SITALWeek #293
Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, tiny whiskers, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.
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In today’s post: physical therapy in VR; old chips are even harder to find than new ones; movie makeovers; streaming video and the void of power laws in art; the ESG guarantee fairy; the asymmetry of direct listing IPOs; and lots more below...
Stuff about Innovation and Technology
VR PT
Physical therapy for rehabilitation in VR is more fun and the moves are easier to remember, giving a boost to recovery. There have been some examples of patients able to achieve more in VR, such as regaining balance, than in real life. Health and wellness seems to be emerging as a key VR use case (e.g., see also last week’s post on exercising in VR). Given the number of Internet videos I’ve seen of people falling while doing VR, virtual rehab might even be a self-perpetuating business. Wired has some tips for how to avoid motion sickness in VR.
Dark Side of Moore’s Law
This old 2008 IEEE article on the costly challenges of dealing with the rapid obsolescence of parts has some mind-blowing numbers, and the problem has likely been even further exacerbated in recent times given chip shortages and a shrinking legacy manufacturing base. Back then, the DoD was already spending $10B a year to manage the problem of spare parts for fighter jets, control systems, outdated software, etc. Fighting obsolescence can take the form of recreating, redesigning, or stockpiling. For example, there are companies that focus on recreating legacy wafers from Texas Instruments at a cost of thousands of dollars per chip, and Rochester Electronics has a vault that stores ten billion obsolete wafer dies. However, shelf life can be a concern. Since the introduction of lead-free alloys, soldered parts can be subject to the phenomenon called “tiny whiskers”, whereby the unleaded alloys sprout conductive tendrils that can cause short circuits. The problem caused Boeing to scrap an entire satellite.
Classic Movies Get Digital Ad Remake
The $20B industry for product placements in movies and TV shows is adopting technology to insert ads in old movies, according to the BBC. The tech allows the ads to change over time as people stream the programs. Given movies are increasingly filmed in digital world engines like Unreal and with virtual sound stages, I wonder how long it will be before nearly everything is changeable post production? A lead actress could wear one fashion brand for the US and a different one in France, China, etc. A getaway car could be a Tesla Plaid in one market and a Ferrari in another. A movie streaming in your house could even have personalized targeted ads. This scenario is already a reality for virtual worlds and games, so, in some ways, movies are just late to the party. Hopefully, customization will be done thoughtfully without changing the intention of the writers, directors, and actors. I think Casablanca would lose some of its charm if I were to spot Humphrey Bogart drinking Nespresso.
Consumerization of Health Tech
Consumerization is a common theme when industries go from the analog Industrial Age to the digital Information and AI Ages. We frequently see expensive, custom legacy hardware (that traditionally relied on distribution to act as a barrier to competition) eclipsed by an alternative with more widespread consumption. For example, in the continuous glucose monitoring (CGM) sector, Abbott’s Freestyle Libre wearable wireless patch, which cost less than $200/month, is being used by health nuts (via a number of different startups that offer off-label use for a higher membership fee) despite a current lack of published studies justifying their off-label use. It’s not necessarily that the devices being used are cheaper, but opening up the market allows startups to collect data to fuel an alternate business model that ultimately subsidizes the technology and grows volumes substantially, all of which should decrease the cost over time.
No Power Laws in Art
As media brands continue to promote their streaming services, cable network programming is turning into infomercials. In my recent experience, Discovery is using Animal Planet to show mostly reruns that advertise new episodes streaming exclusively for paying app subscribers. It’s not clear how the cable and satellite companies feel about paying Discovery to show reruns rather than new content on linear TV or how advertisers feel about buying ad spots that run with old content. The practice seems likely to cause the last of the non-sports fans to jump to streaming, especially if we see bundled apps. However, data from Nielsen suggest a deceleration in cord cutting since the 2016-2018 dive, perhaps because young folks have already left, and older folks are more likely to be sticking around for live sports. Sometimes top-down analysis of a trend can be useful, and the shift from linear to streaming video seems amenable to that line of thinking. To see the value creation, we need some ranges for the number of households paying for streaming services, how many they are paying for, what they are paying (the inevitable streaming bundle combines these last two figures), the amount of money spent on content, other costs, and a multiple of earnings the market might pay for the sector. Here are the numbers I’ll choose for the sake of the exercise: in five to 10 years we might have 500M global households paying an average of $30/mo for streaming apps (combining subscription and advertising ARPU; that figure would be higher in developed worlds/lower in developing); industry-wide spend of $80B on scripted and live (sports) content; an additional 25 points of other costs; and, a 25x multiple of income. So that’s: 25 x (500M x $30/mo x 12mo x 75% − $80B) = $1.375T. You can run various sets of numbers through this exercise, but a range of $1-2T in market value for streaming platforms five to ten years from now seems in the ballpark. This assumes that scripted video is an entertainment of choice because, on a long time horizon, user-generated content (social networks, YouTube) and immersive game universes could take share (unless we enter the metaverse to watch a movie on our virtual TVs).
The next step would be thinking about how that $1-2T in market value will divide up between content makers. There is one school of thought that media is just like any other business that goes from analog to digital, which implies a power law would emerge around data network effects, and one or two studios would make most of the popular content. However, I would argue there is no power law in art, so we are unlikely to see a winner-takes-most scenario. There are certain musicians at points in time who garner a large share of listening, and the same could be said of painters and other artists. But, there is no painter or singer who gets 90% share of all art and music over decades. Indeed, Netflix has seen its share of originals viewed globally drop from 64.6% to 50.2% over the last two years (and to an even lower 48.1% in the US). It seems more likely to me that studios who have proven most capable of producing enduring, quality content at scale (at least here in the US that would be Disney, WarnerMedia, ViacomCBS, NBCUniversal, and newcomer Netflix) will share the bulk of the market value of scripted streaming content with a long tail of niche creators. But, perhaps there is a power law in content spending because we will soon see TV shows that cost around $1M per minute of final, edited video to make, as Amazon’s new Lord of the Rings is apparently clocking in at $465M for the first season. Data (from the same Bloomberg article with the Netflix stats) do show mini power laws quarter to quarter for original streaming shows. For example, WandaVision was viewed ~85x as much as the average streamed show followed by The Mandalorian at 55x. So, while there are some small examples of power laws in video, the industry will most likely be leveled by the concept that there are no power laws in art. That means a handful of successful Hollywood studios with streaming apps splitting a multi-trillion dollar market value opportunity. But, as always, we'll watch the data and consumer preferences, because power laws are more typical in digital transitions.
Cloudflare’s Network Is the Computer
The zero-trust edge network company, Cloudflare, was showcasing their culture of innovation again last week, hosting their sixth product announcement ‘week’ in less than 18 months. Joe has some thoughts on the pace of innovation and their edge computing breakthroughs: Cloudflare has been making the dream of “the network is the computer” (they actually own Sun’s old trademark) a reality for many years by running what Cloudflare calls “isolates” and “durable objects” at the edge. In contrast, the typical cloud application today runs in containers and databases in giant, centralized data centers like AWS or Azure. Cloudflare’s use of isolates (similar to what is running your chrome browser) is an intuitive way to bring compute to the edge in a way that dramatically lowers cold start times (to virtually 0 ms) as well as the cost to the developer (as the company discussed back in 2018). Tie this into Cloudflare’s programmable network, zero-trust security suite, and durable objects (that address the question of storage and state in serverless workloads), and you truly have a distributed computer running on the network instead of in a cloud data center. Last week, Cloudflare took this a step further and partnered with Nvidia to bring AI to the edge. No longer do your AI/ML models need to be confined to a centralized data center, which has a number of hindrances in terms of performance and security. Now, your AI/ML can run on Cloudflare’s edge, utilizing ultra-low latency and high performance, adhere to data sovereignty and other compliance measures, and utilize higher security since you aren’t running your model on the end user’s device. As the world moves closer to AI and IoT via 5G and private networks, distributed inference will play a key role. Equally important as the discrete product announcements is the culture and structure that Cloudflare has developed, which has led to an innovation machine. Cloudflare exhibits several of the attributes of our Complexity Investing framework, including adaptability, a high degree of non-zero sum, stacking s-curves, and data network effects.
Stuff about Geopolitics, Economics, and the Finance Industry
False Platitude Investing Hazards
I am always puzzled when investment firms identify specific funds as ESG focused. If you want to invest in companies gaining share of the global economy (which seems like the goal for all but rearview-mirror investors), then every fund should be looking at the impact their portfolio companies have across a broad spectrum of the world. Having an ESG fund implies, at least to me, that your other products are not focused on the factors that will distinguish tomorrow’s winners. At NZS, we don’t think conscientious, globally-minded investing is just semantics; indeed, we named our company after our guiding principle of non-zero sum, or win-win. Jeff Bezos called it “create more than you consume” in his 2020 annual letter, but even that characterization would seem to require an asterisk: if what you create/consume uses resources in a damaging way, or takes advantage of people, then your contribution could be zero sum (no net benefit) or even negative sum (net negative). Labeling something “ESG” brings to my mind the Guarantee Fairy. In related news, Gisele Bündchen was hired by online betting company DraftKings as their new ESG advisor. Bündchen’s (who has a good track record in environmental and social activism), first task is to plant a bunch of trees (which is great in principle, but I might suggest that DraftKings choose less flammable regions than California and Oregon for seeding combustible fuel). If a company’s interpretation of ESG means carving special products out for investors, or hiring philanthropic supermodels as nominal advisors, it doesn’t necessarily indicate to me any meaningful, culturally-ingrained level of understanding of what types of companies are going to thrive in our economic landscape of ever-increasing transparency, complexity, and uncertainty. In contrast, if a company has, as its core business model, the goal of creating more value for all constituents – and thereby offering consumers a more valuable product/service – it will naturally take share of global GDP, particularly as the economy transitions from analog to digital.
Direct Listing Mechanics
I’ve flagged direct listing IPOs in the past because I worry about investors buying shares from company insiders who may have more information than new public investors regarding the company’s prospects. There are obviously elements of this issue in any corporate transition from one set of shareholders to another, and there is no perfect IPO process today as I covered in The Great IPO Debate in 2019. It is indeed the point of a direct listing to have a handoff directly from insiders to non-insiders, but it seems like disclosures could use a lot of improvement. For example, on the recent Coinbase IPO, senior insiders, including board members, sold around $5B worth of stock a couple of days before disclosing the details of those trades in SEC filings. It’s not clear to me that average investors understand this dynamic, and it would seem to contradict the entire point of direct listings, which is to make the process more democratic! Some unlucky investors acquired shares from insiders above $400, and the stock is below $300 today. I am not sure what is democratic about someone with potentially more information selling before disclosing to someone with potentially less information. To be clear, I am completely fine with insiders selling shares and diversifying their holdings. Also to be clear, I don't think anyone did anything wrong or had any bad intentions, I just question the motivations of direct listings in general. It would be nice to see stronger disclosures ahead of time listing the senior management/board members who plan to sell (and how much they intend to liquidate) and/or a staggered lockup similar to traditional IPOs. Of course, those lockups aren't perfect either, but giving some time for companies to report a quarter or two will typically enable investors to do more due diligence before insiders are free to start selling.
Some Recent Posts From NZS
In case you missed it, checkout our Q1 2021 Letter (PDF). Also, don't miss Brinton's whitepaper on network theory explaining what types of organizations are setup to succeed, and which ones are a recipe for failure (PDF). Lastly, I have collated a couple of SITALWeek sections on inflation and interest rates for easy reference here.
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Disclaimers:
The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC. This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry.
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