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 2017.10.01

Alibaba takes control of delivery business at center of U.S. probe

China’s largest web marketplace agreed to increase its stake in Cainiao Smart Logistics Network Ltd. to 51 percent. Under the deal, Alibaba plans to consolidate Cainiao’s financials into its own books, eroding Alibaba’s bottom line, and will get an additional seat on Cainiao’s board, taking its representation to four out of seven seats.

It oversees a coterie of more than a dozen shipping partners, orchestrating deliveries carried out by about 2 million people across more than 600 cities. Cainiao’s operation had enabled Alibaba to maintain what it called an asset-light model that eschewed expensive warehouse construction.

“They’re realizing that it’s much more capital-intensive than they expected to build this out. Right now they are essentially obligating themselves to report profit and loss on the income statement every quarter, which they probably should have been doing.”


A small-screen iPod, an Internet Communicator and a Phone

This comparison is apt: the Watch is effectively stealing usage from the iPhone. At first it took alerts, timekeeping, and basic messaging away. Now it’s taking basic phone calls and music and maybe maps.

It’s fitting therefore to remember how the iPhone was launched; as a tentpole troika: A wide-screen iPod, an Internet Communicator and a Phone. Today the new Watch is a small-screen iPod, an Internet Communicator and a Phone.

So not only is the Series 3 Watch more powerful than the original iPhone but it is also poetically capable of the same tentpole jobs. But it’s not just a miniature iPhone. It has a new, completely orthogonal attack on non-consumption and market creation: fitness and health. This is a key point. The iPhone was born a phone but grew up to be something completely unprecedented, unforeseen by its creators and, frankly, undescribable in the language of 2007.


Forget the Swiss, it’s Fossil that Apple is threatening

In the watch world, the Fossil Group is a giant. It has 17 brands: six of its own (Fossil, Skagen, etc.) and 11 licensed brands (Michael Kors, Emporio Armani, Tory Burch, etc.) In 2014, it was on a roll, achieving a fifth consecutive year of record revenues, at $3.51 billion. Watches accounted for 78% of that.

Then along came Apple. Suddenly, Fossil was competing with a monster 67 times bigger than it was (measured by revenues). “Prior to that, we were clearly positioned as the competitively advantaged leader in a growing category,” Fossil CEO Kosta Kartsotis told financial analysts in February. “However, with the introduction of technology into wrist devices, traditional watches came under pressure and we were disadvantaged. We didn’t have the technology capabilities to compete with smartwatches, leading to a decline in our market.”

“I haven’t met with anybody [in Switzerland] yet who sees this [downturn] as anything other than a slump,” he told me in March. “They don’t see the threat from the smartwatch.” Apple will continue to perfect the smartwatch, he says. “By version 3 or 4, everyone will be thinking this is a good thing to have. Forty to 80 million people will want this.”


Siemens to merge rail operations with French rival Alstom

Siemens will transfer its business making train and transit cars and signaling equipment to Alstom in exchange for a 50 percent stake in the enlarged company.

The combination will give the German company control of an icon of French industry that developed the high-speed TGV trains that zip across the countryside at upwards of 300 kilometers an hour (186 miles per hour)…Capping years of speculation in the industry about the need for consolidation, the tie up could mirror the emergence of European planemaker Airbus in the 1970s that went on to become the biggest competitor to Boeing Co.

Now, the companies’ tie up comes after Chinese dominance of the train market has solidified. CRRC controls about half of the rail car and locomotive market, while Siemens and Bombardier each have about 12 percent and Alstom around 11 percent, according to Desjardins Capital Markets. The Chinese company was formed in 2015 in a merger of the country’s two main regional train manufacturers and it has won rail orders in U.S. cities such as Boston, Philadelphia and Los Angeles.

China gives automakers more time in world’s biggest EV plan

Under the so-called cap-and-trade policy, automakers must obtain a new-energy vehicle score — which is linked to the production of various types of zero- and low-emission vehicles — of at least 10 percent starting in 2019, rising to 12 percent in 2020, the Ministry of Industry and Information Technology said on its website. The rule applies to carmakers that manufacture or import more than 30,000 traditional vehicles annually, and those who fail to comply must buy credits or face fines.

The targets look achievable for the industry as a whole, McKerracher said. Considering the credit structure, 12 percent in 2020 would translate to about 4 percent to 5 percent of actual vehicle sales.


Why India will tell us when self-driving cars will hit the US

When will self-driving cars arrive? Depends on who you ask. The VCs believe what they’re told by their portfolio companies. Automakers will say anything to inflate their stock price relative to Tesla. Self-driving evangelists and “keynote speakers” on LinkedIn? Broken clocks not yet right even once. The media? There are still less than ten people writing intelligently on a market expected to hit $7 trillion.

Population density is so high that no current Automatic Emergency Braking system could possibly work in traffic, because no car equipped with it would ever move. What about Blind Spot Monitoring systems? They’d be lighting up and chiming so much, you’d have to disable them.

That Indian roads are more dangerous than America’s is obvious, and beside the point. No government ever eases traffic safety laws. Indian traffic fatalities in 2013 approached 240,000, in a country of 1.3 billion. That’s 16.6 deaths per 100,000 inhabitants per year. For those numbers to go down, people have to have choices that lead to them to safety. In a country where the majority have never owned a car, where two wheelers dominate and road conditions are terrible, getting people into any car will improve overall safety.


Learning effects, network effects, and runaway leaders

Learning effects have the potential to generate enormous economic value, as network effects do, if companies are able to close this loop and make it self-reinforcing: that is, if their products learn more because they have become more valuable.

In order for learning effects to produce runaway leaders, a company must secure a definitive advantage over its competitors in one of the component areas of learning effects – data, intelligence, product innovation or user/customer growth – and leverage this into advantages in the others, such that the company can acquire data, learn, innovate and grow not only more rapidly than its competitors do, but more rapidly than they can.

Certain products – particularly those built on highly dynamic datasets – may have perpetual learning curves such that in a rapidly changing world, they can always be meaningfully improved. It’s around these kinds of products that the most valuable runaway leaders will likely develop. Potential examples include search, semantic engines, adaptive autonomous systems and applications requiring a comprehensive real-time understanding of the world.

How Europe’s changes to copyright law will affect America

The goal of these copyright changes is to adopt new protections for publishers and artists. But if they are put in place, the burdens they would place on internet platforms would curtail the kind of quick uploading, sharing, commenting and responding that makes the Web so useful. Additionally, we have no reason to believe that these new plans would actually benefit the journalists and artists in whose name the measures are being proposed.

Yet a lot more is at stake than the fate of Google or Facebook. Those companies at least can afford the cost of complying with (or avoiding) Europe’s copyright proposals. Smaller businesses can’t. For example, medium-sized internet platforms pay between $10,000 and $25,000 a month in licensing fees for a common tool that conducts a copyright scan of uploaded audio files, an impost that could wipe out a new startup.


India: A $6T GDP By 2027?

The government and the Central Bank are on a mission to rapidly formalize and financialize the Indian economy. India has introduced a universal biometric identification system (Aadhaar), initiated measures to boost financial inclusion, moved to a new fully online value-added goods and services tax system and implemented real-time payment systems. Coupled with rising smartphone penetration, likely doubling from 300 million to nearly 700 million by 2020, these changes are driving India’s digitization. We expect a step change in India’s per capita income, banking system and stock market performance over the coming years. The channels of change include more financial penetration, greater tax compliance and increased credit to micro enterprises and consumers.

The result could be a multi-trillion dollar investment opportunity. Aside from the near-term teething issues involved in execution of such big changes and other cyclical problems faced by the economy, there is scope for visible shifts in economic activity starting in 2018.


We’re going to need more lithium

By 2030, Tianqi Lithium, SQM, Albemarle, and FMC, the companies that dominate the business, will have to supply enough lithium to feed the equivalent of 35 plants the size of the Tesla Gigafactory now being built in Nevada, according to BNEF. The total investment in new mines, including some for other elements used in lithium ion batteries, will likely range from $350 billion to $750 billion, according to analysts at researcher Sanford C. Bernstein & Co.


 

Our hankering for meat is a boon for global antibiotic producers

Food animals will consume 200,235 tons of antimicrobial medicines by 2030, 53 percent more than they were getting in 2013, according to a study published Thursday in the journal Science. China, already the world’s largest consumer of veterinary antimicrobials, is forecast to lead the charge, with a 59 percent jump.

Limiting daily meat intake worldwide to the equivalent of one standard fast-food burger per person could reduce global consumption of antimicrobials in food animals by 66 percent, the researchers said.

37 quotes from big corporate execs who laughed off disruption when it hit

“Amazon.com is a very interesting retail concept, but wait till you see what Wal-Mart is gearing up to do,” he said [IBM Chairman, Louis V. Gerstner Jr.]. Mr. Gerstner noted that last year IBM’s Internet sales were five times greater than Amazon’s. Mr. Gerstner boasted that IBM “is already generating more revenue, and certainly more profit, than all of the top Internet companies combined.”

The Apple watch is an interesting toy, but not a revolution,” said Swatch executive Nick Hayek Jr., speaking to a Swiss newspaper. “I personally don’t want my blood pressure and blood sugar values stored in the cloud, or on servers in Silicon Valley … I cannot accept the responsibility of whether my device warns a customer in time before a heart attack.”

“Apple is like a mutant virus, escaping from the traditional structure of the PC industry, but the industry will still eventually build up immunity, thus further blocking this trend, and we believe the size of the non-Apple camp will exceed Apple’s, because this is how the industry normally evolves.”

“Television won’t be able to hold onto any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.”


So few market winners, so much dead weight

Only 4 percent of all publicly traded stocks account for all of the net wealth earned by investors in the stock market since 1926, he has found. A mere 30 stocks account for 30 percent of the net wealth generated by stocks in that long period, and 50 stocks account for 40 percent of the net wealth.

Once you actually find these rare companies, you have to hold on to them. This too is much more challenging than most realize. The stellar stocks tend to have regular, gut-wrenching price slumps; the big winners above have all suffered retreats of 50, 60 even 90 percent on the way to becoming the biggest winners. Most investors lack the fortitude and discipline to manage the pain of these severe price fluctuations.

Once you get through those two challenges, you have to decide when to jettison these winners since nothing continues forever. As Sommer points out, General Motors Co. was a star from 1926 on — that is, until it went bankrupt in June 2009 and basically wiped out equity investors. AT&T Inc., meanwhile, was broken into many smaller parts, some of which have done very well (Verizon Communications Inc.), while others not so much (Lucent).

As we have observed repeatedly, finding the very best companies to own is very difficult to do.


Some market myths hurt investors

Margin debt at all-time highs mean euphoria in the markets. Margin debt reflects the amount of borrowed money used to purchase securities in the markets. It sounds scary when people point to margin debt at an all-time high because that means investors are borrowing more money than ever to buy stocks. But this indicator doesn’t really tell us anything. As markets rise, margin debt will rise. As markets fall, margin debt will fall. All historical margin debt peaks tell you is that margin debt fell when stocks fell. The following chart is more useful, as it shows margin debt as a percentage of the overall market cap of the stock market. Margin debt is a backward-looking indicator that tells you nothing else beyond how the stock market has performed in the past.

Something’s gotta give between stocks and bonds. Investors often assume stocks or bonds are telling them something. So when both rise at the same time, the assumption is that either the equity or fixed-income market must be wrong. The problem with this line of thinking is that stocks and bonds both go up over time, and most of the time they go up at the same time.

Bonds always lose money when interest rates rise. Out of those 36 rising rate years, 27 had positive returns on five-year Treasuries. So three-quarters of the time when rates rose on a calendar-year basis, bonds still earned positive returns. Rising rates will lead to lower bond prices, but you have to think in terms of total returns to understand the relationship between bond performance and interest rates.