur activity for people who might not be able to get a loan otherwise. This could be any small business. It could be a franchise, it could be a veterinarian, it could be a hair salon. It could be a farm, it could be almost anything. The thing is, they're SBA loans. They're small loans. There's a lot of paperwork and documentation required because it's part of a government program.

Moser: Yeah, it could be Primerica, even. Just something that someone's running out of their own house.

Mathews: It could be. If Primerica passes their underwriting standards, it could be Primerica.

Moser: You never know. Listen, I used to work at Bank of America, as many listeners probably know, and having to go through that process of helping a few small business folks get that SBA loan, even at the time, it was 2002 or something like that, and man, oh, man, the paperwork that was involved with trying to get that loan done on my end was tough. For the individual, for the business owner, it was worse. So, it's nice to see, fast-forward to today, we're seeing companies like Live Oak get out there and try to take advantage of that opportunity. And, of course, technology is changing the space and the way that folks and businesses are able to raise capital. It's a little bit of a different ball game now. But clearly, Live Oak sees something there with the SBA.

Mathews: What they've done is, they built a great technology platform to automate the process. That allows them to do a lot of small loans efficiently. They've only been public since 2015, but they've been growing a lot. Over the past three years, each year, they've increased both their loan book and their interest income by like 50% on a compound basis. It's still led by its founder, Chip, and it's 25% owned by insiders. Fast-growing, small banks, risky sector, but I think there's something interesting going on here.

Moser: Yeah. Matt Frankel and I talk about these little banks all the time. It's a competitive space, but there are ways to succeed in there. Having access to that low cost of funds, like you mentioned with Silicon Valley Bank, or having a focus on a big market opportunity like Live Oak there with the SBA, those can be real nice niche services. They can help grow the business. You don't you expect it to ever become the size of something like a J.P. Morgan or whatever, but that's not the point. There's plenty of opportunity there to be had.

For listeners, just to reiterate, that is Live Oak Bank shares. That ticker is LOB.

Brendan, let's talk a little bit, because there is a company that we cover here from time to time in our Foolish universe that is very much in the business of venture capital and investing in a lot of these small businesses. They've been called on what is... let's just say this investment hasn't worked out so well. We're talking about SoftBank. In particular, we're talking about this WeWork story. SoftBank certainly has investments and businesses other than WeWork. Let's talk a little bit about the WeWork debacle here for a minute. I looked at this story as I followed it along, as I read a little bit more, learned a little bit more about Masa Son and how he invests in his reputation. Certainly a big appetite for risk. But, it seemed like that appetite for risk more or less went unchecked. I said a couple of weeks back that maybe he would have been better served to take a page out of the old Book of Abraham Lincoln, right? Surround yourself with a team of rivals who will think differently and push back on your ideas. We do a lot of that here with our investing as well. We try to surround ourselves with people who will maybe push back on an idea, and try to see all sides. It doesn't sound like that's something that was going on with SoftBank, particularly when it comes to WeWork. You've been following this along. What are your impressions?

Mathews: This has been such an awesome story.

Moser: It really has.

Mathews: The Wall Street Journal has done a great job of covering it. So entertaining. Really the best, most interesting story since Theranos. There's a book on the We Co, I can't wait. It's interesting. I think SoftBank and the venture capitalists there let WeWork down a little bit. I've been absorbing this -- as a venture capitalist, you need to have a foot in both worlds. You need to be able to encourage entrepreneurs to be bold, to be unconventional, to follow a vision that doesn't necessarily make sense to the more conventional financial world, but you also need to be able to restrain them at certain times. I think the We Co could have used some restraint.

Moser: [laughs] A little bit.

Mathews: I just wrote down some of the things that Adam Neumann, the CEO of WeWork was doing, that you could probably let him get away with. You could let him get away with walking around the office barefoot. You could let him get away with hiring his wife to be the chief brand officer. She's also the cousin of Gwyneth Paltrow. You could get away with smoking weed in the corporate jet, although you probably shouldn't bring it across international lines, then you're smuggling.

Moser: Just a thought.

Mathews: You could have an expansive vision of the business. You could want to get into housing, finance. You could launch a social network. You can have big parties with tequila at $100 a bottle, and rappers from the '80s. You could say that you want to live forever, that you want to become the prime minister of Israel, that you want to be the world's first trillionaire. You can have 10X voting stocks. You could probably get away with all those things.

The things that you can't get away with, and this is where, as a venture capitalist, you need to step in and be that in-between, between the adult world of public companies and bond vigilantes and the crazy ideas of Silicon Valley. You need to step in and say, "Look, you cannot sell the trademark to the word 'we' for $6 billion to your own company. You cannot lease properties that you own to your company. You cannot sell stock and borrow against stock at rates that you wouldn't even consider letting your own employees do." It's a level of incredible hubris and self-dealing. And then ultimately, you do, at the end of the day, you need to have a business. You can't have $1.8 billion in revenue and $3.5 billion in expenses. At that stage of a company, you cannot have a burn rate, so losses, that exceed 100% of your revenue. You just need to be told to rein it in. I think that's where the venture capitalists that were funding this -- you can give advice, but also, when you give someone $10 billion at a $47 billion valuation, you're endorsing these things. That would have been an opportunity for venture capitalists to still encourage the bold vision, being unconventional, but also sticking to a certain set of rules and best practices, just a few of them, where appropriate.

Moser: Do you feel like going forward -- I think this is the question a lot of people are asking, particularly as this venture fund two is set to come online. It's not to take away from the successes. It's not to say that Masa Son and SoftBank have been nothing but investment failures. That's clearly not the case there. But this is a really big failure. What's the reputation risk there? We forget things pretty quickly as people, as investors, as consumers. That may very well apply here, too. As a matter of fact, I'm pretty sure it probably will, at least until the book comes out and we remind ourselves of how absurd this story actually got. But, do you feel like there's a reputational risk? Is SoftBank going to have a more difficult go of it from this point on?

Mathews: I think fundraising for Fund 2 will be challenging. As far as Masayoshi Son, he's a "win big, lose big" type of a guy, and he's had big successes and big failures. I think ultimately, he'll come out of this OK, having learned something. I do admire the fact that he certainly took some blame for this and admitted what was obviously true, that he made some mistakes. But I think he'll come through this.

Moser: Well, it shows the value in being able to admit your mistakes and then move forward from that. Lesson in there for everybody, I guess.

Mathews: If I ever make a mistake, I plan to admit it.

Moser: I'll hold you to that. We've got it now recorded. It's for posterity. We'll hold you to it, don't worry about that.

OK, Brendan, this is a segment of the show we've incorporated here recently. We've had a lot of fun with it. It started out as a little bit of an innocuous, well, hey, guess what, this is the last stock I bought. We encouraged listeners to tell us the last stock they bought. And now we've just got a long line of everybody telling us the last stock they bought and why, and we're just having a ball reading these things on air because, you know, hey, listeners love to have their stuff read on air, but it's also getting a lot of great stock ideas out there for us, for our listeners. It's been a lot of fun. So we wanted to read off a few more of these today.

Jay Otto from Oshkosh, Wisconsin. He says, "It's actually two stocks I recently bought on the same day, Disney and Microsoft. Picked up a couple of shares of each and I'm just going to collect some dividends and not look at them again for a long time." Jay, good call on both counts. Disney and Microsoft, very popular holdings in our Foolish universe. Hey, man, Disney+ launches tomorrow. I have a feeling that's going to probably be a pretty good catalyst for the business over the long haul.

Then we have Derek, who hit us up on Twitter @dmaincu21. He says, "The last stock I bought was PC Connection, ticker CNXN. It's a small-cap stock carrying zero debt. Earnings per share growth of 29%. The stock is up 42% over 52 weeks. PE ratio of just under 16X. They're a national provider of IT solutions. They currently offer over 425,000 products for brands including Apple, Cisco, Dell EMC, HP, Lenovo, and Microsoft. It's up recently after reporting $0.90 earnings per share last quarter compared to an estimate of $0.57. I'm in this one for the long term." Derek, that's the only way to invest for the long haul.

Brenden, now that I've got you here the studio for a change, you got something you want to share? You got a last stock you bought and why?

Mathews: These days, I've been adding to stocks that I've owned for a long time that I did a lot of research on when I was part of the investing group. One of those is Marriott. It's got a great brand. Biggest hotel company in the world. They've got this really interesting model where they don't actually own the physical properties. They're a management company and a franchisee. They collect franchise fees and management fees that are more or less guaranteed on very long-term contracts. It could be up to 30 years. They get reimbursed with most of their expenses. And then, when things are particularly good, they get a profit share. It's this sort of business where, tails I break even, heads I win by a lot.

Moser: Yeah, and they're making big investments into their own technology, and bringing loyalty members directly to their sites to book their rooms, as opposed to relying on places like booking.com or Expedia or other OTAs.

Mathews: Yeah. A couple of years ago, I actually had a chance to talk to their CEO, Arne Sorenson, at the annual meeting. He was really excited about the potential for direct booking vs. paying somebody else's website to bring a guest to Marriott. There's huge advantages, if you want to do direct, to being the biggest company. You can spread your technology costs out, but you also have the biggest selection and a well-known name.

Moser: Yeah. We got to go check them out recently at their new headquarters up in Bethesda. We got to go over there with Sarah and Mikah a couple of years back to see that. It was interesting to see all of the stuff that they're investing in the business. Seemed like a really fun culture, too. A lot we could relate to there.

All right. Hey, listen, before we close out, anytime I get Brendan in the studio here, we got a couple of things we have to get off our chests, OK? It's what grinds our gears. We got a lot of problems and we want to just take this opportunity to get a few of those problems out there for you, listeners. Brendan, I'm going to go ahead and start this off. You know what really grinds my gears? It's when you're trying to search for something on Slack. Now, I'm not trying to knock Slack. They've been a great advertising partner of ours before. It's a decent tool to use. But I can't find anything on Slack anytime, ever. And then I'm trying to figure, did that person Slack it to me, or did they email it? I can't remember because it's been so long ago. So then I'm searching through Slack. I'm searching through email. I can't find it. I feel like Slack needs to make that search function a little bit more useful.

Mathews: Well, especially since the name is "the searchable log of all conversations and knowledge," right?

Moser: I'm just finding it to not be that friendly on the searchable part of that.

Mathews: Might as well just be Lack.

Moser: Might as well. Might as well.

Mathews: Jason, you know what grinds my gears? The penny. What can you buy with a penny? Nothing!

Moser: Is it even necessary?

Mathews: Why do we need a penny? Just round me up, round me down. Is the metal in a penny even worth a penny?

Moser: Why stop at the penny? What's the nickel doing?

Mathews: Yeah.

Moser: Maybe the nickel's OK. You get round numbers out of it all. But yeah, the penny seems like it costs more to make than the value that it's imparting on our economy.

Mathews: Yeah. Let's just let's round up, round down.

Moser: Here's something else that really grinds my gears, is knowing that this is the last season of Silicon Valley on HBO. We talked a little bit about Silicon Valley in Silicon Valley Bank. Are you watching Silicon Valley on HBO?

Mathews: I'm a little bit behind. I've watched the first season.

Moser: It grinds my gears that you're not even up to date with it. It's a show I know that you would love to follow along. This is the last season. It's just killing me. I don't know what is going to happen. I feel like it's a story that could just go on and on. And given what we do here, it's very relatable. Yeah, I'm a little bit bummed that this is the last season.

Mathews: You know what grinds my gears? Leaf blowers.

Moser: Leaf blowers? But it's that time of year.

Mathews: I'm specifically talking about, usually it's a building maintenance person with a leaf blower, there's a couple of leaves, maybe, on the ground, not really bothering anybody. You go out there with a leaf blower, super loud, blowing leaves up, dirt up, into everyone's eyes. And the next day, the leaves are just going to blow back. If it was that dangerous and that important, just pick them up. Otherwise, we'll live with the leaves.

Moser: Speaking of cooler weather, another thing that grinds my gears is because I'm getting a lot of these this time of year, is an espresso. What really grinds my gears is when people say "expresso," and they throw that x in there, when clearly, there is no x in the actual word. It's espresso, people. Take the x out of there. Get your mind out of the gutter.

Anything else that grinds your gears, Brendan?

Mathews: That's it for me!

Moser: Hey, Austin, behind the glass there, you have to have something you want to get off your chest, right?

Austin Morgan: One thing that really grinds my gears is, I like to go to the gym in the morning, and I like to finish my workout with a couple of minutes in the sauna. Some people like to come straight out of the shower and dry off in the sauna while I'm in there. It's a very small box.

Moser: That just doesn't sound sanitary. It doesn't sound pleasant. Yeah, I can see where you're coming from.

All right. Hey, Brendan, great having you back in the studio again! Thanks for taking the time!

Brendan Mathews works for Motley Fool Ventures, a separate sister company of The Motley Fool LLC. His appearance is not intended as a solicitation or offer of sale of any securities. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Austin Morgan. For Brendan Mathews, I'm Jason Moser. Thanks for listening! And we'll see you next week!

SVB Financial provides credit and banking services to The Motley Fool. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Brendan Mathews owns shares of Apple, Cisco Systems, and Marriott International. Jason Moser owns shares of Apple, Booking Holdings, Twitter, and Walt Disney. The Motley Fool owns shares of and recommends Apple, Booking Holdings, Microsoft, Slack Technologies, SVB Financial Group, Twitter, and Walt Disney. The Motley Fool recommends Marriott International and recommends the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, long January 2021 $60 calls on Walt Disney, long January 2021 $85 calls on Microsoft, and short January 2020 $130 calls on Walt Disney. The Motley Fool has a disclosure policy.


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