Curated Insights 2018.09.21

Brent Beshore: Learning to pole vault

Marketing will only get you where you’re going faster. If your product isn’t valuable, marketing will help put you out of business, fast. The best way to build trust and generate attention is to be relatively excellent. I say “relatively” because some markets are more efficient/mature than others. The less developed a market, the less valuable you have to be in absolute terms. You just have to be better than everyone else. I don’t want to try to outcompete smart, well-read, and hard working people. I want to find the lowest bar to jump over and then get good at pole vaulting.

Picking your field is arguably more important to your success than your current skill and future capacity. In some segments of business, everyone makes lots of money and the very best do outrageously well. In other areas, even the very best often declare bankruptcy. It’s a base rate analysis. Assume you’re only going to be mediocre, then explore what business and life look like if that’s true. So choose your field wisely and get good at what you’re doing before trying to make noise.

AI has far-reaching consequences for emerging markets

Without a cost incentive to locate in the developing world, corporations will bring many of these functions back to the countries where they’re based. That will leave emerging economies, unable to grasp the bottom rungs of the development ladder, in a dangerous position: the large pool of young and relatively unskilled workers that once formed their greatest comparative advantage will become a liability – a potentially explosive one.

The result will be an unprecedented concentration of productive capacity and wealth in the hands of the elite AI companies, almost all of which are located in the US and China. Of the US$15.7 trillion in wealth that AI is forecast to generate globally by 2030, a full 70 per cent will accrue to those two countries alone, according to a study by consulting firm PwC.

Spotify will now let indie artists upload their own music

According to a recent report by The NYT, artists working with labels may see much smaller percentages. The report said that Spotify typically pays a record label around 52 percent of the revenue generated by each stream. The label, in turn, then pays the artist a royalty of anywhere from 15% to as high as 50%. If artists are dealing directly with Spotify, they could be making more money.

Labels suggested that they could retaliate against Spotify for overstepping. The NYT had also said. They may do things like withhold licenses Spotify needs for key international expansions, like India, or not agree to new terms after existing contracts expire. They could also offer more exclusives and promos to Spotify’s rivals, like Apple Music, which has surged ahead in the U.S. and is now neck-and-neck here with Spotify for paid subscribers.

A music upload feature also means artists who own their own rights could break out big on Spotify if they catch the attention of playlist editors – something that Spotify now makes it easier for them to do, as well. In addition, having indies upload music directly means Spotify could better compete against Apple Music by attracting more artists and their fans to its platform.

Apple’s neural engine = Pocket machine learning platform

If you have followed many of the posts I’ve written about the challenges facing the broader semiconductor industry, you know that competing with Apple’s silicon team is becoming increasingly difficult. Not just because it is becoming harder for traditional semiconductor companies to spend the kind of R&D budget they need to meaningfully advance their designs but also because most companies don’t have the luxury of designing a chip that only needs to satisfy the needs of Apple’s products. Apple has a luxury as a semiconductor engineering team to develop, tune, and innovate specialized chips that exist solely to bring new experiences to iPhone customers. This is exceptionally difficult to compete with.

However, the area companies can try with cloud software. Good cloud computing companies, like Google, can conceivably keep some pace with Apple as they move more of their processing power to the cloud and off the device. No company will be able to keep up with Apple in client/device side computing but they can if they can utilize the monster computing power in the cloud. This to me is one of the more interesting battles that will come over the next decade. Apple’s client-side computing prowess vs. the cloud computing software prowess of those looking to compete.

Tim Cook reveals in interview that the Chinese consumer is different because they don’t carry the burden of the desktop era

China has not experienced the so-called stage of the desktop Internet, but directly embraced the mobile Internet. Therefore, Chinese consumers do not have the burden of the desktop Internet era. This explains to some extent why China’s mobile payment share is so high. In other countries, the mobile payment process is much slower. In fact, they just have no more attempts.”

Perhaps Apple’s delay in advancing Macs and angering the pro community comes from this deep seated attitude that it’s a “burden” holding back the advancement of their iOS agenda.

The best company you’ve never heard of

With no true competitive threats, wide-moat commercial real estate data provider CoStar Group is a borderline monopoly. The other companies in the space are predominately small startups focused on crowdsourcing data. These companies can’t replicate the intangible assets from the vast cost and effort associated with compiling the data the company offers to its customer base.

Given the importance customers place on the underlying data, CoStar also keeps competitors at bay with a switching cost moat source. It’s just too risky to switch sources. Strong platform effects found throughout CoStar’s product offerings earn the company a network effect moat source, too.

The company continues to increase its coverage and boasts that it covers every building in the country, widening the gap between itself and its fragmented competition. The firm recently established itself as a leading provider of rental data with its acquisitions of Apartment Finder and CoStar is only 30% penetrated in its target market for apartments, so we see room for growth in this area.

Moreover, CoStar is only 15% penetrated in the broker community and 7% penetrated with institutional investors, two groups we can see the firm going after. As several investments are integrated and benefits are realized, we project CoStar’s economic profit to steadily increase over the next several years, reflecting our positive moat trend rating.

Here’s why Yelp and Grubhub could keep rising

“Grubhub is in the early stages of enabling the shift to online of the still offline dominant restaurant takeout businesses and driving the improved consumer experience that comes with it,” they wrote. About “90% of delivery and pickup orders still come from offline, making the phone book, print out menus and walk-ins the number one competitor to Grubhub and its peers.”

How early is the shift? “We estimate Grubhub has about 40% market share of the third-party online delivery/pickup industry which itself we estimate has a 4% penetration of the $250 billion restaurant takeout industry,” they wrote. “Its early mover and scale advantage—about 85,000 restaurants on its platform in 1,600 cities—has allowed Grubhub to offer, in our view, the best consumer value across its competitors.”

Why Yelp could rise 200%

If we can introduce ourselves to those advertisers with a good ‘til canceled $300, $400 a month, $10, $20 a day kind of service proposition, what we’re finding is it really opens up our sales funnel. It makes our product more competitive in the marketplace. It allows us to get into third-party sales channels that we haven’t been in before. And we’re now kind of one quarter into it and we had this quarter, the first quarter, about 140% as many new or net customer additions in this quarter as we’ve had in any prior quarter and kind of 2x the run rate that we’ve normally seen when we were selling the term contract. And, now, we move to the non-term contract.

In the long-term, our tests and our analysis all show that the LTV of a cohort of advertisers that we bring in today will be quite a bit higher. And what we’ve seen in our tests is that we continue to sell the sort of long and strong loyal long-term advertisers under the new pricing model just as we always have, but on top of that we’re introducing ourselves to a lot more new customers along the way

Yelp is in the early days of elevating the consumer experience by expanding the number of transactional features such as Request-A-Quote from a home service professional or book a restaurant reservation or spa appointment. Request-A-Quote lead volume grew 27% from the first to the second quarter of 2018 and topped 5.5 million delivered requests in the second quarter. During that same short timeframe, revenue attributable to Request-A-Quote increased by more than 50%, surpassing a $35 million annual run rate at the end of the second quarter. The company is not yet fully monetizing Request-A-Quote, which we believe could accelerate free cash growth even further. We like finding misunderstood, yet promising, and free embedded call options within the companies we invest in and hope Request-A-Quote proves to a second material avenue for free cash per share growth.

GGV Capital: Unpacking Xiaomi’s IPO

Instead of paying for users, Xiaomi actually gets paid at least 5% gross margin through hardware to get users…it’s a very different model from almost any other internet services model out there. So if this is sustainable, and to make sure this is sustainable is to have a lot more hardware products out there that the middle class can buy, and use that portfolio of hardware devices to get paid for acquiring users, so that internet services can scale thereafter…There’s definitely elements of Muji and Uniqlo in a different field for Xiaomi, there’s definitely elements of a Costco model of subscription plus very low cost to make sure more products are affordable by the rising consumer class, there’s definitely elements of Amazon in there as a platform to sell many products and being very focused at delivering a superior experience…

If we look at the number of internet users coming online, the next 1.5bn internet users coming online between now and 2030, most of that growth will come from the 74 countries that Xiaomi is in already. So when people ask me if Xiaomi is coming to the US or not, they completely miss the point, the growth is coming from the existing countries that Xiaomi’s already in…

Xiaomi has over 18 apps, each with monthly active users of over 50mn. It also has 38 apps, each with over 10mn MAUs. In aggregate, it did over 1.5bn RMB in internet services revenue in 2017, which already puts them as a top 25 internet services only company in the world. The most popular [app] that people know is probably Xiaomi Video, which has an interesting way of becoming aggregation services. It doesn’t license content from anyone, what it does is it aggregates content from all the top Chinese video apps, each of which have already licensed the content and whenever a user clicks on a video, it takes you to the content from its partners but within the app itself, so you can have a more integrated experience. It charges advertising revenue and also subscription from the users…and they share that revenue with its partners that provide the original video content. So, it can focus on providing the most comprehensive collection of content to the user, at the same time, so far, they don’t have to spend much money on acquiring the content itself.”

Tesla, software and disruption

It’s pretty clear that electric disrupts the internal combustion engine, and everything associated with it. It’s not just that you replace the internal combustion engine with electric motors and the fuel tank with batteries – rather, you remove the whole drive train and replace it with sometime with 5 to 10 times fewer moving or breakable parts. You rip the spine out of the car. This is very disruptive to anyone in the engine business – it disrupts machine tools, and many of the suppliers of these components to the OEMs. A lot of the supplier base will change.

We will go from complex cars with simple software to simple cars with complex software. Instead of many stand-alone embedded systems each doing one thing, we’ll have cheap dumb sensors and actuators controlled by software on a single central control board, running some sort of operating system, with many different threads (there are a few candidates). This is partly driven by electric, but becomes essential for autonomy.

Tesla’s first bet is that it will solve the vision-only problem before the other sensors get small and cheap, and that it will solve all the rest of the autonomy problems by then as well. This is strongly counter-consensus. It hopes to do it the harder way before anyone else does it the easier way. That is, it’s entirely possible that Waymo, or someone else, gets autonomy to work in 202x with a $1000 or $2000 LIDAR and vision sensor suite and Tesla still doesn’t have it working with vision alone.

‘Flash Boys’ exchange IEX wins first listing

The U.S. corporate-listings business, in which companies pay fees to an exchange for services tied to being the primary venue for the company’s stock trading, has for years been an effective duopoly of the NYSE and Nasdaq. A third big exchange group, Cboe Global Markets Inc., lists exchange-traded funds and its own shares, but hasn’t made a bid to attract other companies. NYSE parent Intercontinental Exchange Inc. and Nasdaq earned a combined $684 million from listings last year, according to the two exchange groups.

“We at Interactive Brokers understand that being the first listing on a new exchange may entail certain risk, but we think that individual and institutional customers who own and trade our stock will receive better execution prices and that advantage will outweigh the risk,” Mr. Peterffy said in a press release announcing the move.

Because of China’s outsized workforce, the density of automation usage lags other countries: 68 robots per 10,000 industrial workers, compared with 631 bots for every 10,000 manufacturing staff in South Korea, the global leader in automation. Singapore, Germany and Japan all have higher densities of automation than China. China wants to more than double that usage density to 150 for every 10,000 workers by 2020. To do so would require massive amounts of government help.

‘Made In China 2025’: a peek at the robot revolution under way in the hub of the ‘world’s factory’

A skilled factory worker earns about 36,000 yuan a year in wages and benefits in China’s poorer provinces and second-tier cities, away from the coast. Total remuneration can exceed 60,000 yuan in cities nearer the coast and along the eastern seaboard, like in the Pearl River and Yangtze River deltas. A 200,000 yuan robot that can do the job of three humans can recoup its capital cost in 22 months in central provinces, or in a little over a year in coastal cities. In the face of rising prices pressures for labour, energy and rents, such a cost advantage would be attractive to many manufacturers.

China’s total spending on research and development is estimated to have risen 14 per cent last year to 1.76 trillion yuan, according to the Ministry of Science and Technology.

“Among the thousands of so-called Chinese robotics companies – including robot and automated equipment producers as well as those who only provide automation integration solutions – only about 100 firms could mass produce the main body and core components of high-end and middle-market industrial robots, such as servo motors, robot controllers and speed reducers,” he said. “We lack original research and have already tried to catch up by copying advanced technology. But neither technology-related mergers and acquisitions nor copycat [production] can close the gap in the short term.”

He said many domestic robotics manufacturers were still developing the traditional core parts of robots, like servo motors, robot controllers and speed reducers. But these parts would not be the core components of the future, he said.

Don’t take asset allocation advice from billionaires

One of the best ways to stay out of trouble with your finances is to focus all of your energy on your own circumstances and ignore what other people say or do with their money. Not only will it likely save you from making a grievous financial error but it will also make you happier. Constantly comparing yourself or your portfolio to others can be exhausting.

This is how to raise emotionally intelligent kids: 5 secrets from research

Don’t argue the facts. Feelings aren’t logical. You wouldn’t expect the new employee to know how to find the bathroom and you shouldn’t expect a child to know how to handle emotions that, frankly, you still have problems dealing with after decades of experience. Don’t immediately try to fix things. You need to establish you’re a safe ally before you can solve anything. Understanding must precede advice, and, just as with adults, they decide when you understand.

The critical distinction Gottman realized is that it’s important to accept all feelings — but not all behavior. If you skip immediately to problem-solving, the kid never learns the skill of how to deal with those uncomfortable emotions. You want to use “empathetic listening.” Get them to talk. Help them clarify. Validate their feelings (but, again, not necessarily their behavior). They need to feel you really understand and are on their side.

Providing words in this way can help children transform an amorphous, scary, uncomfortable feeling into something definable, something that has boundaries and is a normal part of everyday life. Anger, sadness, and fear become experiences everybody has and everybody can handle. Labeling emotions goes hand in hand with empathy. A parent sees his child in tears and says, “You feel very sad, don’t you?” Now, not only is the child understood, he has a word to describe this intense feeling. Studies indicate that the act of labeling emotions can have a soothing effect on the nervous system, helping children to recover more quickly from upsetting incidents.

As we have discussed earlier, the implications of teaching a child to self-soothe are enormous. Kids who can calm themselves from an early age show several signs of emotional intelligence: They are more likely to concentrate better, have better peer relationships, higher academic achievement, and good health. My advice to parents, then, is to help your kids find words to describe what they are feeling. This doesn’t mean telling kids how they ought to feel. It simply means helping them develop a vocabulary with which to express their emotions.

In an ideal world, we’d always have time to sit and talk with our kids as feelings come up. But for most parents, that’s not always an option. It’s important, therefore, to designate a time—preferably at the same period each day—when you can talk to your child without time pressures or interruptions.

Curated Insights 2018.05.27

Borrow…If you dare

Your problem is the margin. With $10,000 to start, if you borrowed millions, you would lose all of your equity. In fact, having a leverage ratio more than 4:1 ($30,000 borrowed) would have wiped you out in most years. It’s not a matter of if, but a matter of when.

As soon as he said it, I knew he was right. I had forgotten one of the simplest ideas in finance: the path matters. The problem is that while we know that you will get an a high return by the end of the year, if you hit a bad patch of too many negative return days in a row (which is normal), the leverage will wipe you out completely. In other words, the journey is more important than the destination.

The point of all of this is that even when we know the future with certainty, borrowing money isn’t a surefire solution to win big. Given we will never know the future with any degree of certainty, leverage is one of the most dangerous things you can do as a retail investor, so I do not recommend it. If Warren Buffett only levered 1.6:1 on average throughout his career, and he is arguably the greatest investor of all time, what chance do you stand of using leverage properly?

Your investment journey will effect you far more than your investment destination. Just because you know the market should get 7% on average each year doesn’t mean you won’t live through sharp declines and decades of no real returns. These kinds of events are rare, but they happen and they can affect how you perceive markets.

The Bill Gates Line

This is ultimately the most important distinction between platforms and aggregators: platforms are powerful because they facilitate a relationship between 3rd-party suppliers and end users; aggregators, on the other hand, intermediate and control it.

Of course that is the bigger problem: I noted above that Google’s library of ratings and reviews has grown substantially over the past few years; users generating content is the ultimate low-cost supplier, and losing that supply to Google is arguably a bigger problem for Yelp than whatever advertising revenue it can wring out from people that would click through on a hypothetical Google Answer Box that used 3rd-party sources. And, it should be noted, that Yelp’s entire business is user-generated reviews: they and similar vertical sites are likely to do a far better job of generating, organizing, and curating such data.

Presuming that the answer is the image on the right — driving users to Yelp is both better for the bottom line and better for content generation, which mostly happens on the desktop — and it becomes clear that Yelp’s biggest problem is that the more useful Google is — even if it only ever uses Yelp’s data! — the less viable Yelp’s business becomes. This is exactly what you would expect in an aggregator-dominated value chain: aggregators completely disintermediate suppliers and reduce them to commodities.

If we end up sitting around in self-driving cars watching ads, Google is going to make billions

New research from UBS predicts that US autonomous-vehicle revenue will reach $2.3 trillion by 2030—and 70% of the estimated is expected to come from selling experiences to the former drivers. The biggest opportunity—$1.2 trillion—will be in robo-taxi services, moving people and things around in autonomous vehicles.

The second-biggest opportunity, or $472 billion, will be in in-car monetization: selling ads or services against the time spent in the car not driving. Not surprisingly, UBS thinks Waymo—or more broadly, Google’s parent company Alphabet—will be the dominant player in this category, perhaps capturing 60% of the revenue. UBS thinks Waymo’s combined opportunities in services and software make Waymo worth $75 billion today, or roughly 11% of Alphabet’s current valuation.

Netflix misunderstandings, pt. 1: Netflix’s content budget is bigger than it seems

While it might seem pedantic to criticize statements such as “Netflix will spend between $7 billion and $8 billion on content in 2018,” the distinction is critical. To point, Netflix’s 2018 spend is likely to be closer to $12B. Not only is this nearly 50% more than publicized, it means that Netflix will spend more on non-sports content than any of its traditional TV peers (e.g. Disney, Time Warner, NBCUniversal) – even when their many individual networks are consolidated on a corporate basis. What’s more, the disconnect between Netflix’s cash spend on content and amortization expense has grown substantially over time. In 2012, this ratio was 1.1x (cash spend 10% higher than amortization). In both 2016 and 2017, it was 44%. As a result of this growth, the impact of conflating or confusing the two has also grown.

Netflix’s content costs are high in part because it now buys out all the rights (e.g. home video, syndication, EST) for its Originals on a global basis, while traditional networks (e.g. FX or ABC) will typically buy only select content rights and on a single market basis. Furthermore, buying out all rights means that the talent involved in a hit series (e.g. cast, writers, producers) don’t have access to any of the economic upside from participating in a hit series. As such, Netflix must also pay extra (and upfront) to compensate the talent responsible for their Originals for this lost income opportunity (albeit on a risk-adjusted basis). As a result, Netflix’s costs for a given volume of original content is substantially higher than that of linear and/or domestic networks with the same output. That said, this same dynamic means that while most of its traditional networks hedge their content investments, Netflix quadruples down.

Netflix’s critics and competitors typically focus on the fact that, while profitable on an accounting basis, Netflix keeps spending more cash than it generates from operating its business. The company burned $2B in cash in 2017 (up from $1.7B a year earlier), and expects that figure to grow to $3–4B in 2018. What’s more, Netflix CEO Reed Hastings has promised that negative free cash flow will continue for “many years” and the company continues to accumulate debt (raising annual interest expenses) and content liabilities (increasing the amount it’ll need to pay suppliers over time). However, this cash loss only exists because Netflix is funding next year’s content against this year’s revenue. Netflix could have chosen to stabilize its 2018 content offering at 2017 levels (i.e. not ramp up spending), and its actual cash spent would have been just $6.2B (roughly equivalent to its content amortization) – a “savings” on the books of $2.7B. And had the company done this, it would would have generated $700MM in cash, not lost $2B.

Making sense of mortgages: The problem, and the opportunity

The single most important chart for any portfolio manager or investor – The power of diversification (low correlation)

Of course, the picture represents ideal conditions. There is some bad news with this free lunch. It is hard to find. You will not find many low correlated asset classes and those return to risk values can be volatile. The incremental improvement is strong with the first few diversifiers but there are diminishing returns after that initial boost.

In a practical sense, the first asset class you add to an equity portfolio will be bonds. It has been the great diversify for the last decade or two, but once you get beyond bonds and commodities, the ability to find those low correlation assets becomes much harder. This is the true value of alternative strategies

What does this chart mean in reverse? If there is an increase in correlation across asset classes, the return to risk will fall even if the return to risk of any given strategy stays constant. This is will be the incredible shrinking free lunch and is why it is so important to find strategies or investments that have stable correlation relative to traditional asset classes.

Return is critical but hard to forecast. Volatility is important and leads to downside risks. Unfortunately, many forget the power of covariance and its impact on diversification, yet this is component to portfolio construction that can have a strong impact.

Next climate challenge: A/C demand expected to triple

The amount of energy needed for cooling will triple, reaching a level equal to China’s total power demand, the new report finds. As the world warms in response to human-caused climate change, the need for air conditioning will become more acute, particularly in the Middle East and South Asia. IEA estimates that left unchecked, air conditioning will account for 18 percent of the total worldwide increase in CO2 emissions by 2050. And rising demand for cooling is “already putting enormous strain on electricity systems in many countries,” IEA said.