Idea Brunch with Rob Romero of Connective Capital
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Rob Romero!
Rob is a seasoned entrepreneur and investor with a strong background in technology and finance. As the CEO and portfolio manager of Connective Capital, he oversees the overall operations of the Palo Alto-based long/short equity fund, which he founded in 2004.
Before launching Connective Capital, Rob was involved in early-stage technology venture capital investments and co-founded eVoice, a technology company that became the leading provider of internet-enabled voicemail in the late 90’s and later was acquired by AOL.
Today, Connective Capital concentrates on long/short investments in high-growth technology companies, biotech firms, and emerging energy companies.
Rob, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Connective Capital?
Hi Edwin! Thanks for having me. Back in 1987, when I finished my Master’s degree at Stanford, the market was excited about Artificial Intelligence, public stock pure plays were booming, and money was pouring into startups, so of course I started an AI company! Like all the other AI companies from that generation, it was a failure -- the tech was far too immature — but I learned a critical lesson about hype cycles. It can be easy for compelling-sounding and inspirational technology to attract entrepreneurs, investors, capital, and media influencers, but many times the tech is premature, or the business models are flawed. Nevertheless, interest and valuation can levitate for quite a while before people realize that there’s no sustainable profit or even revenue. After a few years at regular tech jobs to pay back my debt, I went back to early-stage startups and learned more about the power of technology adoption cycles (Cisco’s leadership of networking in the 90’s), as well as the dangers of overvaluation and low entry barriers (optical networking and internet hosting). A couple of good exits helped me accumulate capital so in 2003 I decided to seed a hedge fund to implement my fundamental and investment timing insights in tech investing. The results were great, so I attracted outside capital and launched our flagship fund, CC1.
Over the last 20 years, Connective has meaningfully outperformed its benchmarks, with returns on both the long and short side. Can you please tell readers about your approach?
We have one core long/short portfolio which we deploy in two funds, our flagship CC1 market neutral strategy (compounding 11% since inception), and a higher beta, more volatile CC Enhanced Exposure strategy (about 13% compounded). In keeping with the lessons learned in my career in tech, we look for core longs in companies with strong market positions resistant to margin compressions, and long-term fundamental tailwinds in revenue growth, even in spite of imperfect execution. Intuitive Surgical (ISRG) is a good example. They’ve been able to deliver great investment returns despite a few missteps because they have strong tech leadership in an area that’s poised to outgrow for decades ahead. On the short side, we look for markets at the end of a hype cycle, when there are too many competitors, not enough differentiation, or end-market growth a lot slower than the media or investors are hoping. Investors in CC1 and CCEE got nice returns from our timing of the hype cycles in biofuel in the 00’s, solar panel producers in the 10’s, and crypto/metaverse in the 20’s.
Your portfolio consists of roughly 40 long ideas and a larger number of shorts. Why cast such a wide net and how do you come up with so many investment ideas?
We have a very diversified book because investments in hypey parts of tech, biotech, and consumers can be very dangerous, often leading to >100% losses on shorts if we get the timing wrong. This diversification requirement makes it especially important to have a strong team. At Connective we have 4 people dedicated to investment research, with over 50 years of combined investing experience. While we diversify our book, we focus only on sectors where there are disruptive innovations happening or expected. Then we can “go deep” as much as needed, leveraging our industry background, and connections in Silicon Valley where we live.
Another thing that helps us scale is that we’ve built proprietary systems to help signal company or market sub-sector opportunities that meet a pattern we’ve seen before. While we’re not a quant fund, our 3-person tech team is constantly building better tools to find new alpha pools, reduce risk & improve execution.
High-growth technology, biotech, and emerging energy are all areas littered with frauds, scams, and promotional management. How do you separate the substantive companies with a strong chance of success from the ones doomed to fail from the start?
After being around for so long you start to identify common patterns that repeat over and over again. Building and scaling a company, especially in a brand-new market where “zero - to - one” must be proven, is a very challenging feat only few can accomplish. The attrition process of scaling is aggressive, it requires a good strategy, resources, timing, flexibility, and outstanding execution. We look at management’s behavior and credibility more than what they claim they will do and focus on business and operational models over statements and reports. At the end of the day, the story adds up or it doesn't. Within all those potential fails, there is a unique group of companies that push creativity beyond coherence. In the stock market you can find companies that have rebranded themselves with each one of the last three or four hypes; cannabis, crypto, metaverse and now AI. Too impressive, or too dumb, to be true.
What are some interesting ideas on your radar now?
1/ Long Adeia (NASDAQ: ADEA — $1.22 billion) — Undiscovered next-generation AI play
Adeia stands as one of the largest intellectual property ("IP") licensing platforms within the industry. It boasts a diverse assortment of media and semiconductor IP, encompassing over 9,950 patents and patent applications on a global scale. The company's licensing activities revolve around providing its innovative solutions to media and semiconductor industries and entities under the Adeia brand. Prior to the autumn of 2022, Adeia operated as a subsidiary of Xperi (XPER), a prominent firm recognized for powering renowned consumer brands such as TiVo, DTS, and IMAX through its technology. Subsequently, Adeia underwent a spin-off from Xperi, prompting a strategic shift in its focus towards Media and Semiconductor offerings.
Adeia's IP business model is characterized by robust cash generation and a high level of predictability. However, we perceive a substantial opportunity for the company within its semiconductor licensing portfolio.