Curated Insights 2019.04.05

The risk of low growth stocks: Heighten risk to the best companies

Most simply, ROIC measures how many incremental dollars of earnings a company earns by reinvesting their earnings. As a simple illustration, a company with an average 10% ROIC needs to invest 50% of their earnings to grow 5% (10%*50%=5%). A company with a 50% ROIC only needs to reinvest 10% of earnings to grow 5% (50%*10%=5%). In the former case, $0.50 of every dollar of earnings is not needed to fund growth, while in the latter case $0.90 is not needed to fund growth. This means that the higher ROIC company will generate 80% more free cash flow than the average ROIC company making the company 80% more valuable. This is why we focus on ROIC in our analysis. High ROIC businesses are significantly more valuable than average ROIC companies even when they produce the same level of growth.

Sony’s streaming service Crackle sells majority stake to Chicken Soup for the Soul

The transfer of ownership for Crackle, however, arrives at a time when ad-free streaming services like this are seeing newfound interest, with Amazon’s launch of IMDb’s FreeDive, Roku’s The Roku Channel, Walmart’s Vudu, Viacom’s new addition Pluto, Tubi and others now making gains.

As part of the deal, Sony will contribute to the new venture its U.S. assets, including the Crackle brand, user base and ad rep business, according to The Hollywood Reporter. It also will license to Crackle Plus movies and TV shows from the Sony Pictures Entertainment library, as well as Crackle’s original programming, like its shows “Start Up” and “The Oath,” for example.

CSS Entertainment will bring six of its ad-supported networks — including Popcornflix, Popcornflix Kids, Popcornflix Comedy, Frightpix, Espanolflix and Truli, plus its subscription service Pivotshare — to Crackle Plus.

The combination will lead Crackle Plus to become one of the largest ad-supported video-on-demand platforms in the U.S., the companies claim, with nearly 10 million monthly active users and 26 million registered users. The new service will also have access to more than 38,000 combined hours of programming, more than 90 content partnerships and more than 100 networks.

Andreessen Horowitz is blowing up the venture capital model (again)

So Andreessen Horowitz spent the spring embarking on one of its more disagreeable moves so far: The firm renounced its VC exemptions and registered as a financial advisor, with paperwork completed in March. It’s a costly, painful move that requires hiring compliance officers, audits for each employee and a ban on its investors talking up the portfolio or fund performance in public—even on its own podcast. The benefit: The firm’s partners can share deals freely again, with a real estate expert tag-teaming a deal with a crypto expert on, say, a blockchain startup for home buying, Haun says.

And it’ll come in handy when the firm announces a new growth fund—expected to close in the coming weeks, a source says—that will add a fresh $2 billion to $2.5 billion for its newest partner, David George, to invest across the portfolio and in other larger, high-growth companies. Under the new rules, that fund will be able to buy up shares from founders and early investors—or trade public stocks. Along with a fund announced last year that connects African-American leaders to startups, the new growth fund will give Andreessen Horowitz four specialized funds, with more potentially to follow.

Curated Insights 2019.03.29

How concentration affects portfolio performance

Vanguard calculated the returns of Russell 3000 stocks over the last 30 years and found that 47% of stocks were unprofitable investments and almost 30% lost more than half their value. They also found, and this is the big one, that 7% of stocks had cumulative returns over 1,000%.

What is Amazon?

We’ve seen the strategy that Amazon takes when it sees a regulatory threat looming on the horizon; it voluntarily started collecting sales tax in many states before states could force it to do so, and adopted a $15 minimum wage before it drew the full ire of a populist movement. With multiple headquarters distributed across multiples cities and outside access provisioned for all of its key products and services, Amazon seems more likely to break itself up – along its own preferred lines – than it is to be forcibly disassembled by regulators.

Recall Bezos’s 2002 edict: 1) All teams will henceforth expose their data and functionality through interfaces, 2) teams must communicate with each other through these interfaces, 3) all interfaces, without exception, must be designed from the ground up to be exposed to developers in the outside world, and 4) anyone who doesn’t do this will be fired.

If every meaningful Amazon product or service is exposed to outside developers via an interface, what does it matter whether Amazon is one single company or many? Antitrust action to break it apart could do nothing that it has not done to itself already; this is no doubt by design.


JD vs Alibaba in the last mile: what’s happening behind the Great Wall

China has more internet users than any other nation in the world, but there’s still plenty of room for e-commerce to grow. The Chinese e-commerce market is growing at an unfathomable rate: from 160 million online shoppers in 2010 to 530 million in 2017. This drove parcel growth of 28%, to over 100 million per day. Despite the current slowdown in economic growth, China’s e-commerce boom is likely to continue.

Consider this: 70% of packages in China are delivered same-day. This speed of delivery contributes to the success of e-commerce in China. Speed of delivery and customer experience are key, and China has both.

Alibaba holds a controlling interest in logistics operator Cainiao, which was set up in 2013 and is a collaboration including warehousing, trucking and the last mile. It’s essentially a massive, asset-light, data-sharing platform, with Alibaba owning very little of the infrastructure.

One of the prime drivers for the creation of Cainiao was to ensure capacity for Alibaba deliveries, but Alibaba and Cainiao depend on all the carriers, such as SF, ZTO and YTO. It now has over two million delivery drivers in the network.

JD has a completely different logistics strategy – it does it all itself. There are over 515 warehouses in its nationwide transportation network. Over 90% of orders from JD.com are delivered same-day or next-day by JD’s own fleet, which now comprises 65,000 drivers.

Forget Photoshop. Adobe is a marketing company now

Factor it all in, and Chief Executive Officer Shantanu Narayen has upended Adobe’s business model and quietly transformed it into that of a marketing company. Adobe has been working full crank to track every interaction a consumer has with a brand: tallying her visits to a brick-and-mortar store and what she buys; using cookies to monitor her web activity and figure out how many devices she has; analyzing her interest in emails about sales or promotions; and incorporating social media monitoring to see what she says about a brand. Adobe can combine all of this with other companies’ data about a person’s income and demographics to try to predict the triggers that would make her buy a new phone or pair of shoes. In essence, Adobe is trying to know a consumer’s decision-making process better than she may know it herself.

Demystifying aviation economics

Despite the narrow-body jets being relatively unattractive from a long-haul fuel efficiency perspective, budget airlines removed first class and were able to pack quite a bit more seats on the plane, lowering unit level economics to being competitive with the best wide-body planes today. Over the past four years, according to the International Council on Clean Transportation (ICCT), usage of narrow-body planes on the transatlantic route has more the tripled to nearly 40% of capacity.

Curated Insights 2019.03.15

Buying into the timeshares Hilton Grand Vacations, Wyndham Destinations, and Marriott Vacations Worldwide

All of the timeshare companies offer some form of financing; in general, they offer consumer loans at low double digit interest rates. These are rather attractive loans, and they can generally be packaged up and sold into the ABS market at mid-single digit rates of returns. As of Q3’18, most of the timeshare companies had ~10% of their enterprise values invested into financing receivables that they hadn’t sold into the ABS market yet. I don’t think it’s appropriate to pull those receivable investments from the timeshare companies’ enterprise valuation calculations since they’re generally valued on an EBITDA calculation that includes earnings from those loans, but I could see an argument for why they should be deducted from their EV calculation (i.e. treated as a cash equivalent). Doing so would make the timeshare companies even cheaper.

The twenty craziest investing facts ever

Why am I using the Dow instead of the S&P 500? They’re effectively the same thing. The rolling one-year correlation since 1970 is .95.

If you had invested from 1960-1980 and beaten the market by 5% each year, you would have made less money than if you had invested from 1980-2000 and underperformed the market by 5% a year.
When you were born > almost everything else.

Dow earnings were cut in half in 1908. The index gained 46%.

Curated Insights 2019.03.01

The value chain constraint

To put conservation of attractive profits in generic terms, profit in a value chain flows to whatever company is able to successfully integrate different component pieces of that value chain; the other parts of the value chain then modularize and are driven into commodity competition.

In other words, what matters is not “technological innovation”; what matters is value chains and the point of integration on which a company’s sustainable differentiation is built; stray too far and even the most fearsome companies become also-rans.

The reality is that technology has an amplification effect on business models: it has raised the Internet giants to unprecedented heights, and their positions in their relevant markets — or, more accurately, value chains — are nearly impregnable. At the same time, I suspect their ability to extend out horizontally into entirely different ways of doing business — new value chains — even if those businesses rely on similar technology, are more limited than they appear.

What does work are (1) forward and backwards integrations into the value chain and (2) acquisitions. This makes sense: further integrations simply absorb more of the value chain, while acquisitions acquire not simply technology but businesses that are built from the ground-up for different value chains. And, by extension, if society at large wants to limit just how large these companies can be, limiting these two strategies is the obvious place to start.

The risk of low growth stocks

If a 5% growing business requires a 4% cash flow yield (a free cash flow multiple of 25x, the inverse of 4%) for investors to earn 9%, you can easily do the math to figure out what sort of cash flow yield a 3% growth business or a 1% growth business requires. While a 4% yield plus 5% growth gets you to 9% total return, if a business is only growing at 3%, it needs a 6% cash flow yield. If it is only going to grow at just 1% per year, it needs an 8% cash flow yield.

Now that’s scary. And seriously risky. Because an 8% cash flow yield means a stock is worth exactly half of what it would be worth if it was trading at a 4% cash flow yield. We’re talking about a $100 stock that needs to fall to $50 if the company is only going to grow at 1% rather than 5%. Even a small change, like a 5% business slowing to 4% (in perpetuity) requires the cash flow yield to jump from 4% to 5%. This means a change from 25x cash flow to 20x or a 20% decline in the price. Ouch.

That perpetual 5% growth rate? Remember it is descriptive of the market as a whole. But under the surface, individual companies are experiencing large swings in their growth rate. The market as a whole keeps returning to about 5% growth because that’s approximately the growth rate of the overall economy. But many companies find that while they might be able to reverse temporary periods of decline, once their ongoing growth rate slows down they hit what might be thought of as “stall speed”. In aerodynamics, the stall speed is the minimum speed at which an aircraft must travel to remain in flight. If it slows to a speed below this rate, it will stall and eventually crash.

Zillow is now the Netflix of homes

You already know how Netflix shows you stuff. When you browse, you see Netflix originals plus you see all the content other studios serve through Netflix. Going forward you’ll now see this on Zillow. Why? Because last April they started buying homes directly from sellers, and want to ramp up to buying 5,000 homes a month over the next 3-5 years. How? Fill out a form on their site, get an offer. If you accept, you close in days. If you decline, they pair you with a local non-Zillow agent who can list your home for you the traditional way.

Listing with an agent might be slightly cheaper than the 7% of sales price you might pay to sell to Zillow (or other instant offer firms like Opendoor), but it doesn’t have the same certainty or speed. Since 61% of you sellers are also buying a new home, you’ll need a new mortgage. Zillow bought a mortgage company last year so they can also do your loan—whether you buy your new home directly from them or through another real estate company.

So you might hit Zillow to look for a new home or ask them to buy your existing home. Either way, this is as close as the housing industry has gotten to a one-stop shop. Over time, they might prioritize Zillow listings over non-Zillow listings like Netflix prioritizes Originals, but our TV habits have gotten us used to that already.

Aligning business models to markets

USHG is a constellation of very different restaurants and chains. At one end it has michelin star fine dining restaurants like The Modern and Gramercy Tavern. While at the other end it has the large chain Shake Shack. And many restaurants in between those two ends of the spectrum of pricing and scale.

If you do well you could go on to run a restaurant in USHG’s portfolio. Or if you wanted to open your own restaurant, you could open one with Danny Meyer as part of USHG–or start your own restaurant and have USHG as an early investor. In fact, another possibility is what the three michelin star restaurant 11 Madison Park did. It was a USHG restaurant that they sold to its general manager and head chef, who’d both worked at USHG for years.

By having a portfolio of restaurants at different scales and price points, employees are able grow their careers while staying in the family. And USHG is able to have high retention and invest more in its employees.

Curated Insights 2019.02.22

“Hollywood is now irrelevant,” says IAC Chairman Barry Diller

“Netflix has won this game. I mean, short of some existential event, it is Netflix’s. No one can get, I believe, to their level of subscribers, which gives them real dominance.”

And that includes its closest rival Amazon Prime, which isn’t designed to bid as aggressively on tomorrow’s media stars as Netflix is. “Amazon’s model is saying, ‘If you join Prime, we’re giving you things,’” Diller said. “‘So our job is to get you to join Prime. If we can get you to do that by giving you Black Panther, or whatever, or The Marvelous Mrs. Maisel, then great.’ But that model, to people in the entertainment business, is like, ‘Oh my god, how did that happen?’”


Tollymore Investment Partners’ investment thesis on Trupanion

TRUP is vertically integrated; it owns its insurance subsidiary and is responsible for acquiring and servicing existing customers as well as underwriting their insurance. TRUP estimates this vertical integration has eliminated frictional costs of c. 20% of revenues. These economic savings have been donated to consumers in the form of higher claims payout ratios. TRUP’s strategy has therefore been to sacrifice the near-term margin upside of this cost advantage in the pursuit of a larger and stickier customer base and subscription revenue pool. This cost advantage does not manifest itself in lower prices, but rather the highest sustainable expenditure on vet invoices per dollar of premiums.

TRUP has built a database over 15 years using 7.5mn pet months of information and > 1mn claims; it has segmented the market into 1.2mn price categories in order to more accurately underwrite insurance costs for a given pet. Of course, determining the point at which the marginal returns on incremental data diminish is difficult, but according to the CEO it would take a competitor 13 years to replicate this data asset. Although Nationwide is larger by number of pets enrolled, its data are likely to be less comprehensive for two reasons: (1) a lack of data for conditions not covered by policies, such as hereditary and congenital diseases, and (2) pricing categories by state rather than zip code, even though the cost of vet care can vary widely within states. TRUP considers its ability to accurately estimate the costs of pet healthcare costs by granular sub- categories crucial to its leading value proposition. This allows for the provision of more relevant products for the customer.

The addressable market is large and underpenetrated relative to other developed markets. The differences in these other markets are not demographic, social or economic, but rather (1) the length of time comprehensive pet insurance has been available, (2) the value proposition in the form of higher claims payments as a ratio to premiums (higher loss ratios) and (3) vet vs. direct to consumer distribution models. Pet insurance companies in the US typically do not cover hereditary and congenital conditions, which are the forms of illness most likely to be suffered by cats and dogs, they increase rates when claims are made, they impose payout limits, and pay claims according to an estimated cost schedule rather than actual vet invoices. TRUP is different in all these respects and as such expects to grow the addressable market in North America to greater than 1% penetration. In any case, it appears to be the case that TRUP’s value proposition is driving adoption in North America.

The unit economics associated with the pursuit of this opportunity to grow the company’s assets are attractive. The cost to acquire a pet is c. $150, around 3x the average monthly ARPU. Assuming the current 10% discretionary margin and a six-year average pet life, the IRR on new pets is 30-40%. At a 15% discretionary margin the IRR would be double this. I estimate that both ARPUs and discretionary margins would need to decline by 20-25% to render reinvestment in pet acquisition a capital destructive pursuit. This would contradict the economic reality of a market in which pet healthcare costs are increasing mid-single digits as new technologies and treatments are ported over from human healthcare, and the scalability of the business model.

Purchases with plastic get costlier for merchants—and consumers

Merchants paid an estimated $64 billion in Visa and Mastercard credit and debit interchange fees last year, according to new data from an industry publication, the Nilson Report. That is up 12% from a year earlier and up 77% from 2012.

Other fees are on the rise, as well. Visa, the largest U.S. card network, is increasing several fees in April, according to people familiar with the matter. Unlike interchange fees that are paid to card issuers, these fees are collected by Visa.

Visa raised its “credit-card assessment fee” this year by 0.01% for most credit-card purchases made in the U.S. While seemingly small on a percentage or flat-fee basis, the increased fees that Visa will put in place during the first four months of the year are expected to cost U.S. merchants at least an additional $570 million through April 2020, according to estimates by merchants-payments consulting firm CMSPI.

But network fees aren’t the only additional charges merchants face. There are also other fees charged by firms that process merchants’ card transactions. Those, which include the network fees, totaled $14.8 billion on Visa and Mastercard debit and credit transactions in 2018, up 10% from a year earlier and 70% from 2012, according to the Nilson Report.


MSG says the Knicks aren’t for sale. It’s a good time to invest in sports either way.

That $5 billion is a big number, 25% higher than the recent $4 billion valuation by Forbes. And $5 billion amounts to more than $200 per share, or about 71% of MSG’s current stock price. Just because the number is large doesn’t mean it isn’t realistic. Don’t forget the Clippers were sold to former Microsoft (MSFT) CEO Steve Ballmer for $2 billion in 2014. That year, before the sale was announced, Forbes valued the Knicks at $1.4 billion and the Clippers didn’t crack Forbes top-10 most valuable NBA franchises.

Live TV content is part of the reason the value of sports franchises have swelled. Live content is becoming increasingly more valuable to media outlets like traditional networks and streaming companies. But other factors are also at play. Sports betting is another important avenue for franchise owners to generate brand-new streams of cash. “I think everyone who owns a top four professional sports team just basically saw the value of their team double” Dallas Mavericks owner Mark Cuban said in 2018, after the U.S. Supreme Court cleared the way for legalized sports betting in states other than Nevada.

If the Knicks are sold, MSG would be left with the New York Rangers, the WNBA’s New York Liberty, the Hartford Wolf Pack of the American Hockey League, and the Westchester Knicks of the NBA’s developmental league. In addition to Madison Square Garden itself, MSG also owns the Hulu Theater at Madison Square Garden, Radio City Music Hall, the Beacon Theatre, the Forum, the Chicago Theatre, and the Wang Theatre.

Curated Insights 2019.01.18

10 years since BNSF

“It’s a crazy deal. It’s an insane deal. We looked at Burlington Northern at $75 and I’ll give you the exact calculation we did. You don’t have a high earnings return. They are paying 18 times earnings, but it’s really much worse than that. They report maintenance cap-ex very carefully. They report depreciation and amortization, and they report only about 70% of the maintenance cap-ex.”

One very important fact of this transaction, was his level of conviction. In November 2009, there were a ton of cheap opportunities. Buffett picked BNSF, and paid a 30% premium to gain full ownership. Also, 40% of the total consideration was paid with arguably deeply undervalued BRK shares. So, safe to say he really wanted BNSF. The $34bn paid for BNSF, represented almost 25% of Berkshire’s equity! It was a huge bet, with significant repercussions.

Applying similar numbers, we get to an Enterprise Value of $125bn and an equity value of $105bn for Berkshire´s railroad. Once again, Buffett paid $34bn, took out $31bn in dividends and is left with +$100bn in value…Good job Warren.

So we know returns for this massive investment have been impressive, but let´s get to a number. And the number is…~18%. That is massive for an investment many thought at the time would produce mediocre returns. Remember many experts thought he was overpaying for a capital-intensive, regulated and cyclical business.

18% is 1.5x the return of the S&P 500 during a bull market. But it gets better…At the time of the acquisition, Berkshire already owned ~20% of BNSF stock…so he didn´t have to pay the takeout premium on 100% of the shares outstanding. In reality, he had to pay ~$26bn for the shares he didn´t own. Also, Berkshire employed a bit of leverage to fund the acquisition. The company issued $8bn in bonds, so we get, leveraged returns. If we take into account the leverage and the shares of BNSF Berkshire already owned, then the return on the equity would go…way up. But I think we get the point.

Fund manager: Why Amazon could double

The market is not correctly conceptualizing normalized profitability. It seems that the market views AMZN’s profitability primarily through a legacy e-commerce lens, viewing AMZN as a single-digit-margin business. Piecing apart the business, I think this is wrong. First, AMZN has not known the meaning of the word “operating leverage” for the past 10 years, but it is showing through recently with beautiful impact. In Q3 18, fulfillment as a percentage of sales actually declined for the first time time in five years (having gone from 8.5% in 2010 to 15% of sales in 2018). This is a nascent signal, but suggests that the fulfillment infrastructure expansion is nearing its final stages. There are supplementary data points to support this notion, including the slowing in new DCs and headcount. As a result of this operating leverage, operating margins went from 0.8% in Q3 17 to 6.6% in Q3 18, with incremental margins of 26%. Second, there is a real mix shift going on at AMZN that benefits GMs and fundamentally changes the OM outlook for the combined business. Core e-commerce (lower margin) grew revenue only 10% in Q3, but third party seller services grew 31% and AWS grew 46%. As a result of this positive mix shift, gross margins went from 37% Q3 17 to 41.7% in Q3 18, with incremental gross margins coming in at 57.5%. Amazon effectively has a powerful combination of mix-driven GM expansion and operating leverage driven OM expansion in play here, and my view is that this dynamic will hold for at least a number of years to come.

PayPal quietly took over the checkout button

In 2013, PayPal bought Braintree Payment Solutions LLC, which processes the credit card transactions on the mobile apps of Uber, Airbnb, StubHub, and thousands of smaller businesses. The acquisition brought in an influx of programmers and designers, as well as Venmo, which Braintree had acquired the year before. Venmo is a way to quickly settle small debts between friends: a dinner check, a get-well present for a colleague. With Venmo, informal financial interactions formerly governed by social norms about reciprocity, forgiveness, and passive-aggressive hinting could be easily recorded and quickly paid. (“I only have a twenty” is no longer a viable excuse.) You could even “bill” your friends. The app—complete with a feed of the payments your friends have made to each other—has proved enormously popular with millennials.

Over the next six months, Schulman negotiated similar partnerships with Mastercard and Citibank, committing to make it as effortless as possible for customers to use Citibank-issued credit cards and Mastercard’s network. “When PayPal first spun out of EBay, there was a lot of competition and a lot of negative sentiment,” says Heath Terry, an analyst who covers the industry for Goldman Sachs Group Inc. “Basically, in 18 months on the job, Dan was able to completely change that narrative.” As with the Visa deal, PayPal was forgoing some profit but placating powerful and formerly antagonistic payments incumbents. Citi and Mastercard—along with Google, Apple, Amazon, and Samsung, each of which has an eponymous “pay” product—began steering customers to link their accounts with PayPal, seeing it not as a competitor but as a driver of transactions and the fees they generate. In short, as a pal.

The result has been a surge in growth. “It took us 14 years to go from 50 million subscribers to 250 million,” Schulman says. “I mean, it’s impressive, but it’s a long time. We went from 200 million to 250 million in about 18 months,” tripling the rate at which the company added users, or what it calls “net new actives.” PayPal’s stock is up more than 100 percent since the start of 2017. However, PayPal’s most impressive statistic may be its conversion rate. People who design online and mobile shopping apps are obsessed with smoothing and shortening the path from idle browsing to purchase—humans are acquisitive and impulsive creatures, but they’re also easily distracted and bad at remembering their credit card numbers. Too many options hurts conversion, and so does having to type out stuff or wait for a page to load. PayPal’s conversion rate is lights-out: Eighty-nine percent of the time a customer gets to its checkout page, he makes the purchase. For other online credit and debit card transactions, that number sits at about 50 percent.

This differential was cited by the hedge fund Third Point in an investor letter last July: “We see parallels between PayPal and other best-in-class internet platforms like Netflix and Amazon,” it read. It applauded PayPal’s $2.2 billion purchase in May of IZettle, a Swedish payments processor known as the “Square of Europe.” The praise was particularly striking coming from Third Point, whose billionaire founder Dan Loeb, like Icahn, is better known for publicly excoriating the leadership of the companies in which he invests. Built into PayPal’s high share price is the expectation that the company will figure out a way to turn Venmo’s popularity into profit. Third Point’s letter predicted that the app will be contributing $1 billion in additional annual revenue within three years. Disagreements over how to do that, or how much to even try, have led to the departures of two Venmo heads in two years. Employees who have left in recent months describe mounting mutual frustration. According to multiple people familiar with the company’s finances, the app is still losing hundreds of millions of dollars annually. In an interview after the announcement of Venmo’s latest leadership change in late September, Schulman’s deputy, PayPal Chief Operating Officer Bill Ready, downplayed any suggestion of turmoil. “Any startup that goes through rapid growth is going to experience this,” he says. “You evolve, and you have to bring in different skill sets for each stage of the journey.”

Cancer deaths decline 27% over 25 years

Deaths from cancer dropped 27% over a quarter century, meaning an estimated 2.6 million fewer people died of the disease during that period, according to a new report from researchers at the American Cancer Society.

For most of the 20th century, overall cancer deaths rose, driven mainly by men dying from lung cancer, researchers noted. But since the peak in 1991, the death rate has steadily dropped 1.5% a year through 2016, primarily because of long-running efforts to reduce smoking, as well as advances in detection and treatment of cancer at earlier stages, when prognosis for recovery is generally better.

Curated Insights 2018.11.30

What’s next for marketplace startups? Reinventing the $10 trillion service economy, that’s what.

The service economy lags behind: while services make up 69% of national consumer spending, the Bureau of Economic Analysis estimated that just 7% of services were primarily digital, meaning they utilized internet to conduct transactions.

In the a16z portfolio, Honor is building a managed marketplace for in-home care, and interviews and screens every care professional before they are onboarded and provides new customers with a Care Advisor to design a personalized care plan. Opendoor is a managed marketplace that creates a radically different experience for buying and selling a home. When a customer wants to sell their home, Opendoor actually buys the home, performs maintenance, markets the home, and finds the next buyer. Contrast this with the traditional experience of selling a home, where there is the hassle of repairs, listing, showings, and potentially months of uncertainty.

Managed marketplaces like Honor and Opendoor take on steps of the value chain that platforms traditionally left to customers or providers, such as vetting supply. Customers place their trust in the platform, rather than the counterparty of the transaction. To compensate for heavier operational costs, it’s common for managed marketplaces to actually dictate pricing for services and charge a higher take rate than less-managed marketplace models.

The last twenty years saw the explosion of a number of services coming online, from transportation to food delivery to home services, as well as an evolution of marketplace models from listings to full-stack, managed marketplaces. The next twenty years will be about the harder opportunities that software hasn’t yet infiltrated–those filled with technological, operational, and regulatory hurdles–where there is room to have massive impact on the quality and convenience of consumers’ everyday lives.

The services sector represents two-thirds of US consumer spending and employs 80% of the workforce. The companies that reinvent various service categories can improve both consumers’ and professionals’ lives–by creating more jobs and income, providing more flexible work arrangements, and improving consumer access and lowering cost.

Country stock markets as a percent of world

Keyence’s miraculous margins

The outsourcing reduces capital expenditure costs, and the associated depreciation, as there’s no machinery to purchase. It is also said to help Keyence to retain its valuable intellectual property. Suppliers, according to Morten Paulsen, Head of Research at CLSA Japan, have no visibility on how the respective pieces of the product puzzle fit together.

But Keyence are not the only business to run a “fabless” model. Apple, perhaps the most successful consumer brand of all time, outsources the creation of its iPhone to Taiwanese Foxconn. It reported operating margins of 26 per cent last quarter. Similarly, semiconductor designers such as Nvidia, Broadcom and Qualcomm also outsource to businesses like Taiwan Semiconductor. Their margins tend to range from 20 per cent to 40 per cent.

Keyence is also excellent at leveraging its suppliers, which it does “in a cleverer way than any other company I’ve seen”, he told us. Indeed, Keyence often has multiple suppliers manufacturing the same part, which stops one raising prices in fear of losing orders to competitors. Further to this, Keyence develops some of its manufacturing processes in house, then trains the suppliers, which means it can switch suppliers with greater ease than most if it begins to get strong armed, Paulsen argues.

What about its products? To its credit, Keyence has positioned itself right at the forefront of several key trends in an era of increasing factory automation, such as sensors which detect infinitesimal assembly-line mistakes. Customers, such as automakers — which make up roughly 25 per cent of its sales, according to Paulsen — are happy to pay top dollar for products that pay for themselves in 2 years, giving Keyence some degree of pricing power.

The reason for achieving high profitability is to maximise customer’s evaluation of products with high value added — that is, for customers, “I do not think it is expensive” and “I think it is cheap if it [our problem] can be solved” . . . As we explore the potential needs of our customers and develop them [the products] in advance, about 70 per cent of the new products of Keyence are the industry’s first and world’s first product as a result. Even in terms of management, we concentrate resources on product planning and design . . . we are trained to not only sell goods but also propose ideas that can solve customer’s problems.

Amazon, with little fanfare, emerges as an advertising giant

“The online retailer has ascended to the No. 3 spot in the U.S. digital ad market behind the dominant players, Alphabet Inc.’s Google and Facebook Inc. Though Amazon has just 4% of the market now, the company is expanding its avenues for marketers and hiring aggressively for its ad unit.

Amazon’s ad revenue is on pace to double this year, to $5.83 billion, according to eMarketer. Its ad sales are expected to jump $28.4 billion over the next five years, according to Cowen & Co.—more than the combined increases in ad revenue for all television networks globally, according to figures from media-buyer GroupM.”

Amazon’s ad business now contributes to gross profit and is expected to generate more income than its cloud business—which currently provides the bulk of its profits—as soon as 2021, according to Piper Jaffray analysts.

Amazon is expected to collect 15 cents of each new dollar spent on U.S. digital ads in 2020, up from 5 cents last year, according to an analysis of data from research firm eMarketer.

Why doctors hate their computers

This, I discovered, was the real reason the upgrade cost $1.6 billion. The software costs were under a hundred million dollars. The bulk of the expenses came from lost patient revenues and all the tech-support personnel and other people needed during the implementation phase.

Optimize your programming decisions for the 95%, not the 5%

Without having a deep understanding of what you’re developing and have put in the time to come up with good abstractions based on real experience, you’re just shooting in the dark hoping your generic user system works for all cases when you haven’t even programmed it yet for 1 use case. How is that even possible to do?

When you blindly follow what Google and other massive companies are doing, you’re optimizing for the 5% in a slightly different way. Instead of just getting your app up and running and seeing how it goes, you try to make decisions so that your application can be developed by 100 different teams sprawling across 5,000 developers. Meanwhile it’s just you developing the app by yourself in nearly all cases for new projects.

As soon as you start trying to make it work for a real application, or more specifically, your application, it all falls apart until you spend the time and really learn what it takes to scale an application (which is more than just picking tools). The companies that created these tools have put in the time over the years and have that knowledge, but that knowledge is specific to their application.

Premature optimization is the root of all evil (or at least most of it) in programming.

Optimizing for the 5% is a type of premature optimization. Maybe not so much for your development environment choices, but certainly for the other cases. Base your decisions on optimizing for the 95%, keep it simple and see how it goes. In other words, optimize when you really need to not because of “what if”.

Curated Insights 2018.11.02

Steve Jobs had an incredible definition of what a company should be

The company is one of the most amazing inventions of humans, this abstract construct that’s incredibly powerful. Even so, for me, it’s about the products. It’s about working together with really fun, smart, creative people and making wonderful things. It’s not about the money. What a company is, then, is a group of people who can make more than just the next big thing. It’s a talent, it’s a capability, it’s a culture, it’s a point of view, and it’s a way of working together to make the next thing, and the next one, and the next one.


Fossil fuels will save the world (really)

That fossil fuels are finite is a red herring. The Atlantic Ocean is finite, but that does not mean that you risk bumping into France if you row out of a harbor in Maine. The buffalo of the American West were infinite, in the sense that they could breed, yet they came close to extinction. It is an ironic truth that no nonrenewable resource has ever run dry, while renewable resources—whales, cod, forests, passenger pigeons—have frequently done so.


Gundlach: People want to be told what to think. I don’t

My biggest lesson that I’ve learned… I have the same flaw that every human being has and that is: As you’re growing up and getting older, you believe that everybody’s like you. You just extrapolate your personality traits and proclivities on other people. Then you start to realize increasingly, that that’s not true. And I believed, therefore, that everybody was intellectually objective and honest and wanted to figure things out for themselves. And I didn’t understand, for probably as long as 20 years, why I couldn’t convince people of almost mathematically analytical arguments regarding markets. And it was finally after years of this that I realized that people actually want to be told what to think.

It took me a long time to understand that. Not me, see, I don’t want to be told what to think. And so I figured nobody wants to be told what to think. But indeed, I think almost everybody wants to be told what to think. That creates a tremendous advantage in managing money. Because in that window of time between a fact and people being told what the fact means, you have a window if you’re capable of figuring out what it means – and don’t need to be told what it means – where you can actually act before other people and I found I’ve made a lot of money that way.

I remember when Ben Bernanke announced the Fed funds rate was going to stay at 0% for three years, and the markets didn’t move. And I had my traders look for this asset class in the bond market that would be the primary beneficiary of rate staying at zero for three years. And I said, “How much of the prices up?” And they said, “They’re not up at all.”

Assessing IBM’s $34 billion Red Hat acquisition

Dan Scholnick, general partner at Trinity Ventures, whose investments have included New Relic and Docker, was not terribly impressed with the deal, believing it smacked of desperation on IBM’s part. “IBM is a declining business that somehow needs to become relevant in the cloud era. Red Hat is not the answer. Red Hat’s business centers around an operating system, which is a layer of the technology stack that has been completely commoditized by cloud. (If you use AWS, you can get Amazon’s OS for free, so why would you pay Red Hat?) Red Hat has NO story for cloud,” he claimed in a statement.

Forrester analyst Dave Bartoletti sees the cloud native piece as being key here. “The combined company has a leading Kubernetes and container-based cloud-native development platform, and a much broader open source middleware and developer tools portfolio than either company separately. While any acquisition of this size will take time to play out, the combined company will be sure to reshape the open source and cloud platforms market for years to come,” he said.


IBM’s old playbook

The best thing going for this strategy is its pragmatism: IBM gave up its potential to compete in the public cloud a decade ago, faked it for the last five years, and now is finally admitting its best option is to build on top of everyone else’s clouds. That, though, gets at the strategy’s weakness: it seems more attuned to IBM’s needs than potential customers. After all, if an enterprise is concerned about lock-in, is IBM really a better option? And if the answer is that “Red Hat is open”, at what point do increasingly sophisticated businesses build it themselves?

The problem for IBM is that they are not building solutions for clueless IT departments bewildered by a dizzying array of open technologies: instead they are building on top of three cloud providers, one of which (Microsoft) is specializing in precisely the sort of hybrid solutions that IBM is targeting. The difference is that because Microsoft has actually spent the money on infrastructure their ability to extract money from the value chain is correspondingly higher; IBM has to pay rent:

The threat of Amazon’s content strategy

Even if content is created by a publisher and merely distributed through the tech platform, the tech company still captures its data; Netflix, for example, doesn’t share ratings data with TV producers, and Amazon doesn’t share Kindle readership data with the publishing industry. Meanwhile, Facebook actually shared false data with brands about their video’s viewership for years.

  • Anheuser-Busch InBev acquired a stake in RateBeer, a leading beer review platform, and October, a beer culture website.
  • Popular makeup startup Glossier initially launched as a content site; it then used insights gathered from users to develop its own line of cosmetics. Now, it aims to launch a new social commerce platform to encourage user reviews and feedback.
  • L’Oreal invested in Beautycon Media, which creates digital beauty content and hosts festivals for influencers
  • Mattress startup Casper even launched its own magazine; the current issue includes features like “A skeptic’s guide to crystals” and an adult coloring book.

Social Capital’s Chamath Palihapitiya says ‘we need to return to the roots of venture investing’

“The dynamics we’ve entered is, in many ways, creating a dangerous, high stakes Ponzi scheme. Highly marked up valuations, which should be a cost for VCs, have in fact become their key revenue driver. It lets them raise new funds and keep drawing fees.”

“VCs bid up and mark up each other’s portfolio company valuations today, justifying high prices by pointing to today’s user growth and tomorrow’s network effects. Those companies then go spend that money on even more user growth, often in zero-sum competition with one another. Today’s limited partners are fine with the exercise in the short run, as it gives them the markups and projected returns that they need to keep their own bosses happy.”

“Ultimately, the bill gets handed to current and future LPs (many years down the road), and startup employees (who lack the means to do anything about the problem other than leave for a new company, and acquire a ‘portfolio’ of options.)”

The coming storm for consumer staples dividends

AB InBev argued that by taking its leverage down to 2x net debt/EBITDA, it will reduce its cost of capital and “maximize total enterprise value.” All else equal, a lower cost of debt would in theory increase enterprise value, yet AB InBev already has solidly investment-grade credit ratings (e.g., A- from S&P). A ratings upgrade within the investment-grade space would likely only have a marginal impact on lowering cost of debt. Deleveraging could even increase its cost of capital, as more expensive equity takes a greater share of the capital structure.

Ultimately, a company’s dividend should be affordable, reflect the growth in shareholder value creation, and help management more prudently select high-return projects rather than pursue wasteful “empire building” deals. Dividends can be a problem, however, when they become too generous and handcuff management’s ability to invest in high-return projects and defend or widen the firm’s economic moat. When this happens, a dividend “rebasing” or “cut” would benefit long-term shareholders.


Uber-inequality

Uber received proposals from investment banks that pegged the ride-hailing firm’s IPO valuation at $120B. So, that posits Uber’s value is greater than the value of the US airline industry or the US auto industry (excluding Tesla). I love Uber and think the firm is genius. But that valuation is insane. Uber’s model doesn’t have the moats of an auto firm or even Airbnb, which must create global demand and supply (a local competitor to Airbnb doesn’t work, as visitors from other countries wouldn’t know about it). In contrast, local on-demand taxi services abound, even if without an app. The 120K readers of this newsletter could each put in $250, and boom — we have the number-three ride-hailing firm in Miami. Who’s with me?

In today’s economy, innovation means elegant theft: robbery of your data, privacy, health insurance, or minimum-wage protection. Uber has 16K employees and 3M driver partners. “Driver partner” means some great things. It means you don’t have to show up to an office. And it means you can work whenever you want — this is key. When I speak to Uber drivers, I always ask, “Do you like working for Uber?” The overwhelming majority say yes and reference the flexibility. I’ve been especially struck by how many need the flexibility, as they’re taking care of someone who’s sick. So many people taking care of others. So many people loving other people. And it comes at a huge cost. Many of them used to have jobs with benefits. Many had to move to a strange place to take care of their sister, mother, nephew.

The economic value of artificial intelligence

In the near term, around $6.6 trillion of the expected GDP growth will come from productivity gains, such as the continued automation of routine tasks. Over time, increased consumer demand for AI-enhanced offerings will overtake productivity gains and result in an additional $9.1 trillion of GDP growth by 2030.

China is expected to see the greatest economic gains from AI, a $7 trillion or 26% boost in GDP growth. One reason is the high proportion of China’s GDP that is based on manufacturing, where AI is expected to have a particularly big impact between now and 2030. Even more important over the longer term is China’s higher rate of AI investments compared to North America and Europe.

China is expected to see the greatest economic gains from AI, a $7 trillion or 26% boost in GDP growth. One reason is the high proportion of China’s GDP that is based on manufacturing, where AI is expected to have a particularly big impact between now and 2030. Even more important over the longer term is China’s higher rate of AI investments compared to North America and Europe.

In North America, the economic gains from AI are expected to reach $3.7 trillion or 14.5% of GDP growth by 2030. North America will see the fastest growth in the near term, given its current lead in AI technologies, applications, and market readiness. But China will likely begin to catch up by the middle 2020s given its accelerating AI investments.


A.I. is helping scientists predict when and where the next big earthquake will be

Some of the world’s most destructive earthquakes — China in 2008, Haiti in 2010 and Japan in 2011, among them — occurred in areas that seismic hazard maps had deemed relatively safe. The last large earthquake to strike Los Angeles, Northridge in 1994, occurred on a fault that did not appear on seismic maps.

Curated Insights 2018.10.26

A change in perspective

Which one of these investments would you want for the next 20 years? Mathematically you should be indifferent, but behaviorally you won’t be.

If you are aged 25-44, asset C will be cheap while you are still in the wealth accumulation stage of your life. This is why Josh Brown says millennials should be stoked for a market crash, and he is right. However, since we don’t know the future, it would be near impossible to stay with asset C while assets A and B also exist. Once again, the deciding factor is perspective.

This is why you should never forget the impact of your perspective, and the perspectives of others, when making investment decisions. You have to consider someone else’s investment umwelt before you make any important financial choices. When you see friends rushing into the hottest asset class, consider what their goals are. When you hear about a new stock tip from a broker, think about why they would be telling you that. When you feel the panic set in as everyone around you is selling, remind yourself of your long term financial plan.

Can the stock market predict the next recession?

By my calculations, the S&P 500 has had 20 bear markets (down 20% or worse) and 27 corrections (down 10% but less than 20%) since 1928. The average losses saw stocks fall 24% and lasted 228 days from peak-to-trough. Of those 47 double-digit sell-offs, 31 of them occurred outside of a recession and didn’t happen in the lead up to a recession. That means around 66% of the time, the market has experienced a double-digit drawdown with no recession as the main cause. Of those 31 which occurred outside of a recession, the losses were -18% over 154 days, on average.

We’ll have a recession at some point but odds are the stock market won’t tip us off ahead of time. In fact, most of the time people don’t even realize we’re in a recession until after it’s already begun. NBER typically gives the official word for a recession around the time they’re ending or already in the midst of a slowdown. The recession that began in March 2001 wasn’t officially called a recession by NBER until November 2001, the month it ended. The recession that began in the summer of 1990 wasn’t determined until the spring of 1991. And the recession that began in the summer of 1981 wasn’t called a recession until January of 1982.

21 lessons from Jeff Bezos’ annual letters to shareholders

2017: Build high standards into company culture
2016: Move fast and focus on outcomes
2015: Don’t deliberate over easily reversible decisions
2014: Bet on ideas that have unlimited upside
2013: Decentralize decision-making to generate innovation
2012: Surprise and delight your customers to build long-term trust
2011: Self-service platforms unlock innovation
2010: R&D should pervade every department
2009: Focus on inputs — the outputs will take care of themselves
2008: Work backwards from customer needs to know what to build next
2007: Missionaries build better products
2006: Nurture your seedlings to build big lines of business
2005: Don’t get fixated on short-term numbers
2004: Free cash flow enables more innovation
2003: Long-term thinking is rooted in ownership
2002: Build your business on your fixed costs
2001: Measure your company by your free cash flow
2000: In lean times, build a cash moat
1999: Build on top of infrastructure that’s improving on its own
1998: Stay terrified of your customers
1997: Bring on shareholders who align with your values
Links to Jeff Bezos’s Shareholder Letters (1997-2017)

The quality of quantity at Netflix

Calculating the customer acquisition cost for Netflix is easy — take the segmented marketing costs (handily provided by the company), and divide by the number of paid subscribers added.

The lifetime value of a Netflix subscriber. To work this out: 1. take the average revenue of a user in the quarter; 2. multiply it by the gross margin (to figure out how profitable a subscriber is), then
3. divide this figure by the churn rate — the proportion of customers which leave each quarter.

On to stage 2 of our calculation: the profitability per user. So that’s the numbers above, multiplied by the gross margin (revenues, minus the cost of providing the service).

Lower gross margins in the future due to higher content costs might effect the lifetime value assessment, but lets stick with existing numbers for now. So we’ve got the first two parts of our customer lifetime value calculation, leaving just the churn rate.

But that isn’t really what we’re after, what we want to know is the ratio between how much money a paid subscriber is worth — the lifetime value — and how much it costs Netflix to pull one in to its platform — the customer acquisition cost.

Tesla short seller warns of ‘massive’ supply-chain disruption

“We question the ability for Tesla to actually deliver on their promises to their customers when they’re on the brink of potentially a massive supply-chain disruption,” Quadir said in an interview on Bloomberg Television. “We see very little contingency planning, and we also see executives from the supply chain department departing in recent weeks and months.’’


Trupanion stock sinks after report of state probe

Part of the short thesis on Trupanion is based on the idea that vet activity may not comply with some state insurance regulations. It represents a bigger risk than consumer complaint investigations, which are commonplace for insurers. If regulatory challenges continue it could further dent investor sentiment about the shares.

Serverless computing’s innovative approach to software development

“By purchasing more cloud computing capacity then they really need – even as a deliberate strategy to safeguard against crashing key systems – or buying advanced reserves that they will never use, companies across all industries may be overspending on cloud services by an average of 42%, according to data compiled by Densify, a cloud optimization firm that works with big companies worldwide. That can translate into hundreds of thousands or even millions of lost dollars in IT budgets a year, depending on the size of cloud deployments, the firm said. Its estimates are based on input from 200 cloud-industry professionals and 70 global companies over the last year.”

Serverless is based on a very different resource management model. The biggest overhead is in the design of the application. Serverless applications are woven or composed from a collection of loosely coupled, lightweight modules or microservices. Each such module is only given resources when triggered by another application module or invoked by an external function. Serverless modules are expected to run for a relatively short time, and are generally limited in how long each invocation is allowed to run. Once the module finishes running, its resources are returned to the serverless platform and made available to other modules that need them. The modules are stateless, meaning that no information is carried over or remembered between invocations. Any information that needs to be persistent across invocations must be explicitly stored in a separate file or data base.

Given the special nature of serverless applications, developers no longer need to plan, allocate or provision module instances. Once a module is invoked, the serverless platform will figure out the resources it requires and automatically provision them. As other modules are invoked, the platform will automatically allocate the required resources, and take them away once they’ve finished running. Developers are only charged for the resources used during the time their modules actually run. If invoked infrequently, or if invocations are spiky, there’s no need to plan for and pay for just-in-case-resources.


Now apps can track you even after you uninstall them

Uninstall tracking exploits a core element of Apple Inc.’s and Google’s mobile operating systems: push notifications. Developers have always been able to use so-called silent push notifications to ping installed apps at regular intervals without alerting the user—to refresh an inbox or social media feed while the app is running in the background, for example. But if the app doesn’t ping the developer back, the app is logged as uninstalled, and the uninstall tracking tools add those changes to the file associated with the given mobile device’s unique advertising ID, details that make it easy to identify just who’s holding the phone and advertise the app to them wherever they go.

Curated Insights 2018.10.12

“[The whole tech bubble] is very interesting, because the stock is not the company and the company is not the stock. So as I watched the stock fall from $113 to $6 I was also watching all of our internal business metrics: number of customers, profit per unit, defects, everything you can imagine. Every single thing about the business was getting better, and fast. So as the stock price was going the wrong way, everything inside the company was going the right way. We didn’t need to go back to the capital markets because we didn’t need more money. The only reason a financial bust makes it really hard is to raise money. So we just needed to progress.”

“Everything I have ever done has started small. Amazon started with a couple of people. Blue Origin started with five people and the budget was very small. Now the budget approaches a billion dollars. Amazon was literally ten people, today it’s half a million. For me it’s like yesterday I was driving packages to the post office myself and hoping one day we could afford a forklift. For me, I’ve seen small things get big and it’s part of this ‘day one’ mentality. I like treating things as if they’re small; Amazon is a large company but I want it to have the heart and spirit of a small one.”

“I believe in the power of wandering. All of my best decisions in business and in life have been made with heart, intuition and guts. Not analysis. When you can make a decision with analysis you should do so. But it turns out in life your most important decisions are always made with instinct, intuition, taste and heart.”

“AWS completely reinvented the way companies buy computation. Then a business miracle happened. This never happens. This is the greatest piece of business luck in the history of business as far as I know. We faced no like-minded competition for seven years. It’s unbelievable. When you pioneer if you’re lucky you get a two year head start. Nobody gets a seven year head start. We had this incredible runway.”

“We are so inventive that whatever regulations are promulgated or however it works, that will not stop us from serving customers. Under all regulatory frameworks I can imagine, customers are still going to want low prices, they are still going to want fast delivery, they are still going to want big selection. It is really important that politicians and others need to understand the value big companies bring and not demonise or vilify big companies. The reason is simple. There are certain things only big companies can do. Nobody in their garage is going to build an all carbon-fiber fuel efficient Boeing 787. It’s not going to happen. You need Boeing to do that. This world would be really bad without Boeing, Apple, Samsung and so on.”

How big can Amazon get?

What business is Amazon most similar to? Definitely not Wal-Mart. Amazon’s model is much, much closer to Costco’s model. How does Costco’s model differ from Wal-Mart’s model?

Costco does not try to be a leading general retailer in specific towns, counties, states, the nation as a whole, etc. What Costco does is focus on getting a very big share of each customer’s wallet. Costco also focuses on achieving low costs for the items it does sell by concentrating its buying power on specific products and therefore being one of the biggest volume purchasers of say “Original” flavor Eggo waffles. It sells these waffles in bulk, offers them in one flavor (Wal-Mart might offer five different flavors of that same product) and thereby gets its customer the lowest price.

There’s two functions that Costco performs where it might be creating value, gaining a competitive advantage, etc. One is supply side. Costco may get lower costs for the limited selection it offers. In some things it does. In others, it doesn’t. The toughest category for Costco to compete in is in fresh food. I shop at Costco and at other supermarkets in the area. The very large format supermarkets built by companies like HEB (here in Texas) can certainly match or beat Costco, Wal-Mart, and Amazon (online and via Whole Foods stores) when it comes to quality, selection, and price for certain fresh items. But, what can Costco do that HEB can’t? It can have greater product breadth (offering lots of non-food items) and it can make far, far, far more profit per customer.

Now, an interesting question to ask is what SHOULD determine the market value per customer. Not what does. But, what should? In other words, if we had to do a really, really long-term discounted cash flow calculation – what variables would matter most? If two companies both have 10 million customers which company should be valued higher and why? Two variables matter. One: Annual profit per customer. Two: Retention rate. Basically, we’re talking about a DCF here. If Company A and Company B both have 10 million customers and both make $150 per customer the company that should have a higher earnings multiple (P/E or P/FCF) should be the one with the higher retention rate.

What Spotify can learn from Tencent Music

Tencent Music is no small player: As the music arm of Chinese digital media giant Tencent, its four apps have several hundred million monthly active users, $1.3 billion in revenue for the first half of 2018, and roughly 75 percent market share in China’s rapidly growing music streaming market. Unlike Spotify and Apple Music, however, almost none of its users pay for the service, and those who do are mostly not paying in the form of a streaming subscription.

Its SEC filing shows that 70 percent of revenue is from the 4.2 percent of its overall users who pay to give virtual gifts to other users (and music stars) who sing karaoke or live stream a concert and/or who paid for access to premium tools for karaoke; the other 30 percent is the combination of streaming subscriptions, music downloads, and ad revenue.

Tencent Music has an advantage in creating social music experiences because it is part of the same company that owns the country’s leading social apps and is integrated into them. It has been able to build off the social graph of WeChat and QQ rather than building a siloed social network for music. Even Spotify’s main corporate rivals, Apple Music and Amazon Music, aren’t attached to leading social platforms.


Traffic acquisition costs

In other words the two companies have an agreement that Apple is paid in proportion to the actual query volume generated. This would extend the relationship from one of granting access for a number of users or devices to revenue sharing based on usage or consumption. Effectively Apple would have “equity” in Google search sharing in the growth as well as decline in search volume.

The idea that Apple receives $1B/month of pure profit from Google may come as a shock. It would amount to 20% of Apple’s net income and be an even bigger transfer of value out of Google. The shock comes from considering the previously antagonistic relationship between the companies.

The remarkable story here is how Apple has come to be such a good partner. Both Microsoft and Google now distribute a significant portion of their products through Apple. Apple is also a partner for enterprises such as Salesforce, IBM, and Cisco. In many ways Apple is the quintessential platform company: providing a collaborative environment for competitors as much as for agnostic third parties.

Shares of pet insurer Trupanion are overvalued

Much of the Trupanion excitement is based on the low 1% penetration rate and the fact that it’s the only pet-insurance pure play. Bradley Safalow, who runs PAA Research, an independent investment research firm, disputes the lofty expectations. Bulls extrapolate from industry data that say about two million pets out of 184 million in North America are insured now. Safalow says that ignores a key factor—the income levels of pet owners. Because Trupanion’s policies cost about $600 to $1,500 annually and don’t cover wellness visits, he estimates that, in the case of dogs, which represent 85% of the pet market, a more realistic target customer would be owners who earn $85,000 or more a year. Based on that benchmark, Safalow estimates insurance penetration—of those most likely to buy it—at about 6% already for dogs.

The requests for rate increases would indicate that premiums aren’t keeping up with claims; that the policy risks are worse than the company expected; and that the profitability of its book of business is relatively weak. APIC’s ratio of losses and loss-adjustment expense to premiums earned have risen steadily over the past four years to 75.6% in the first quarter of this year from 68.9% for all of 2014, according to state filings. The loss ratio is total losses incurred in claims plus costs to administer the claims (loss adjustment expense) divided by premiums earned.

Bob Iger’s bets are paying off big time for Disney

Iger thinks he knows how to coax consumers who already pay for one streaming service to either add another or switch to Disney’s. “We’re going to do something different,” he says. “We’re going to give audiences choice.” There are thousands of barely watched movies on Netflix, and Iger figures that people don’t like to pay for what they don’t use. So families can buy only a Disney stream, which will offer Pixar, Marvel, Lucas, Disney-branded programming. Sports lovers can opt just for an ESPN stream. Hulu, of which Disney will own a 60% stake after it buys Fox (and perhaps more if it can persuade Comcast to sell its share), will beef up ABC’s content with Fox Searchlight and FX and other Fox assets. “To fight [Amazon and Netflix], you’ve got to put a lot of product on the table,” says Murdoch. “You take what Disney’s got in sports, in family, in general entertainment—they can put together a pretty great offer.”

Having a leader who is willing to insulate key creative people from the vicissitudes of business has helped Disney successfully incorporate its prominent acquisitions. They have not been Disneyfied. Marvel movies are not all of a sudden family friendly (at least not by Disney standards). Pixar movies have not been required to add princesses. Most of the people who ran the companies before Disney bought them still run them (with the exception of John Lasseter, who was ousted in June in the wake of #MeToo). “I’ve been watching him with his people and with Fox people; he’s clearly got great leadership qualities,” says Murdoch.”He listens very carefully and he decides something and it’s done. People respect that.”


Can anyone bury BlackRock?

Today the Aladdin platform supports more than $18 trillion, making it one of the largest portfolio operating systems in the industry. BlackRock says Aladdin technology has been adopted in some form by 210 institutional clients globally, including asset owners such as CalSTRS and even direct competitors like Vanguard.

“Not only does it provide risk transparency, but it also provides an ability to model trades, to capture trades, to structure portfolios, to manage portfolio compliance — all of the operating components of the workflow,” Goldstein says. “It’s a comprehensive, singular enterprise platform versus a model where you’re piecing together a lot of things and trying to figure out how to interface them.”

In a market that’s traditionally been very fragmented, BlackRock’s ability to offer an integrated, multipurpose platform has proven a strong selling point for prospective clients — even when it’s up against competitors that perform specific functions better.

How to break up a credit ratings oligopoly

This is not to say Kroll’s firm, Kroll Bond Rating Agency, hasn’t been successful. It grew gross fees by 49 percent annualized between 2012 and the end of 2017 on the back of growing institutional demand for alternative investments. Since 2011 it has rated 11,920 transactions, representing $785 billion and 1,500 issuers. Still, KBRA and other competitors, including Lisbon-based ARC Ratings and Morningstar Credit Ratings, that have entered the sector in the last decade have barely made a dent in the market share of the big three.

The upstarts are facing more than just deeply entrenched competition, although that is striking: S&P, Moody’s, and Fitch control more than 90 percent of the market combined. A host of other complex factors have combined to make it nearly impossible to dislodge the big three — and to address the central conflict of interest baked into the ratings agency business model.


Elon Musk, Google and the battle for the future of transportation

We think a similar analogy is likely with AV/EV — the most economically well-off people will still care about comfort, features, and identity that the AV/EV they ride and arrive in imparts on them. If Waymo can deliver a premium experience at a better price and higher utility than their current solution (i.e. driving themselves in their own cars or Ubers/taxis) with cost economics that yield a strong profit margin/ROIC at scale (1/2-1/3 the pricing of Uber at 1/10 the cost), it will have built an offering that will be set to be the leading AV service and create tremendous value for shareholders despite the early capital intensity. Estimates of the value of this Transportation as a Service (TaaS) or Mobility as a Service (MaaS) go from hundreds of billions on up based on Morgan Stanley’s estimate of 11 billion miles (3B in the US) driven globally and forecasted to double over the next decade.

Eventually, if Waymo is successful at taking the strong lead via network effects in AV and converting enough consumers to use its premium service (achieving a cultural and regulatory tipping point), it could decide to open up its service’s usage across other auto “hardware” partners as they demonstrate their ability to deliver a certain level of quality experience and scale globally, enabling a broader application of its service to lower tiers of the market with lower capital intensity (akin to Apple’s 2nd hand iPhone market, which broadens its user base for services offerings).


Network effect: How Shopify is the platform powering the DTC brand revolution

“The 21st-century brand is the direct-to-consumer brand,” said Jeff Weiser, chief marketing officer at Shopify. “A couple of things have enabled the rise of the DTC, which is the ability to outsource the supply chain.” For Weiser, who described himself as “loving” anything to do with DTC, what Shopify does is power all of that ability — from selling to payments to marketing. “We run the gamut of a retail operating system.” The company has admittedly benefited from a DTC boom: Starting with small businesses run from people’s kitchens, then going upmarket to giant Fortune 500 companies, Weiser said that DTC’s “graduation” into giant juggernauts themselves has made a huge difference. Shopify powers hundreds of those companies, from Allbirds to mattress brand Leesa to Chubbies.

Just as Google and Facebook are core to anyone marketing online, Shopify is becoming the same to those who sell directly online. Like any platform, Shopify is building an ecosystem of developers, startups and ad agencies. The company has 2,500 apps through its own app store. The company can, like the Apple App Store, add apps into its ecosystem that merchants can then purchase.


Why the Elastic IPO is so important

Elastic’s open source products are downloaded voluminously, with over 350M downloads of its open source software to date. As a result, sales engages with customers who are already users and highly familiar with the products. This leads to shorter sales cycles and higher sales conversions. Additionally, awareness and engaged prospects are generated by popular open source projects, such as Elasticsearch and others from Elastic, obviating the need for top-of-funnel and mid-funnel marketing spend. Elastic still spent a healthy 49% of revenue on Sales & Marketing in FY ’18 (year ending Jan ’18) but this was down from 60% the prior year, and the implied efficiency on Elastic’s Sales & Marketing spend is extremely high, enabling the 79% top-line growth the company has enjoyed. Finally, Elastic shows how disruptive an open source model can be to competition. There are already large incumbents in the search, analytics, IT Ops and security markets, but, while the incumbents start with sales people trying to get into accounts, Elastic is rapidly gaining share through adoption of its open source by practitioners.

Elastic controls the code to it open source projects. The committers are all employed by the company. Contributions may come from the community but committers are the last line of defense. This is in contrast to open source projects such as Linux and Hadoop, where non profit foundations made up of many commercial actors with different agendas tend to govern updates to the software. The biggest risk to any open source project is getting forked and losing control of the roadmap, and its difficult for a company to build a sustainable high margin business supporting a community-governed open source project as a result. Elastic, and other companies who more tightly control the open source projects they’ve popularized, have full visibility to roadmaps and are therefore able to build commercial software that complements and extends the open source. This isn’t a guarantee of success. The viability of any open source company rests with the engagement of its open source community, but if Elastic continues to manage this well, their franchise should continue to grow in value for for foreseeable future.


Elastic closed 94% up in first day of trading on NYSE, raised $252M at a $2.5B valuation in its IPO

“When you hail a ride home from work with Uber, Elastic helps power the systems that locate nearby riders and drivers. When you shop online at Walgreens, Elastic helps power finding the right products to add to your cart. When you look for a partner on Tinder, Elastic helps power the algorithms that guide you to a match. When you search across Adobe’s millions of assets, Elastic helps power finding the right photo, font, or color palette to complete your project,” the company noted in its IPO prospectus.

“As Sprint operates its nationwide network of mobile subscribers, Elastic helps power the logging of billions of events per day to track and manage website performance issues and network outages. As SoftBank monitors the usage of thousands of servers across its entire IT environment, Elastic helps power the processing of terabytes of daily data in real time. When Indiana University welcomes a new student class, Elastic helps power the cybersecurity operations protecting thousands of devices and critical data across collaborating universities in the BigTen Security Operations Center. All of this is search.”

The Big Hack: How China used a tiny chip to infiltrate U.S. companies

One government official says China’s goal was long-term access to high-value corporate secrets and sensitive government networks. No consumer data is known to have been stolen.

With more than 900 customers in 100 countries by 2015, Supermicro offered inroads to a bountiful collection of sensitive targets. “Think of Supermicro as the Microsoft of the hardware world,” says a former U.S. intelligence official who’s studied Supermicro and its business model. “Attacking Supermicro motherboards is like attacking Windows. It’s like attacking the whole world.”

Since the implants were small, the amount of code they contained was small as well. But they were capable of doing two very important things: telling the device to communicate with one of several anonymous computers elsewhere on the internet that were loaded with more complex code; and preparing the device’s operating system to accept this new code. The illicit chips could do all this because they were connected to the baseboard management controller, a kind of superchip that administrators use to remotely log in to problematic servers, giving them access to the most sensitive code even on machines that have crashed or are turned off.

Can anyone catch America in plastics?

Ethane, once converted to ethylene through “cracking” is the principal input into production of polyethylene. Simply put, ethane is turned into plastic. Polyethylene is manufactured in greater quantities than any other compound. U.S. ethane production has more than doubled in the past decade, to 1.5 Million Barrels per Day (MMB/D).

The result is that ethane trade flows are shifting, and the U.S. is becoming a more important supplier of plastics. The Shale Revolution draws attention for the growth in fossil fuels — crude oil and natural gas, where the U.S. leads the world. But we’re even more dominant in NGLs, contributing one-third of global production. The impact of NGLs and consequent growth in America’s petrochemical industry receives far less attention, although it’s another huge success story.


Amazon’s wage will change how U.S. thinks about work

If $15 an hour becomes the new standard for entry-level wages in corporate America, its impact may be felt most broadly among middle-class workers. Average hourly earnings for non-managerial workers in the U.S. were $22.73 an hour in August. The historically low level of jobless claims and unemployment, combined with $15 an hour becoming an anchor in people’s minds, could make someone people earning around that $22 mark feel more secure in their jobs. Instead of worrying about losing their job and being on the unemployment rolls for a while, or only being able to find last-ditch work that pays $9 or $10 an hour, the “floor” may be seen as a $15 an hour job.

That creates a whole new set of options for middle-class households. In 2017, the real median household income in the U.S. was $61,372, which is roughly what two earners with full-time jobs making $15 an hour would make. A $15-an-hour floor might embolden some workers to quit their jobs to move to another city even without a job offer there. It might let some workers switch to part-time to focus more time on education, gaining new skills or child care.

Circle of competence

It’s not the size of your circle of competence that matters, but rather how accurate your assessment of it is. There are some investors who are capable of figuring out incredibly complex investments. Others are really good at a wide variety of investments types, allowing them to take advantage of a broad set of opportunities. Don’t try to keep up with the Joneses. Figure out what feels comfortable, and do that. If you are not quite sure whether something is within your circle of competence or not – that in and of itself is an indicator that it’s better to pass. After all, to quote Seth Klarman’s letter to his investors shortly after the Financial Crisis of 2008, “Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return.”


Lessons from Howard Marks’ new nook: “Mastering the Market Cycle – Getting the Odds on Your Side”

… you can prepare; you can’t predict. The thing that caused the bubble to burst was the insubstantiality of mortgage-backed securities, especially subprime. If you read the memos, you won’t find a word about it. We didn’t predict that. We didn’t even know about it. It was occurring in an odd corner of the securities market. Most of us didn’t know about it, but it is what brought the house down and we had no idea. But we were prepared because we simply knew that we were on dangerous ground, and that required cautious preparation.


Market timing is hard

People use data to justify market timing. But it’s hindsight bias, right? If you know ahead of time when the biggest peaks and troughs were through history, you can make any strategy look good. So Antti and his co-authors made a more realistic and testable market timing strategy. And here’s the key difference — instead of having all hundred years of history, Antti’s strategy used only the information that was available at the time. So, say for example it’s 1996, early tech bubble. We know after the fact that the U.S. stock market would get even more expensive for a few years before it crashed. But in 1996 you wouldn’t actually know that. So by doing their study this way, Antti could get a more realistic test of value-based market timing.

The interesting and troubling result was when we did this market timing analysis the bottom line was very disappointing. It was not just underwhelming, it basically showed in the last 50-60 years, in our lifetimes, you didn’t make any money using this information.

The Decision Matrix: How to prioritize what matters

I invested some of that time meeting with the people making these decisions once a week. I wanted to know what types of decisions they made, how they thought about them, and how the results were going. We tracked old decisions as well, so they could see their judgment improving (or not).

Consequential decisions are a different beast. Reversible and consequential decisions are my favorite. These decisions trick you into thinking they are one big important decision. In reality, reversible and consequential decisions are the perfect decisions to run experiments and gather information. The team or individual would decide experiments we were going to run, the results that would indicate we were on the right path, and who would be responsible for execution. They’d present these findings.

Consequential and irreversible decisions are the ones that you really need to focus on. All of the time I saved from using this matrix didn’t allow me to sip drinks on the beach. Rather, I invested it in the most important decisions, the ones I couldn’t justify delegating. I also had another rule that proved helpful: unless the decision needed to be made on the spot, as some operational decisions do, I would take a 30-minute walk first.

Risk management

Once you frame risk as avoiding regret, the questions becomes, “Who cares what’s hard but I can recover from? Because that’s not what I’m worried about. I’m worried about, ‘What will I regret?’”

So risk management comes down to serially avoiding decisions that can’t easily be reversed, whose downsides will demolish you and prevent recovery.

Actual risk management is understanding that even if you do everything you can to avoid regrets, you are at best dealing with odds, and all reasonable odds are less than 100. So there is a measurable chance you’ll be disappointed, no matter how hard you’ll try or how smart you are. The biggest risk – the biggest regret – happens when you ignore that reality.

Carl Richards got this right, and it’s a humbling but accurate view of the world: “Risk is what’s left over when you think you’ve thought of everything.”


The most important survival skill for the next 50 years isn’t what you think

Even if there is a new job, and even if you get support from the government to kind of retrain yourself, you need a lot of mental flexibility to manage these transitions. Teenagers or 20-somethings, they are quite good with change. But beyond a certain age—when you get to 40, 50—change is stressful. And a weapon you will have [is] the psychological flexibility to go through this transition at age 30, and 40, and 50, and 60. The most important investment that people can make is not to learn a particular skill—”I’ll learn how to code computers,” or “I will learn Chinese,” or something like that. No, the most important investment is really in building this more flexible mind or personality.

The better you know yourself, the more protected you are from all these algorithms trying to manipulate you. If we go back to the example of the YouTube videos. If you know “I have this weakness, I tend to hate this group of people,” or “I have a bit obsession to the way my hair looks,” then you can be a little more protected from these kinds of manipulations. Like with alcoholics or smokers, the first step is to just recognize, “Yes, I have this bad habit and I need to be more careful about it.”

And this is very dangerous because instead of trying to find real solutions to the new problems we face, people are engaged in this nostalgic exercise. If it fails—and it’s bound to fail—they’ll never acknowledge it. They’ll just blame somebody: “We couldn’t realize this dream because of either external enemies or internal traitors.” And then this is a very dangerous mess.

The other danger, the opposite one, is, “Well, the future will basically take care of itself. We just need to develop better technology and it will create a kind of paradise on earth.” Which doesn’t take into account all of the dystopian and problematic ways in which technology can influence our lives.