Curated Insights 2018.08.03

Once in a lifetime, if you’re lucky

Apple did it the old fashioned and the new fashioned way – great products, great marketing, incredible innovation, brilliant people, global supply chain, incessant improvements and updates, buybacks and dividends, R&D and M&A, domestic hiring and international outsourcing, wild creativity and diligent bean-counting. They had it all and used it all. It’s an amazing story. Many of us were able to be along for the ride.


Business lessons from Rob Hayes (First Round Capital)

It is a red flag for me if the founders have 20 slides in their deck on their product and are not getting into issues like distribution, team or other parts of the business. There have been very few products that cause people to beat a path to the door of the business on their own [like Google or Facebook]. Successful companies almost always have operators running them who know how to market, sell, manage an income statement and hire.


Why do the biggest companies keep getting bigger? It’s how they spend on tech

The result is our modern economy, and the problem with such an economy is that income inequality between firms is similar to income inequality between individuals: A select few monopolize the gains, while many fall increasingly behind.

The measure of how firms spend, which Mr. Bessen calls “IT intensity,” is relevant not just in the U.S. but across 25 other countries as well, says Sara Calligaris, an economist at the Organization for Economic Cooperation and Development. When you compare the top-performing firms in any sector to their lesser competition, there’s a gap in productivity growth that continues to widen, she says. The result is, if not quite a “winner take all” economy, then at least a “winner take most” one.

What we see now is “a slowdown in what we call the ‘diffusion machine,’” says Dr. Calligaris. One explanation for how this came to be is that things have just gotten too complicated. The technologies we rely on now are massive and inextricably linked to the engineers, workers, systems and business models built around them, says Mr. Bessen. While in the past it might have been possible to license, steal or copy someone else’s technology, these days that technology can’t be separated from the systems of which it’s a part.

This seemingly insurmountable competitive advantage that comes with big companies’ IT intensity may explain the present-day mania for mergers and acquisitions, says Mr. Bessen. It may be difficult or impossible to obtain critical technologies any other way.

Everything bad about Facebook is bad for the same reason

Facebook didn’t intend for any of this to happen. It just wanted to connect people. But there is a thread running from Perkins’ death to religious violence in Myanmar and the company’s half-assed attempts at combating fake news. Facebook really is evil. Not on purpose. In the banal kind of way.

Underlying all of Facebook’s screw-ups is a bumbling obliviousness to real humans. The company’s singular focus on “connecting people” has allowed it to conquer the world, making possible the creation of a vast network of human relationships, a source of insights and eyeballs that makes advertisers and investors drool.

But the imperative to “connect people” lacks the one ingredient essential for being a good citizen: Treating individual human beings as sacrosanct. To Facebook, the world is not made up of individuals, but of connections between them.

The solution is not for Facebook to become the morality police of the internet, deciding whether each and every individual post, video, and photo should be allowed. Yet it cannot fall back on its line of being a neutral platform, equally suited to both love and hate. Arendt said that reality is always demanding the attention of our thoughts. We are always becoming aware of new facts about the world; these need to be considered and incorporated into our worldview. But she acknowledged that constantly giving into this demand would be exhausting. The difference with Eichmann was that he never gave in, because his thinking was entirely separated from reality.

The solution, then, is for Facebook to change its mindset. Until now, even Facebook’s positive steps—like taking down posts inciting violence, or temporarily banning the conspiracy theorist Alex Jones—have come not as the result of soul-searching, but of intense public pressure and PR fallout. Facebook only does the right thing when it’s forced to. Instead, it needs to be willing to sacrifice the goal of total connectedness and growth when this goal has a human cost; to create a decision-making process that requires Facebook leaders to check their instinctive technological optimism against the realities of human life.

Thinking about Facebook

If you accept that assumption, 35% EBIT margins on $97 billion in sales would equal $34 billion in operating income. Inversely, that implies more than $60 billion in expenses (COGS + OpEx). This suggests that Facebook’s run rate expenses will more than triple from 2017 to 2022. Over that same period, these assumptions would result in cumulative revenue growth of around 140%.

Let me give you one example to show just how much money we’re talking about here (over $40 billion in annual expenses). It’s assumed that Facebook will need to hire many people for its safety and security efforts. If it adds an additional 20,000 employees and pays them $200,000 each (not a bad salary!), that would cost them $4 billion a year. For some context, Facebook announced back in October that it planned on hiring an additional 10,000 safety and security personnel by the end of 2018. I’ve tried to give them plenty of room, and this still only covers roughly 10% of the incremental costs we need to account for to push operating margins to the mid-30s.

Here’s my point: I have a tough time understanding how Facebook can possibly need to spend this much money. It seems to me that this is largely a choice, not a necessity.


Apple’s stock buybacks continue to break records

No company has bought back more shares since 2012 than Apple. It has repurchased almost $220 billion of its own stock since it announced in March 2012 that it would start to buy back shares. That is roughly equivalent to the market value of Verizon Communications. Over that period, the number of Apple’s shares outstanding has dropped by just over a quarter.

Waymo’s self-driving cars are near: Meet the teen who rides one every day

Tasha Keeney, an analyst at ARK Invest, says that Waymo could choose to offer an autonomous ride-hailing service today at around 70 cents a mile—a quarter of the cost for Uber passengers in San Francisco. Over time, she says, robotaxis should get even cheaper—down to 35 cents a mile by 2020, especially if Waymo’s technology proves sturdy enough to need few human safety monitors overseeing the autonomous vehicles remotely. “You could see software-like margins,” Keeney says.

Bill Nygren market commentary | 2Q18

A closer look reveals that Gartner stock fell when management opted to substantially increase selling and marketing expenses to pursue accelerated organic growth, which in turn decreased the company’s reported earnings. The way GAAP (generally accepted accounting principles) works, because the future benefit of a marketing expense is uncertain, the cost is immediately expensed. But at a company like Gartner, these marketing expenses could easily be seen as long-term investments in company growth. That’s because a Gartner customer tends to remain with the company for a long time—a little more than six years, on average. So we adjusted the sales and marketing expenses to reflect a six-year life, just like GAAP would treat the purchase of a machine that was expected to last six years. With that one adjustment, Gartner’s expected EPS increased by almost $3. Using our adjusted earnings, which we believe reflect a more realistic view of those intangible assets, Gartner appears to be priced as just an ordinary company.

Ferrari slumps after CEO says Marchionne target is ‘aspirational’

Ferrari is banking on Camilleri getting up to speed quickly to press ahead with Marchionne’s plan. While Marchionne was planning to retire from Fiat Chrysler in 2019, he was meant to stay on at Ferrari for another five years. His succession plan was not as advanced at the Maranello-based company as it was at FCA.


WeWork is just one facet of SoftBank’s bet on real estate

If the market opportunity is big, SoftBank will typically make investments in regionally dominant companies operating in that sector. After all, if worldwide dominance is difficult to obtain for any one company, SoftBank is so big that it can take positions in the regional leaders, creating an index of companies that collectively hold a majority of market share in an emerging industry.

Heineken inks $3.1 billion deal to grow in hot China market

The deal will help Heineken gain a tighter foothold in a crowded field by leveraging China Resources Beer’s extensive distribution network, while also sharing in the returns of China’s beer market leader. China is now the second-largest premium beer market globally, and is forecast to be the biggest contributor to premium volume growth in the next five years.

Under the deal, Heineken’s operations in the country will be combined with those of China Resources Beer, and the Dutch brewer will license its brand to the Chinese partner on a long-term basis, according to company statements Friday. China Resources Beer’s parent company will acquire Heineken shares worth about 464 million euros ($538 million). Heineken will also make its global distribution channels available to China Resources’ brands including Snow, according to the statement.

Branded Worlds: how technology recentralized entertainment

There are two answers to the first question: cost and time. Maybe it’s a lot easier to shoot and edit movies/TV than it used to be, but sets, locations, actors, scripts — those are all expensive and difficult. Better amateur work is still far from professional. And while it’s true we’re seeing interesting new visual modes of storytelling, e.g. on Twitch and YouTube, it’s very rarely narrative fiction, and it’s still distributed and monetized via Twitch and YouTube, gatekeepers who implicitly (and sometimes explicitly) shape what’s popular.

More importantly, though, democratizing the means of production does not increase demand. A 10x increase in the number of TV shows, however accessible they may be, does not 10x the time any person spends watching television. For a time the “long tail” theory, that you could make a lot of money from niche audiences as long as your total accessible market grew large enough, was in vogue. This was essentially a mathematical claim, that audience demand was “fat-tailed” rather than “thin-tailed.”

China is building a very 21st century empire—one where trade and debt lead the way, not armadas and boots on the ground. If President Xi Jinping’s ambitions become a reality, Beijing will cement its position at the center of a new world economic order spanning more than half the globe. Already, China has extended its influence far beyond that of the Tang Dynasty’s golden age more than a millennium ago.
It used to be the case that active portfolio management was the default investment style. Over time, and with the help of academic finance, we have come to realize that there are other factors at work. The most obvious of which is the market factor or beta. It is this insight that underlies the rise in index investing. A trend which by all accounts is still in place.

Curated Insights 2017.07.09

Massive Chinese Brainpower Is the Next Really Big Thing

The large scale and low cost of Chinese brainpower is another game changer. Suddenly thousands of engineers can be ramped up in a matter of days. And this phenomenon is starting to ripple through industry after industry. What is the impact on the pharmaceutical industry if companies can now access tens of thousands of scientists cheaply? If your competitor is opening a research and development center in China with 10,000 technical specialists, how big of a problem is that for you? Chinese brainpower is starting to impact many industries – often in unexpected ways.”


Could India become the best-performing stock market of the next ten years?

India’s estimated domestic consumption growth of 12 percent y-o-y through 2025 is forecast at more than double the global average of 5 percent — poised to triple to $4 trillion by 2025.

India will have the largest middle class globally by 2027. Currently, only 5% (27 million) of the 519 million strong workforce is classified as “urban middle,” earning more than $11,000 per year.

A structural shift of household savings into equities is helping propel Indian stock markets. A Morgan Stanley analysis concludes that domestic equity savings are on-track to rise by $525 billion over the next decade. The government is also taking steps to increase public-equity exposure.


We are still waiting for the robot revolution

Our chief economic problem right now isn’t that the robots are taking our jobs, it’s that the robots are slacking off. We suffer from slow productivity growth; the symptoms are not lay-offs but slow-growing economies and stagnant wages.

…Imagine an economy that was the exact opposite of one where the robots took over, and it would look very much like ours.

…productivity growth stalled before the financial crisis, not afterwards: the promised benefits of the IT revolution petered out by around 2006.


Could Amazon Spur a CapEx Boom Rather Than Disinflation?

Younger investors haven’t yet seen a Capital Expenditure bubble. What went in the mid-aught’s was a debt and real estate bubble and what’s going on now is a buyback bubble. (Yes, everything is a bubble).

But in the mid- to late 1990’s, we had the CapEx bubble to end all CapEx bubbles (involving computers and wireless telephony), and it was good for the economy (for awhile). The 1950’s featured an infrastructure CapEx bubble (the Interstate Highway System), the 1960’s had its “Space Age” CapEx bubble and the late 1800’s enjoyed a railroad CapEx bubble.

These spending sprees were unlike the debt bubble of the 2003-2007 period in that, when the dust settled, at the very least they had left something useful behind (roads, rails, fiber optics, jets and rocket technologies). The last bubble we had only left behind unpaid loans and financial losses.


Watch Out, Intel. New Types of Chips Are Gaining Ground

“If I look at the latest generation of microprocessors, this year, performance only went up by 3%.”

While Intel’s microprocessor is broadly useful, running everything from scientific computing to spreadsheets, the TPU focuses on a specific problem such as speech recognition so it has power where it counts. It has 3.5 times as much memory as a comparable Intel part in a chip half the size. “We threw out a lot of stuff that was not needed. Instead of the Honda for everyone, we are making these Formula One race cars for some things.”

…the TPU went from sketch to finished chip in just 15 months whereas the latest Intel processors take years to develop. “We are at a paradigm shift in computing architecture. This is a big revolution in terms of the technology approach. Intel is working for two years to squeeze out 10% improvements in performance, and this can get you 10 times the performance, while being less expensive than Intel’s most complex parts.”


Tencent Dominates in China. Next Challenge Is Rest of the World

…the company was also learning how to cut its losses and play to its strengths. In 2013, Tencent gave up on its floundering search business, turned it over to a competitor, Sogou Inc., and invested $448 million in Sogou instead. The following year it sold its equally unsuccessful e-commerce initiative to JD.com Inc. and invested $214 million in JD for a 15 percent stake. Before these deals, Tencent “was involved in everything.” After the deals, “it only focused on what it did best and entrusted other sectors to partners.” Zhang gives much of the credit for these moves to Lau. “Martin is first and foremost a great business analyst. He knows what wars to fight.”

“It’s a little bit like the Godfather Don Corleone saying, ‘I’m going to make you an offer you can’t refuse.’ If you don’t take their money, and they invest in a competitor, it can be deadly.”

Beyond Bitcoin: How Blockchain Is Changing Banking

The government, for its part, hasn’t even settled on what Bitcoin is. The Internal Revenue Service considers it an asset; the Commodity Futures Trading Commission says it’s a commodity; and Treasury Department regulators have described it as a “virtual currency.” Fed Chair Janet Yellen has said the agency has no authority to oversee Bitcoin, but has encouraged central bankers to study it.

“…half of the people in the group are looking for a solution; the other half are there uniquely to obstruct progress.”

Moats & Knights, Part Deux

1. Has management been forthcoming about competitive challenges or do they downplay the threat of new entrants?

2. Does management have the right financial incentives in place or has the board set up low hurdles to make sure large bonuses are realized, regardless of performance?

3. Does management know what the company’s advantages are and have plans in place to extend and strengthen those advantages?

4. Does management have meaningful personal ownership in the business (and thus have skin in the game) or are they akin to mercenaries? 

5. Does management have a track record of sacrificing short-term results for long-term results or do they seem to play the quarterly earnings game?


What I Believe Most

Incentives are the strongest force in the world. They cause otherwise good people to do awful things, and vice versa. They’re also the most misunderstood and counterintuitive force in business. Brent Beshore: “I want to know what motivates people. The problem is not that they won’t tell me, because they will. The problem is that none of us know the truth, even about ourselves. The only thing to do is watch someone over a very long period of time and try to piece it together.”

There are five sources of edge: 1) Learn faster than your competition, 2) empathize with stakeholders more than your competition, 3) communicate more effectively than your competition, 4) be willing to fail more than your competition, and 5) wait longer than your competition.