Curated Insights 2019.08.09

Good for Google, bad for America

A.I.’s military power is the simple reason that the recent behavior of America’s leading software company, Google — starting an A.I. lab in China while ending an A.I. contract with the Pentagon — is shocking. As President Barack Obama’s defense secretary Ash Carter pointed out last month, “If you’re working in China, you don’t know whether you’re working on a project for the military or not.”

Netflix is not a tech company

Hence, Netflix isn’t using TV to leverage some other business – TV is the business. It’s a TV company. Amazon is using content as a way to leverage its subscription service, Prime, in much the same way to telcos buying cable companies or doing IPTV – it’s a way to stop churn. Amazon is using Lord of the Rings as leverage to get you to buy toilet paper through Prime. But Facebook and Google are not device businesses or subscription businesses. Facebook or Google won’t say ‘don’t cancel your subscription because you’ll lose this TV show’ – there is no subscription. That means the strategic value of TV or music is marginal – it’s marketing, not a lock-in.

Apple’s position in TV today is ambivalent. You can argue that the iPhone is a subscription business (spend $30 a month and get a phone every two years), and it certainly thinks about retention and renewals. The service subscriptions that it’s created recently (news, music, games) are all both incremental revenue leveraging a base of 1bn users and ways to lock those users in. But the only important question for the upcoming ‘TV Plus’ is whether Apple plans to spend $1bn a year buying content from people in LA, and produce another nice incremental service with some marketing and retention value, or spend $15bn buying content from people in LA, to take on Netflix. But of course, that’s a TV question, not a tech question.

Why we sold Trupanion

Why is Trupanion not outpacing the industry when it is the first name many pet owners hear? It could be that pet owners hear about pet insurance from their vet, go home, compare prices, and choose a more affordable option. It’s not an impossible problem for Trupanion to solve, but again, consumers don’t typically understand insurance value until they file a claim.

But at an investor event we attended a few months ago, Darryl said that he was making plans to switch to an executive chairman role in 2025. While we understood Darryl’s choice on a personal level, it also sharply increased our uncertainty around whether company management will be able to successfully build a moat and transform pet insurance as we had hoped. In our opinion, Trupanion will continue to need a visionary leader in the CEO role and finding another visionary to replace Rawlings will be a massive challenge.

Given the industry’s rapid growth, we think it’s perfectly normal for both regulators and pet insurance companies to have some growing pains. While Trupanion has been fined, faces more state investigations, and admits it should have paid more attention to regulators as a stakeholder, we considered these matters minor to our thesis. Regulators may require Trupanion’s Territory Partners to be licensed in all states, but this is more like a speed bump rather than a roadblock.


TGV Intrinsic on MercadoLibre

Network effects are among the highest entry barriers for competitors to build and leverage business. As market leader, MercadoLibre has been able to permanently focus on strengthening the network effects of the marketplace and eliminate points of conflict in transaction processing between buyer and seller. The most important point of conflict between seller and buyer in the past were the payment arrangements. To simplify this process, MercadoLibre launched its own payment service “MercadoPago” in 2004 (comparable to PayPal). MercadoPago provides a secure way to pay for goods and simplified the coordination between buyers and sellers in terms of payment. Today, over 90% of the value god goods sold on MercadoLibre is paid with MercadoPago, which equates to a payment volume of 11 billion US dollars.

Apart from that, logistics costs in many Latin American countries pose a major hurdle for buyers and sellers. The investments required to setup one’s own logistics system are high, delivery times in Latin America are relatively long, and service is rather mediocre. With the founding of MercadoEnvios in 2013, MercadoLibre took over an ever more extensive control over the logistics of goods in several steps. Today, MercadoEnvios operates its own logistics centres, takes over the first mile from the seller or organises the last mile to the end customer with selected partners. In 2018, at least part of the logistics was taken over by MercadoEnvious for 66% of the goods sold through the marketplace. Thanks to the sizeable investments in a proprietary payment system and the continuous expansion of its own logistics, MercadoLibre has massively expanded its marketplace and the network effect that has been set in motion over the past two decades. The value of these investments is reflected in the growth in the number of transactions amounting to 28% per annum over the past decade.

The value of this ecosystem lies in the ever-growing economy of scale. MercadoLibre has more touch points with its customers than its competitors, be it specialised online retailers, payment service providers, or logistics companies. At each of these points of contact, MercadoLibre can distribute its costs in customer acquisition to more services than its competitors. As a result, the costs for new customers per product are lower than for competitors. Second, MercadoLibre can freely decide which areas of a customer relationship to monetise and which not. For example, MercadoLibre may offer MercadoPago payment service to new brick-and-mortar retailers for free but would require a marketplace transaction fee for this merchant’s online product sales. A specialised payment provider does not have this flexibility. As a result, MercadoLibre has created a flexible and cost-effective customer acquisition engine that only very few companies have.


Zebras can change their stripes

Since 2012, JUVE has gone on to secure many other high profile “free” transfers with established winners such as Dani Alves and Sami Khediera, but then also find those that have significant upside potential like Adrien Rabiot, Kingsley Coman, and Emre Can. By far, the most impactful and value-accretive “free” transfer was Paul Pogba. In 2012, Juventus signed 19 year-old Pogba from Manchester United, and only four seasons later (and after winning four league titles) sold him back to Manchester United for a world-record fee of $116 million. In total, since 2011, the top 10 free transfer signings by Juventus have created $204m of value (i.e. market value of the players at time of signing) and over $135 million of cash from transfer sales proceeds. Yes, Pogba was an outlier, but JUVE has utilized the free transfer market better than any other club over the past decade.

Let us not forget this is a business, and Ronaldo prints money. Before the ink dried on the contract, the Ronaldo effect took Juventus, and Italy, by storm. His name generated over $60 million in jersey sales in one day – that is the best global branding a club can ask for. JUVE’s Twitter account showed a 10% increase in followers on the day he was signed. Then ESPN acquired the U.S. Serie A TV rights at a massive step-change in the fee ($55 million per year, versus $28 million previously) only one month later. And to no one’s surprise, the first game aired on August 18th showcasing Ronaldo in his new black and white jersey. Your author duly signed up for ESPN+ exclusively to live stream I Bianconeri. The acquisition led to a nice bump in GreenWood’s performance, and most importantly, Ronaldo helped his team win another Serie A title.

The periodic table of investments

Winner-take-all phenomenon rules the stock market, too

Just 1.3% of the world’s public companies account for all the market gains during the past three decades. Outside the U.S., the gains are even more concentrated, with less than 1% of all equities driving all of the net appreciation in share prices.

Just five companies — Apple Inc., Microsoft Corp., Amazon.Com Inc., Alphabet Inc. (Google) and Exxon Mobil Corp. — accounted for 8.3% of global net wealth creation. It is hard to imagine a greater example of the winner-take-all distribution — these five companies account for just 0.008% of the total sample set of 62,000 publicly traded companies. Expand that to the top 0.5%, or 306 companies, and they account for 73% of global net wealth creation. The best performing 811 companies (1.33% of the total) accounted for all net global wealth creation.


Negative rates could happen in America, too

What’s behind negative interest rates? Many observers blame central banks like the European Central Bank (ECB) and the Bank of Japan (BOJ) that are taxing banks’ excess reserves with negative deposit rates and have made bonds scarcer by removing them from the market through their purchase programs. The BOJ now owns about half and the ECB about 30% of the bonds issued by their respective governments, according to Bloomberg.

However, we believe central banks are not the villains but rather the victims of deeper fundamental drivers behind low and negative interest rates. The two most important secular drivers are demographics and technology. Rising life expectancy increases desired saving while new technologies are capital-saving and are becoming cheaper – and thus reduce ex ante demand for investment. The resulting savings glut tends to push the “natural” rate of interest lower and lower.

LBOs make (more) companies go bankrupt, research shows

According to researchers at California Polytechnic State University, roughly 20 percent of large companies acquired through leveraged buyouts go bankrupt within ten years, as compared to a control group’s bankruptcy rate of 2 percent during the same time period.


Is great information good enough? Evidence from physicians as patients

We compare the care received by a group of patients that should have the best possible information on health care service efficacy—i.e., physicians as patients—with a comparable group of non-physician patients, taking various steps to account for unobservable differences between the two groups. Our results suggest that physicians do only slightly better in adhering to both low- and high-value care guidelines than non-physicians – but not by much and not always.


Health facts aren’t enough. Should persuasion become a priority?

Those who were most opposed to genetically modified foods believed they were the most knowledgeable about this issue, yet scored the lowest on actual tests of scientific knowledge. In other words, those with the least understanding of science had the most science-opposed views, but thought they knew the most.

Curated Insights 2018.03.04

The #1 reason Facebook won’t ever change

Google’s core DNA is search and engineering, though some would say engineering that is driven by the economics of search, which makes it hard for the company to see the world through any other lens. Apple’s lens is that of product, design, and experience. This allows it to make great phones and to put emphasis on privacy, but makes it hard for them to build data-informed services.

Facebook’s DNA is that of a social platform addicted to growth and engagement. At its very core, every policy, every decision, every strategy is based on growth (at any cost) and engagement (at any cost). More growth and more engagement means more data — which means the company can make more advertising dollars, which gives it a nosebleed valuation on the stock market, which in turn allows it to remain competitive and stay ahead of its rivals.

Facebook’s challenge is that their most lucrative market — the US and Canada — are saturated. And to keep making money in these markets — already a ridiculous $27 in ARPU for the last three months of 2017 — they need us to give more time and attention to them. This is a crisis situation for Facebook because it doesn’t make as much money from markets outside of the US and Canada. For the same three months, it made $2.54 in ARPU in Asia-Pacific, $1.86 in rest of the world, and $8.86 in Europe.


Netflix

And if you’re dependent upon advertising you’re done. The public will not sit for it, only the cheapest individuals will endure ads, and then the ads don’t work on them, because they’re so damn tight. No, the people advertisers want to reach are the spenders, which is why everybody’s now advertising on Amazon, check it out, that’s where the dollars change hands.

So the networks and other ad-supported channels are on life support. They’re dependent upon hits, which come and go, and what do I always say…DISTRIBUTION IS KING!

So, just having good content is not enough, you’re reinventing the wheel every season, you’re only as good as your last hit.

As for HBO… That’s a dying model. If the outlet were smart, they’d band together with Hulu or another player and release all episodes on the same day. People don’t like to wait, appointment viewing is passe. We want it all and we want it NOW!

As for Hulu, forget about it, it doesn’t have critical mass, and unlike Netflix, it’s only in America. Sure, the “Handmaid’s Tale” burnished the outlet’s image, but Netflix has more than that, “Narcos,” Stranger Things,” 13 Reasons Why,” “Wormwood”… A record company can’t survive on one act, you need a steady flow of product, which Netflix has. And it’s a virtuous circle, they keep adding subscribers to the point they’ve got more money and they spend it on the best creators! So they end up with the lion’s share of the viewers. Which is why Fox wanted out, why it sold to Disney.

Nobody wants to let Google win the war for maps all over again

The companies working on maps for autonomous vehicles are taking two different approaches. One aims to create complete high-definition maps that will let the driverless cars of the future navigate all on their own; another creates maps piece-by-piece, using sensors in today’s vehicles that will allow cars to gradually automate more and more parts of driving.

Alphabet is trying both approaches. A team inside Google is working on a 3-D mapping project that it may license to automakers, according to four people familiar with its plans, which have not previously been reported. This mapping service is different than the high-definition maps that Waymo, another Alphabet unit, is creating for its autonomous vehicles.

Mobileye argues that it’s more efficient and cost-effective to let the cars we’re driving today see what’s ahead. In January, the Intel Corp. unit announced a “low-bandwidth” mapping effort, with its front-facing camera and chip sensor that it plans to place in 2 million cars this year. The idea is to get cars to view such things as lane markers, traffic signals and road boundaries, letting them automate some driving. Mobileye says this will take less computing horsepower than building a comprehensive HD map of the roads would.

Hidden profits in the prescription drug supply chain

Analysts at Bernstein tried to get a better picture of how profitable these companies are by excluding the cost of the drugs that are included in their revenue. The analysts compared the rate at which gross profit converts into earnings before interest, taxes, depreciation and amortization for pharmacy-benefits managers and other pieces of the drug supply chain, including drug distributors, insurers and pharmacies.

By this analysis, pharmacy-benefit managers are exceptionally profitable; 85% of their gross profit converted into Ebitda over the past two years. Drug distributors converted 46% of their gross profit, while health insurers and pharmacies achieved about 30%.


Sergio Marchionne’s final lap

Few people in automotive history have as impressive a legacy of wealth creation as the 65-year-old Marchionne: Henry Ford, Billy Durant, Karl Benz and Kiichiro Toyoda among them. But those titans were like the industry’s farmers — cultivating businesses from scratch and nurturing them into today’s automaking giants. Marchionne, in contrast, has been the fireman — running into the ruins of once-great companies, putting out the flames and rebuilding something better than before.

“In 2004, when you were first introduced to the auto industry, a lot of people were thinking, ‘Who the hell is this guy?’ Right? I was one of them, frankly,” Morgan Stanley analyst Adam Jonas told Marchionne during FCA’s Jan. 25 quarterly call with analysts. “We hadn’t seen anything like you. You took $2 billion, roughly, and you’ve turned it into around $72 billion, and more important than that, there are many hundreds of thousands of families across many nations that are better off because of you and your team.”

In 2009, Marchionne inherited a mess. Daimler and later Cerberus Capital had largely failed to invest in necessary product improvements or modernize the company’s industrial footprint. Morale among employees who had survived constant cost-cutting, including several rounds of layoffs, and then the bankruptcy could not have been lower. Marchionne offered the automaker’s disheartened employees a path back to potential health — one that demanded long hours, hard work, humility and sacrifice. The employees accepted the challenge. They set to work fixing many of the things that had gone so wrong with Chrysler and its products — improving quality, overhauling 16 vehicles in 19 months, banning rat-gray interiors and fixing manufacturing plants. Their level of commitment and dedication to restore the company to some semblance of health continually surprised Marchionne.


Didi Chuxing took on Uber and won. Now it’s taking on the world

With 400m registered customers in more than 400 Chinese cities, it delivers 25m rides a day, roughly twice as many as Uber and all the other global sharing apps combined. In the future, Liu imagines an even larger purpose, as Didi uses big data and machine learning to fix the many problems that snarl-up urban areas. “When you redesign the transportation system, you basically redesign the whole city,” Liu says. “You redefine how people should live.”

AI currently matches thousands of riders and drivers each minute, as part of a decision-making platform the company calls “Didi Brain”. This already predicts where riders are likely to want cars 15 minutes ahead of time, guessing right 85 per cent of the time. As it seeks out more patterns, Zhang says, the system will see forward an hour, or even a full day, using reinforcement learning, a powerful AI technique in which computers learn via experimentation, much as a child might use trial and error.

But for Didi, machine learning helps solve more basic problems, like traffic signals. “They’re sometimes manually operated every 90 seconds by someone sitting in a room,” Liu says. In the eastern city of Jinan, Didi algorithms now power “smart” traffic lights, which optimise patterns based on real-time car data, cutting congestion by ten per cent. Similar projects are under way in dozens of cities, along with plans to improve traffic lane management and bus systems.


Dyson bets on electric cars to shake up industry

Dyson has worked extensively on lightweight materials, leading several people to speculate the first vehicle may be substantially comprised of plastics rather than metals, something usually reserved for high-end supercars. This would make the cars lighter — important because of the weight of electric batteries — but also allowing for more inventive designs. When announcing the project last September, Sir James said the first car would look “quite different” to any currently on the market.

Dyson aims to lean less heavily on suppliers than traditional carmakers, partly because of a penchant for making components in house, and partly because electric cars contain substantially fewer bits than their combustion engine counterparts. The group already produces electric motors, which turn the wheels, as well as battery cells in-house, and is investing heavily in software development, an increasingly important part of modern cars.


SpaceX joins race to make web truly worldwide

If successful, however, SpaceX has said it plans to start launching its first commercial satellites next year, with a constellation of more than 11,000 circling the earth in low-earth orbit by the time the network is complete in 2024.

The satellite trial points to an impending space race that has drawn in powerful backers. Google, which once looked at developing its own satellite-based network, became one of SpaceX’s biggest backers when it led a $1bn investment round three years ago. Meanwhile, SoftBank and Richard Branson are among the backers of OneWeb, a European rival that hopes to start providing broadband internet next year.


Driverless cars: mapping the trouble ahead

“Everyone is trying to develop their own in-house HD map solution to meet their self-driving needs, and that doesn’t scale,” says Mr Wu of DeepMap. “It’s all reinventing the wheel, and that’s wasting a lot of resources. That will probably be one of the reasons to block self-driving cars from becoming a commodity.” Because companies do not share mapping data and use different standards, they must create new maps for each new city that they plan to enter. “It will delay the deployment in certain geographies,” Mr Wang says.

Willem Strijbosch, head of autonomous driving at TomTom, says the maps needed for driverless cars are different from the current map applications because they will need to “serve a safety critical function”, rather than just being used for navigation. “Another change is that you can no longer use GPS as your only means of localisation in the map,” he adds, because the global positioning system is not precise enough for self-driving cars.


Eyes in the sky: a revolution in satellite technology

Farmers can use the imagery to estimate crop yields around the world, investors are counting the number of oil storage tanks in China and estimating consumption trends, while human rights campaigners have used it to map the flight of the Rohingya population from Myanmar. On a daily basis, we can now study the shrinkage of glaciers, the expansion of cities, the deforestation of remote wildernesses and the devastation of armed conflict in intense detail.

“Seeing the whole Earth as a single entity is not new,” says Martin Rees, Britain’s astronomer royal. “But what is happening now is that we are monitoring it on a daily basis at high resolution. Satellites have enough resolution to observe every big tree in the world every day.”

Planet now has a fleet of 190 satellites in orbit, including 13 SkySat satellites. That network provides a steady feed of imagery — more than 1.3 million photographs a day — that can be combined with other data streams to create a comprehensive “space data processing platform”. The company includes feeds from the Sentinel satellites, which operate as part of the EU’s Copernicus programme, and the US Landsat 8 satellite, adding infrared and radar capability.

Over the past two years, Planet has sold its data services to hundreds of customers in about 100 different countries, including the US, UK and German governments and big companies such as Bayer, Monsanto and Wilbur-Ellis. Planet says it has strict ethical guidelines and vets its customers as best it can to ensure that sensitive images do not end up in the wrong hands.

The number

Dr. Edward Deming once said that the numbers that best define a company are two factors that do not appear on any financial statement. These factors are the value of a satisfied customer and the value of a dissatisfied customer. These factors must be multiplied by every other number in a financial statement in order to assess the prospects of the business. A high satisfaction leads to repeat purchases and referrals, growing the business; while a low satisfaction leads to ending relationships and a repulsion of potential new customers. These numbers determine everything about the future and nobody quite knows what they are.

Stocks are more similar to bonds than you think

The table demonstrates that stocks have done an admirable job diversifying negative returns in bonds over time, showing losses only in three out of the 16 different times that bonds had down years. The spread between the two averaged more than 16 percent. It should also be comforting to those who practice diversification that even when both have fallen in the same year, bonds typically don’t get crushed like stocks do and instead tend to only show minor losses.

Companies pay workers to get savvier with money

Carrie Leana, a professor of organizations and management at University of Pittsburgh, said participants reported significant declines in their financial worry and increases in both their physical and psychological health.

To tackle this, companies are using incentives to boost participation in financial-wellness programs. These typically combine financial education with customized advice delivered by mobile apps and human advisers. The goal: to teach employees basic money-management skills and remind them—via text messages, emails or one-on-one meetings—to stick to budgets, pay bills and save more for everything from emergencies to retirement.

“We know that stress is the No. 1 cause of health-related issues, and the No. 1 cause of stress is money,” said SunTrust CEO William Rogers Jr. “If we can attack financial stress, we can improve our employees’ physical well-being as well.”