Sees software ecosystem flourishing
Orlando Bravo’s initiation as an investor was the dot-com bubble burst of the early 2000s, which wiped out an estimated $5 trillion in stock market value. Surviving this trial by fire, to then go on to become the first Puerto Rican-born billionaire, has resulted in an optimistic but more temperate approach to the current Artificial Intelligence (AI) boom.
Bravo is the co-founder and managing partner of Thoma Bravo, a private equity firm focusing on software companies, which currently manages $180 billion in assets. His investment philosophy often echoes the precept established by Warren Buffet and by his mentor Carl Thoma. However, Bravo’s approach to business is also marked by what he learned growing up at the tennis courts in Puerto Rico and Florida.
“I found out pretty quickly that I wasn’t that good. But I did private equity, so that’s okay. I’ll take it. That’s really an important part of who I am, how I think about business, and how I lead,” Bravo said at a student talk at Stanford Graduate Business School, from which he has an MBA.
“In tennis, when you get on the court with somebody, it doesn’t matter what your ranking is, you could be ranked higher, you could be ranked lower, the other player might have more coaching, this or that, but you have to try to figure out how to win that match,” he said.
So, tennis helped frame his approach to business deals. He competes for every deal, regardless of how much. Thoma Bravo has grown in the same way that you show up to every match, he argued to the Stanford students.
Bravo’s business philosophy is more straightforward, saying that as an investor, he looks past the flashy or trendy elements of tech companies and looks for the fundamentals. This echoes the philosophy of Warren Buffet, the co-founder of investment firm Berkshire Hathaway and one of the world’s leading investors for the past five decades.
These fundamentals include looking for good quality companies that the market is currently undervaluing, healthy debt ratios, and businesses’ earning power over time, among other factors.
We’ve Seen This Before
While the tech IPO (initial public offering) landscape of 2021 was marked by an exuberance in valuations, Bravo reads the current AI landscape through the lens of a more distant, albeit impactful reference: the dot-com bubble.
From 1995 to 2000, the valuation of emerging internet companies skyrocketed, despite most of them not being profitable or showing a path towards profitability. Between 2001 and 2002, the dot-com bubble burst and the result was that $5 trillion in market value was wiped out from the Nasdaq stock exchange.
“The same thing that happened [then] is happening—the misunderstanding that occurred in the year 2000 when the dot-com bubble burst as we started investing in software companies. The first misunderstanding, just like now, is that these companies carry a lot of risk because they are technology companies and technology comes and goes,” Bravo said.
The Thoma Bravo head had to learn this lesson the hard way during the dot-com bubble era. Forbes noted that at the start of his career— during the tail end of the dot-com bubble— he made disastrous investment choices. For example, his investments in NerveWire and Eclipse Networks resulted in $100 million in losses.
“I learned I didn’t want to invest in risky things ever again,” Bravo told Forbes in 2019. “It was too painful to live through.”
Bravo seems to understand that opportunity often comes from learning to pivot. He went to Stanford instead of Harvard University, which was his top choice, because the former was the only university that gave him an enrollment deferment, allowing him to have an internship at Morgan Stanley. That put private equity in his path. Not getting a return offer from a summer job then led him to Carl Thoma, his former boss turned business partner.
From his financial losses in the early 2000s, Bravo learned to lean into companies that
have good fundamentals and offer specialized services that engender a loyal clientele, he argued in his Forbes interview.
What investors like Bravo are hearing and seeing today are similar narratives and business indicators to those at the beginning of the dot-com bubble. The business world is getting repeats about the transformative capabilities of these emerging companies, combined with business models that are not showing a path to profitability.
“In the year 2000, almost all software companies also did not obtain profits, and we said that we could provide a model to take these companies from zero profits to margins of 20%, 30%, or 40%. Because the gross margins of the companies were not very good. They were losing a lot of money,” Bravo said.
He explained that the role of private equity firms is to find the good companies from among the deluge of AI-related companies and provide them with leadership and a profitable business structure. The investor warned that part of the issue is that there’s probably not a big enough pool of business experts to take all these companies to the next level.
Keep Your Feet on the Ground
Major AI companies are attracting massive amounts of investment. In the most recent funding rounds for Anthropic and OpenAI, for example, they raised $30 billion and $40 billion, respectively. The AI sector also ranks first or second in economic growth, depending on the analysis.
Bravo sees a great opportunity to invest, particularly in software companies with potential whose value has dropped due to current industry analysis. However, the Thoma Bravo managing partner is seeing two divergent strategies in AI investments.
On the side of private equity firms, there is much greater resistance to investing in new companies because, aside from being a new technology, investors do not project that these companies will make money this year or in the short term. In addition, many AI companies have an unproven business model.
According to Bravo, the investment firms managing their exposure to AI intelligently are those making investments in promising LLMs (large language models) or AI infrastructure companies, but at the same time “keeping their feet on the ground” regarding cash flow, business models, and the leadership at the helm of these companies. Large language models are “advanced deep learning models trained on massive datasets— often billions or trillions of words—to understand, process, and generate human-like language,” according to the website geeksforgeeks.com. Examples include OpenAI’s GPT- 4 and Anthropic’s Claude 3.
Venture capital firms, according to Bravo, are being very aggressive in investing in startups that have high valuations—sometimes without well-defined products—because no one wants to lose the opportunity to invest in the next “unicorn” like Google or Meta (the parent company of Facebook). The co-founder of Thoma Bravo used the acronym FOMO, popularized on social media, which stands for “fear of missing out.”
“There is a hunger and FOMO is not going to end well… We believe AI is going to be transformative. It is definitely a transformative technology but with a business model that is unproven,” Bravo said.
“The investments are astronomical, the business model is unknown, and most importantly, there isn’t enough leadership in the world to develop these companies, period. You have to do sales and marketing, but there isn’t enough to create 100 companies worth $10 billion overnight.”
Bravo also noted that AI companies that are at the bleeding edge of technology maintain a narrative of adoption at rapid speed, particularly with the promise of the tasks that generative AI or LLMs can now take over from humans. From the more traditional corporate side, the Thoma Bravo head sees a more muted response that will take more years for AI adoption.
Regardless of whether AI proponents are correct or those being more cautious are right, Bravo understands that both paths can lead to economic trouble. The loss of 50% of white-collar jobs, as some proponents predict
destabilizing transformation for society. On the other hand, the problem with this boom is that AI companies do not yet have net profits; if they do not start generating earnings in the short or medium term, it could have a negative domino effect on the economy.
What Cannot be Copied
While much of the public focus is on emerging AI companies, the value of many software companies that provide other services has suddenly dropped. In February, the S&P 500 index announced that this has been the worst quarter for software companies since 2002, when the dot-com bubble burst.
For Bravo—again echoing Buffett’s investment philosophy—this drop in valuations is an opportunity to invest in companies that have good fundamentals but where the market is misunderstanding what their role will be.
One aspect that can protect software companies is the mastery of knowledge regarding how their respective industries function, which then translates to the needs of their industry and leads to the design of more specialized products. This is knowledge that cannot be copied and one cannot give AI a prompt to replicate it. This falls in line with the concept of another Buffet concept— economic moat.
The concept alludes to the moats dug around castles, which made it difficult for enemies to enter. In the economic sphere, the term refers to companies that have a competitive advantage that other businesses cannot replicate, which tends to secure their market share.
Access Continues to be the Key Factor for Puerto Rico
In technology and the emerging sector of artificial intelligence, Bravo recognizes that Puerto Rico is not in a competitive position regarding several aspects.
To begin with, Puerto Rico does not have the established ecosystem that different regions of the United States have, such as the San Francisco Bay Area, which includes both Silicon Valley and the city of San Francisco. This area of California also has the benefit of its proximity to elite universities in science and technology like Stanford, the benefit of networks formed by having a high concentration of these companies within a short distance, and the access to billions of dollars in capital that would be needed to compete with the largest AI companies.
With the expansion of artificial intelligence, the need to build data centers that house the computer servers LLMs need to function has also increased. According to a study by the real estate firm JLL, the demand for data centers is expected to grow by 23% each year until 2030; therefore, there is an emerging, though controversial, market in the construction of these data centers.
However, problems in Puerto Rico’s electrical infrastructure and high energy costs, in addition to the P.R. Electric Power Authority’s long-standing and as yet unresolved bankruptcy case, make the Island an unsuitable destination for companies looking to build data centers.
For Bravo, the card Puerto Rico can play is its relationship with the United States and how it can use this to compete with countries in Latin America. Puerto Rico can benefit by renting AI services to companies that offer services more specifically adapted for different industries.
“I believe Puerto Rico has many opportunities because we have access, we can do business in the United States, and the United States can do business with us. We have a level of protection and stability that perhaps is now in doubt in other parts of Latin America,” Bravo said.
“Being in a place of stability right now is super important for businesses and for countries, and it seems to me that in Puerto Rico we are well-positioned for what is coming,” he added, who in a recent conference expressed support for Puerto Rico becoming a state.
Editor’s Note: Not all Wins
As this newspaper went to print, reports came out that Medallia, one of Thoma Bravo’s software companies, could not meet its $3 billion debt obligations. The company reportedly has yearly earnings of $200 million, which is not enough to pay interest on its debt. Thoma Bravo acquired software company Medallia for $6.4 billion during the aforementioned period of exuberant valuations of 2021.
According to reports in the Wall Street Journal (WSJ) and Reuters, Thoma Bravo is negotiating with creditors the possibility of handing over control of Medallia to its creditors, which are Blackstone, Apollo, KKR and Antares Capital. The WSJ reported that Apollo co-president John Zito criticized the arrogance of the private equity segment and used the Medallia situation as an example.
For his part, during an interview with CNBC, Bravo declined to comment on Zito’s statement. While the Thoma Bravo head tried to present a positive outlook in general during the CNBC interview, Bravo acknowledged to the media outlet that the firm made a mistake in estimating Medallia’s rate growth that caused them to pay too much for the company.
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