A Wayward Path to Venture Investment

Venture investment is risky. But when a venture investment matures, the returns make mutual funds in a bull market seem like Japanese CDs.

I have invested in 15 companies that later went public. The most recent, GeneMax, started trading on July 15, reaching a high of $6.25, before selling off along with most stocks in the broad market’s waterfall decline. It closed the week at $4.40, up $0.25 on a day that the Dow fell 390 points, or 4.7%.

In the fullness of time, I expect GeneMax to be a real winner, possibly a $100 stock, based on its unique immotherapy for treating cancers. In trials on laboratory animals which were given the biomass equivalent of basketball-sized tumors, 70% of the subjects treated with the GeneMax therapy were cured, while 100% of the untreated animals died. A similar result for humans could make GeneMax a $1,000 stock.

I don’t say it will happen, but it would be a delight for humanity if it did. As Will Durant said, "Hope is not a feeling of certainty that everything ends well. Hope is just a feeling that life and work have meaning." I am confident that my life and work have meaning.

With my involvement in GeneMax, I played a crucial role in launching and directing a biotechnology company that may end up doing more to alleviate suffering than all the efforts of the Sisters of Charity over the ages. I keep my fingers crossed, and hope. Of course, only time will tell how the story turns out.

For example, members of a venture investment club I founded called Strategic Opportunities Group, who took advantage of my invitation to invest in GeneMax at $1.00 at the end of May, have quadrupled their money in two months, with an excellent prospect of making vastly higher profits as GeneMax gets its feet in the market.

It is a disappointing venture investment that doesn’t ultimately return 10-to-one. I have had some where I made 1,000-to-one.

When I tell stories such as this, I am frequently asked: how does one’s career in venture investment begin? I seldom give the same answer twice. I took such a circuitous route that each time I try to recall my path I remember a different landmark along the way. I suppose the story probably began before my birth. I must have been genetically disposed to entrepreneurship. Both of my parents were descended from horse traders.

I also suspect that my environment had something to do with disposition to create companies the way that some people create paintings or write novels. My environment as a child was a little out of the ordinary. Something was off in the water, perhaps, or I spent too many afternoons talking with Bill Bonner after choir practice. He and I grew up in the same area of southern Maryland, and gave free reign to our fancies about all the abundant possibilities life had to offer.

Something in that mix freed me from the normal imperatives to suppose that I had to grow up and get a job. I choose to invent my own work instead. To that end, I founded Agora with a modest investment in 1971. Agora has grown to be a great success in the publishing field and many allied businesses. Starting Agora would have to rank as one of the better investments decisions I made. Which reminds me of another twist – one of the apparently most stupid investments I ever made – the launch of a flimsy science magazine, ultimately known as Frontiers of Science.

It cost me a fortune in direct losses. But its ultimate impact was more complicated, in several ways. It shows that sometimes bad investments can compound your fortune.

How? For one thing, the personal financial crisis occasioned by the losses in Frontiers of Science led to Agora being re-organized. My holding in the company plunged as a result from an 80% majority to a minority position. On a simple-minded basis, this could have been a disaster. But it was probably to my benefit. Bill Bonner took over, and has done a fabulous job, making millions in which I have shared to some degree. If I had retained control, I probably would have run the company into the ground years ago. I am not an operator, and I would have had a weaker base upon which to build my later venture activities.

It is comforting to know that you have a piece of a well-run company that is generating profits while you sleep.

I also benefited in another unexpected way from my apparently disastrous investment in Frontiers of Science. The magazine had a subtext of interest in biocosmology, or extraterrestrial life. As a result of that interest, I fell into what seemed a charmed circle of scientists and "technology freaks" organized under the leadership of the late Bernard M. (Barney) Oliver, renowned scientist, inventor of the pocket calculator and sometimes fellow of All Souls College, Oxford.

When I met him while doing graduate work at Oxford, he was not only well-connected academically, he was a living legend in Silicon Valley, having become director of research at Hewlett Packard in 1952. There was a story that William Hewlett and David Packard had originally invited Oliver to join their start-up firm, even promising to expand the name of the firm to Hewlett, Packard and Oliver. But Barney initially rejected their offer, and joined Bell Labs in New York, working on schemes to improve television quality, and on radar in World War II. In 1952, he accepted another offer from Hewlett and Packard, ultimately becoming Vice-President and a director of the company in 1957. He also founded Biosys, a biotech company specializing in biological controls for agriculture. Although his name wasn’t in headlines, Bernard Oliver held a vast fortune in Hewlett and Packard stock. He was certainly the richest don at Oxford.

Barney Oliver made his money the hard way. He held over 50 patents to reflect his continuous flow of creative ideas. One of his fascinations was the search for evidence of life throughout the universe. My connection with Frontiers of Science earned me an introduction, which ultimately led to a seat at the table during gracious dinners and lunches that Barney Oliver hosted at Oxford. These meals were not only a blessed relief from the dreary food served in Pembroke College, they were intellectual feasts as well.

Barney Oliver knew everyone in science and technology. He was excited by developments along a broad front, and shared his infectious enthusiasms, as epitomized by these comments of his on the "miracle of life."

"But wait! How can we accept all this so calmly? Isn’t science describing a miracle to us? If you were to witness the fireball of creation, would you ever believe that in only 15 billion short years, through the wonderful laws of physics and chemistry, some of the matter of that fiery chaos would have evolved itself into apple blossoms, into birds and eyes, and into minds? In 15 billion years, a small part of the universe now contemplates the whole of it. Man is always seeking the miraculous. What greater miracle could there be than the one spread before us?"

When I found myself listening to such conversation, my education took an important turn. I am sure I sat slack jawed while Barney and his brilliant friends analyzed and mapped the frontiers of science and technology. I had studied literature, and art history, as an undergraduate, then shifted to PPE (politics, philosophy and economics) at Oxford. Nothing in my academic career would have seemed to prepare me for a career in venture investment. I never took a business course and studied little science.

What I had studied had always been too punk to open my eyes to the exciting parts. I had never heard anyone seriously excited about "the wonderful laws of physics" before. But Barney’s group had the exciting parts at the tips of their tongues, which were only slightly the worse for having imbibed glass after glass of first growth Bordeaux. To make a long story short, Barney always took us to the best restaurants in Oxford, where we ate wonderfully, drank the best wine, and shared conversation that has seldom been bettered.

This made a deep impression on me, and informed my ambitions in venture capital. For one thing, I came to understand, as I hadn’t previously, the pregnant implications of technology, and rapid-fire change it was igniting. Also, I came to appreciate the freedom of being able to invite anyone you please to share in a great meal. It was so civilized. Barney Oliver always paid. He inspired me in the way that young baseball players are inspired by Barry Bonds.

Over the intervening quarter of a century, I have started company after company. Their adventures gave me a lot of additional experience which has compounded my basic tutorial in venture capital investment.

For one thing, I have seen almost every kind of screw up and experienced failure in so many forms that I don’t have to refer to Harvard Business School case studies.

Indeed, one of the more attractive aspects of venture investment, in addition to the millions you can make, is the advantage of associating with brilliant people who have breakthroughs to share with the world. You can not only earn a lot for backing them, you can learn a lot in the process. The way the tax laws are, even the Democrats haven’t proposed raising the capital gains rates on investments that are fun.

In short, I learned a lot from an apparently disastrous investment in Frontiers of Science. It taught me that I, too, wanted to start great technology companies, and make so many millions that I could afford to spend splendid moments hosting dinners as delicious and stimulating as those to which Barney Oliver treated me.

I doubt he realized how much influence he was having on an impressionable country boy, but he taught me to dream on a grand scale.

Warm regards,

James Davidson,
for the Daily Reckoning
July 25, 2002

P.S. As you might expect, I quickly realized I was too late to invent the pocket calculator. But I knew I could still launch technology companies and explore the potential for converting other peoples’ inventive ideas into innovations. I also saw the chance to turn a necessity into an advantage. The advantage of being the entrepreneur, not the technologist, arises from the fact that it is a heck of a lot easier to incorporate a company than it is to invent the pocket calculator or cure cancer.

So I have proceeded with my eyes open, looking for opportunity. When Oxford-educated cytologist Dr. Wilf Jefferies introduced me to his exciting ideas for harnessing the immune system to fight cancer, I didn’t hesitate to help him launch GeneMax.

Editor’s note: James Davidson has enjoyed astounding personal success founding new companies in a variety of industries. A graduate of Oxford University, Davidson is a renowned author and venture capitalist who sits on the boards of over 20 thriving, technology-driven companies. His latest research and investment picks can be found in the Vantage Point Investment Advisory.

"Dow Up 489 as Congress Acts on Rules" says today’s headline in the International Herald Tribune. We did not actually buy the paper – we just read the headline on the subway on the way to work this morning.

"Something’s gotta give…" we warned last week. Like a fat girl on a brownie binge, things seem to be giving in every direction – up, down and sideways…

We recall that the IHT’s executive editor, David Ignatius, recently opined that the bear market was all the fault of the Bush administration. Bush had lost the trust of investors, said the editor.

We cannot comment on Ignatius’s opinion; it is so mindlessly puerile and vacuously fluffy, we wouldn’t be able to get a purchase on it. But, who knows, maybe the man will be struck by the #42 bus outside the paper’s editorial office…and get some sense knocked into him.

But that is not the way of the world, we suspect. People publish preposterous opinions in the editorial pages of the leading papers…hold them all their lives…and carry them to the grave.

What ‘rules’ could Congress enact that would reverse a bear market – unless it were to prohibit people from selling…or perhaps abolish itself? Or, if it could make stocks more valuable simply by passing laws…heck, why not pass a lot of them? The notion is as crippled and absurd as a newspaperman hit by a crosstown bus.

The Christian Science Monitor quotes a former high school principal, forced back to work by the bear market: "Hopefully within a five-year period my portfolio will be close to where it was before and I can pull out of the market," he says. "But to do that now would literally be suicide."

Oh la la…how did these rubes and patsies get into stocks in the first place? They have no idea what they are doing. Why does he think the market will recover in 5 years? Only because he needs the money! But that is not the way of the world either. Mr. Market does not give people what they want, nor even what they need – but only what they deserve.

"The American economy is a disaster waiting to happen," explained Marc Faber in January of this year. "Mr. Greenspan’s interest rate cuts have supported consumption artificially and borrowed from the future. The so-called booms in car sales and housing will come to a bitter end. Mr. Greenspan basically moved the bubble from Nasdaq into other sectors of the economy and these bubbles will also burst."

Six months later, on July 15, Philip Demuth and Ben Stein wrote in Barron’s: "Since peaking in the third quarter of 2000, S&P 500 earnings have fallen more than 50%. This is the greatest percentage drop since the early 1930s. S&P profits have fallen to roughly the same level in 1993 – the longest period of no growth since the decade of the 1930s."

"Profits of the 30 Dow stocks have fallen by 40% since their peak in autumn 2000. Again, this is the worst dive in Dow’s earnings since the early ’30s’…what we are witnessing in earnings in recent quarters is a Great Depression in profits, a collapse in earnings as deep and frightening as anything we’ve seen since our parents were scarred for life."

It may be time for a bear market rally. But it will probably take more than changing a few ‘rules’ in Washington to bring this Great Bear market to a close…

Most likely, the end won’t come until stocks go down again…enough to scare the former high school principal into selling out…and ruining him.

In the meantime, Daily Reckoning readers are advised to sell the rallies…get out now and enjoy the show.

Eric…more details from Wall Street, please…


Eric Fry, our man on the scene in NYC:

– Mr. Market served up a heaping portion of "uptick casserole" yesterday…and investors gorged themselves. By the time the feasting ended, U.S. stocks had mounted their biggest one-day rally in almost 15 years.

– The Dow rocketed 489 points, or 6.4%, to 8,191. The S&P 500 soared 5.7% to 843. For both indices, it was the largest gain since the rebound from the crash in October 1987. Meanwhile, the Nasdaq surged 5% to 1,290.

– The New York Stock Exchange had its busiest day ever. Trading exceeded 2.7 billion shares, as investors first rushed in to sell stocks and then – thinking better of the idea – rushed in to buy them. The Dow dropped more than 150 points in the first five minutes, giving little hint of the massive rally that was to follow. But the selling soon dried up and then the buyers showed up. They didn’t stop buying until the closing bell.

– We have all learned that "buying the dip" in the stock market doesn’t work as well as it used to. So maybe you wouldn’t want to buy the dip in the stock market each and every time. But as dips go, yesterday morning’s would have been a pretty good one to buy. From trough to peak, the Dow soared an astounding 658 points – or 8.7%.

– "There is a buying panic," one fund manager told Bloomberg News. "People are jumping to get in because they don’t want to miss the bottom." Isn’t it funny how quickly fear turns to greed? For weeks, the only emotion on Wall Street has been paralyzing fear. And the only story on Wall Street has been the one about painful losses.

– All the newspapers and all the financial news stations have been packed full of stories about investors who "have hit their breaking points." Several recent Wall Street Journal stories have been so full of woeful tales about steep stock market losses that tears virtually streamed off the page.

– Many investors have responded to their losses by yanking money out of the market. "In the last nine weeks, [mutual fund] firms that report their data to AMG have suffered $29 billion in investor defections from their U.S. stock funds, nearly 2.4% of their assets under management."

– Fear and self-loathing had become so thick on Wall Street that you needed a machete to hack through it. From a contrarian perspective, the bearish sentiment had become so extreme that a rally seemed all but certain. (The exact timing of said rally, however, was somewhat less certain!) As I observed in yesterday’s Daily Reckoning, "Some day soon, the forced selling will likely come to a halt for a while, and then a great big trading rally will get underway…or not."

– As it turns out, yesterday was the day.

– Whom ought we to thank for yesterday’s rally? I nominate Maria Bartiromo for her "Closing Bell" report last Tuesday. Her declaration after the close of trading on Tuesday that investors ought to start trading the market from the short side was the contrarian coup de grace that virtually guaranteed yesterday’s rally.

– Ms. Bartiromo, the CNBC commentator known as the "Money Honey," came to epitomize the bubble bull market. (Jim Grant once predicted that her career would follow the trajectory of the Nasdaq). She was never not- bullish…until her Closing Bell report on Tuesday, when she said something like the following: "Maybe we should stop looking for a bottom and just acknowledge this is a bear market and start short selling to see if we can make some money in this market."

– Thank you Maria! But for that remark, there might not have been any rally yesterday, much less a 500-point rally.

– But now that the explosive one-day rally is over, what next? Will it become a two-day rally, at least? Or will it flame out just as quickly as it ignited? Mr. Market isn’t saying. But we’d guess the rally has more to go. A new bull market is another matter…but we’ll try to remain flexible.

– "If there is no such thing as a perfect investment, neither is there a perfect opportunity," writes Jim Grant. "As a rule, only in retrospect does a major stock-market bottom appear irresistibly inviting. Often it looks frightening. Sometimes, inconveniently, it does not look frightening. To us, the 1991 bottom did not look frightening at all. It just looked a little overvalued."

– Today’s market looks about the same – a little overvalued, albeit cheaper than it used to be. Is it cheap enough to kick off a new bull market? We have our doubts. But more on this topic tomorrow.


Back in Paris…

*** Warren Buffett wrote a letter to the New York Times. Forget about changing the rules, said the world’s second richest man. What’s needed is perfectly obvious – CEO’s have to stop making unrealistic pension fund growth estimates (some are as high as 11% per year, says Buffett)…and stop treating stock options as though they were cost-free.

*** "Savings are still rising. Investment is still falling," writes the Mogambo Guru. "Bankruptcies are still rising ominously. And since all the money that financed the glorious Nineties came from debt, a lack of new debt means less spending. Especially now that returns from those debt-financed investments are not paying the bills anymore."

Mogambo mentions a guess by Martin Weiss that one out of every three American families will declare bankruptcy. "Wow! One in three!," Mogambo hyperventilates. "Makes you wonder what THAT will do to consumer spending, eh? What is the mechanism that allows a consumer economy to thrive when the consumers are broke?"

*** The rest of the world wonders too. "The falling dollar and falling U.S. equities are sending a message," writes Chris Wood in Hong Kong. "America can no longer be taken for granted as the growth driver of the world economy."

*** And a letter posted to Richard Russell’s website:

"…the parallels between the USA and Japan are frightening. The US equity bubble is going to do even more damage to the consumer than the Japanese bubble bursting did to the Japanese consumer. This is because the average Japanese had a very low exposure to the stock market during the bubble and also maintained a very high savings ratio. In the US the opposite is the case, so if the market goes down the effects on the consumer will be absolutely terrible. If the property market goes down it will really be "game over" for the economy and this will prelude a very nasty bear market. When Greenspan cuts rates again and it has no effect on the economy panic will begin. This is exactly what has happened in Japan."

The Daily Reckoning