The Man Who Taught Mutual Funds How to Invest in Startups

Henry Ellenbogen

T. Rowe Price Fund Manager Henry Ellenbogen. Photographer: Michael Short/Bloomberg

By the age of 6, Henry Ellenbogen knew he wanted to be an investor. Not the kind he is today at T. Rowe Price Group Inc., where he manages $18.7 billion. He wanted to invest in an Atari game console.

It was 1979, and Ellenbogen persuaded his two older sisters to chip in for the $200 device and named himself in charge of the syndicate. Growing up with a single mom, who worked as a nursing-home administrator in Miami, he had to be creative to keep up with the affluent kids in the neighborhood.

Now, at 42, that entrepreneurialism has transformed private investing. A pioneer of the strategy of mutual funds writing big checks for startups before they go public, Ellenbogen’s returns lured other investors into the fray. The billions of dollars in new capital are largely responsible for skyrocketing valuations, fewer initial public offerings and talk of a bubble.

“The asset class is scary,” Ellenbogen said in an interview at T. Rowe Price’s Baltimore headquarters, acknowledging that increased competition has made his job more difficult. “We’re not just buying the basket -- we’re being highly selective and trying to invest in the best ones.”

Ellenbogen closed his New Horizons Fund to new investors at the end of 2013 and has disclosed only two private investments in 2015, eyeglass retailer Warby Parker Retail Inc. and salad-restaurant chain Sweetgreen Inc., compared with 14 last year. He said he’s wary of rapid revenue growth at startups. Returns from private investments, which make up about 5 percent of his fund, probably will be lower this year than in the past, he said.

Twitter Investment

New Horizons, which invests mostly in small-cap stocks, has outperformed 99 percent of peers over the past five years, according to data compiled by Bloomberg.

When Ellenbogen backed Twitter Inc. six years ago, only five other investors were interested, he said. Today, given the same metrics that the microblogging service had, there would be about 50 suitors. He’s earned more than a 1,000 percent return in Twitter. Luckily for Ellenbogen, only one company ever turned him down.

Almost everyone in Silicon Valley knows who Ellenbogen is, even though he’s 3,000 miles away. Getting an introduction to “Henry,” as he’s known, is a big deal, and bankers often use their connection to him as a way to impress corporate clients.

Act II

Ellenbogen is pensive when he talks, leaning back in his chair and gesturing with one hand. He said he saw that he could capitalize on private companies about a decade ago. He was spending time with startups to understand how and if they were disrupting public companies.

In 2007, he met the management team of Bill Me Later Inc., which had developed a way for consumers to buy online and pay later. It became his first private investment -- and a success. EBay Inc. later bought the company for $1 billion and merged it with PayPal.

Now he instructs his team of analysts to look for companies that have what he calls an Act II, “a second leg of growth in a new product or market that they can enter once they have exhausted Act I.”

He spends about 100 days a year on the road, often in search of private companies perched below the hype, such as Diplomat Pharmacy Inc., which provides drugs for rare and complex diseases. Ellenbogen invested in the company last year, after meeting Chief Executive Officer Phil Hagerman, 63, in 2013. Hagerman started the Flint, Michigan-based company with his father four decades ago as a corner drug store.

‘Solid Step’

Hagerman said he accepted T. Rowe’s cash before going public as a validation for investors who would come in later. The company’s shares have tripled since its October IPO.

“We hadn’t taken outside money before T. Rowe,” Hagerman said. “We weren’t shopping Diplomat to raise capital. But the fact of having a partner of T. Rowe’s stature and the confidence that T. Rowe would bring is a good solid step for us.”

Not all of Ellenbogen’s investments thrive in public markets. Shares of Zulily Inc., an e-commerce site for parents, are down 43 percent from their November 2013 IPO price. Still, Ellenbogen has kept most of his stake in the company and says spending more time advising management is the key. New Horizons Fund’s return on that investment has been more than 124 percent.

“He has stuck with us through the ups and downs,” said Zulily CEO Darrell Cavens. Ellenbogen agreed to speak with employees this week to boost morale, Cavens said.

Work Ethic

Ellenbogen was named for his maternal grandfather, a lawyer who fled Austria in the 1920s. After getting certified as a lawyer in the U.S., he was elected to the House of Representatives in 1932 from Pittsburgh, where he helped write legislation for Social Security and housing. He also used his connections to help other Jews escape from Europe.

Ellenbogen looked up to his grandfather after his parents divorced and his father disappeared. His mother, who supported three kids, encouraged him to work in the nursing home’s kitchen at age 14 for $3.25 an hour.

“He understands the value of money,” Judith Ellenbogen, 75, said by phone. “You know how some people can accept responsibility, and others can’t? He very early could.”

That work ethic got him into Harvard University, though he left at 19 to work on the campaign of Peter Deutsch, who was running for Congress from southern Florida. Deutsch won, and Ellenbogen became his administrative assistant, one of the youngest people to hold such a job in Washington.

Ellenbogen returned to Harvard to get a bachelor’s degree. He was approached by Democratic Party officials to run for the Florida legislature at 22, he said, but turned them down after realizing he was more interested in finance than politics. He earned a master’s degree in business and a law degree from Harvard, and then went to work at T. Rowe.

‘High Bar’

The company’s history of investing in private companies dates back several decades, though on a much smaller scale, according to Roger McNamee, who started at the firm in 1982.

Private financing “was by exception and with an extremely high bar,” McNamee, who later went on to start private-equity firm Silver Lake Management and venture-capital firm Elevation Partners, said in a phone interview. “The culture of doing things in the private market has always been there, which explains why the firm is so supportive of Henry doing this.”

At first, T. Rowe didn’t need to write big checks because companies were going public more quickly. In 1999, the median age of firms having IPOs was five years, according to data compiled by the University of Florida. In 2014, it was 11. All the capital flowing to into private investments lessened the need for companies to to tap public markets. For many investors today, waiting until an IPO to buy equity would mean missing critical periods of growth.

Capital Flood

Mutual funds such as T. Rowe, BlackRock Inc., Fidelity Investments and Wellington Management invested $5.5 billion in the private markets from 2012 to 2014, according to Pacific Crest Securities. The flood of capital has led some venture capitalists to point out the heightened risk.

“The very act of dumping hundreds of millions of dollars into an immature private company can also have perverse effects on a company’s operating discipline,” Bill Gurley, a general partner at Benchmark, wrote in a February blog post. “We are in a risk bubble. Companies are taking on huge burn rates to justify spending the capital they are raising in these enormous financings.”

Bankers, CEOs and fellow investors describe Ellenbogen as cerebral. While he never takes a board seat, he’s not shy about giving advice.

Warby Parker

When he met Warby Parker co-founder Dave Gilboa at an Allen & Co. conference two years ago, the company operated mostly online and had plans for opening a few stores. Ellenbogen suggested that the firm, which sells glasses for as little as $95, develop the brick-and-mortar side of the business. That vision aligned with Warby Parker’s, Gilboa said. When Warby Parker decided to raise new funding this year, the company called Ellenbogen to lead.

“We had offers at higher valuations, but we took a discount to have Henry lead the round,” Gilboa said in a phone interview about the more than $100 million investment that closed a few weeks ago. Warby Parker was valued at more than $1 billion, people familiar with the matter said at the time. Neither Ellenbogen nor Gilboa would comment about the valuation.

For Ellenbogen, the appeal wasn’t just the company’s business potential. When his older sister needed glasses 35 years ago, he said, the eyewear industry was controlled by a few firms and glasses cost at least $100 -- almost $300 in today’s dollars.

“It actually put a lot of stress on the family because it was a real expenditure,” Ellenbogen said. “If you’re going to do that, you’re not going to do something else.”

Ellenbogen, who had investments in private companies during the financial crisis, said he knows the risks that lie ahead. He said he plans to be one of the survivors.

“The private and public markets are in a transitional period where they are merging,” Ellenbogen said. “While there may be a shakeout coming, we’re not going back to the world as it was.”

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