SITALWeek #224

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, cannonballs, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Facebook enters the operating system battle as tech co-opetition rises; a new cannonball run record has been set; iBuying is surging along with demand for new single family homes in the US; use of technology in schools is proving problematic; AI should have a will to live; don’t sweat the blue light; delayed IPOs contributing to inequality; and lots more below…

Stuff about Innovation and Technology
Cannonball Run!
A team of sophisticated speedsters broke the record for a nonstop drive from NY to LA – averaging 103 mph (including pit stops) over 27 hours and 25 minutes. The trio drove a high-tech, custom-outfitted Mercedes and used scouts along the way to evade police and complete the drive as safely as possible (probably safer than texting while driving!). The article describing the new cannonball record is sure to quicken your pulse. 

Uber Air and Building a Better Battery
Uber is partnering with Joby Aviation for an electric air taxi service targeted for launch in 2023. Few details are available about the Joby craft, which is described as a hybrid drone/plane that can travel at twice the speed of a helicopter. Maybe the flying craft can get a boost from the new battery technology unveiled by IBM this week – higher power density, faster charging, and safer compared to Lithium Ion...and they are made from minerals extracted from ocean water. These yet-to-be-commercialized batteries don't need any heavy metals like cobalt, which is a good thing, as International Rights Advocates are suing Apple, Google, Microsoft, Tesla, and Dell over child deaths in the Democratic Republic of Congo related to cobalt mining – the suit claims the tech giants are not implementing their existing policies to protect children in their quest for EV-battery raw materials.

AlGaAs and AlGaInP
Scientists at NREL have figured out how to combine aluminum with lower-cost gallium arsenide (AlGaAs) and gallium indium phosphide (AlGaInP) in hydride vapor phase epitaxy (HVPE) reactors to create solar panels. If commercialized, it would bring improved efficiency (perhaps up to 29%) at lower costs. A lot of solar “breakthroughs” should be met with skepticism, but this one appears to be a legitimate advance.

Google Recreates Voices for People Who Can’t Speak
Google and Deepmind used audio from old footage of NFL linebacker Tim Shaw to create a new AI speaking engine for the ALS-afflicted man. Using Wavenet, which mimics intonation and emphasis, combined with Google’s specialized TPU chips, the system can create one second of speech in just 50 milliseconds. The tech is set to debut in a new YouTube miniseries hosted by Robert Downey Jr. titled “The Age of AI.”

The StarCraft of Shopify
Ever wonder how Shopify is like the game StarCraft? Well, I never did either. But, this fascinating example of non-obvious dot connecting in the Non-Gaap Thoughts newsletter does just that. If you’re interested in understanding Shopify’s business, the CEO of Shopify himself responded to the creative post by saying “that's a frighteningly good read of my psyche.” Mike provides the following description, which appears to have interesting similarities with adaptability and evolutionary fitness functions: "StarCraft is like a constantly evolving game of chess with incomplete information about the opponent’s layout, pieces, and attack/defense strategies. You must continually “read and adjust” your go-to-battle strategy as you learn more about your opponent’s positioning, buildings, and army composition. It’s an iterative loop."

Facebook's New OS
The Information reports that Facebook is building a new standalone operating system to rival Android as the company makes a more concerted effort to gain share of the hardware market for AR, VR, etc. There are a lot of themes in the article that are squarely aligned with a recurring topic at SITALWeek: vertical integration of semiconductors, operating systems, and hardware is creating new customers and spurring device proliferation, thus supporting long-term growth for the chip industry (FB apparently even mulled acquiring Cirrus Logic, a maker of audio chips for Apple and others, for more than it paid for Oculus). There is no particular reason why FB’s dominance in social networking implies an advantage in hardware, operating systems, or chip design. The key driver of vertical integration and increasing returns to scale in new consumer technologies is extensive access to data, which creates AI advantages. Social data are interesting, but their utility pales in comparison to the mega datasets at Amazon and Google. (Meanwhile, Apple remains the most disadvantaged with their anti-data stance). 

Tech Giants are Playing Nice
While there are a lot of reasons to be concerned about lack of competition amongst the tech giants, there are pockets of very healthy sparring – including cloud computing, AI, voice, hardware, and, now, operating systems with Facebook’s efforts. However, over the last 18 months, Amazon, Google, and Apple all started to play more nicely with each other, which may be the beginning of a consumer technology and services leaders’ bloc – to the detriment of other emerging competitors. Examples include: Apple TV+ on Amazon Fire, Apple Music on Alexa devices, Prime Video on Chromecasts (covered briefly in SITALWeek #201), YouTube returning to Fire devices, etc. Another example would be Microsoft and Sony joining forces on cloud gaming (SITALWeek #193/#194). 

And, this week we saw an interesting, key example of co-opetition between Apple, Amazon, and Google as they join with Zigbee to make smart home devices interoperable. In this instance, the tech giants are joining other smart home device makers, like Samsung, who are already members of the Zigbee alliance, which is an important step toward open competition in the home. To wrap this section on tech platform competition trends: in isolation, these developments don't seem like a lot, but in aggregate, there is a clear tension between competition and cooperation today that, depending on which way the pendulum swings, could lead to non-optimal outcomes if data access remains monopolized at the tech giants.

Schools' use of Tech is at the Bottom of Learning Curve
We recently boycotted our school’s “turn off technology week” primarily because we think teaching a fear of technology likely leads to a worse outcome than teaching how to thoughtfully balance time spent with technology. The school’s reward for skipping screens for a week was ice cream, which is ironic given that the only negative impact that has ever been tied to children's screen use is a moderate risk for obesity!  That said, this article in MIT Tech Review suggests there is a good reason to turn off technology in the classroom itself – at least until device providers figure out how to sync up tech and student learning needs: “A study of millions of high school students in the 36 member countries of the Organisation for Economic Co-operation and Development (OECD) found that those who used computers heavily at school ‘do a lot worse in most learning outcomes, even after accounting for social background and student demographics.’...‘Even more troubling, there’s evidence that vulnerable students are spending more time on digital devices than their more privileged counterparts’.” 

Amazon vs. FedEx
FedEx whiffed on earnings and outlook this week, and, at this point, I’m starting to feel bad for them, so I won’t dwell on their stock underperforming the S&P 500 by 1800 bps since I first discussed their existential problems in SITALWeek #196 (sorry, it was too hard to resist). But, Amazon has been on a PR blitz for its shipping and logistics lately: delivering half of their 7B orders themselves this year (3.5B packages); dunking on FedEx for missing deliveries by banning Prime sellers from using the struggling shipper; touting the 100,000 jobs created in its last-mile delivery franchises; featuring SVP Operations head Dave Clark in the media – like this Bloomberg puff piece (did Bezos endorse Bloomberg for president in return for good coverage? 😂); and highlighting further the Prime delivery franchising on CNBC. The CEO of FedEx called Clark a smartass in the WSJ a little while back, and maybe he’s right – the Amazon ops head was seen throwing emoji “shade” toward rival Shopify on his Twitter feed.

Breaking News: AWS Using Open Source!
Balancing out the upbeat reporting above on Amazon was the NYT, which reported Amazon is “strip-mining” software startups – copying the products and hiring the engineers. This is quite an amusing attempt by the paper, which contains ALL the news that’s fit to print mind you, failing to understand open-source software. Much of what the NYT cites is just the software pot calling the Amazon kettle black. Open source has been driving software for decades, and AWS’ use of it isn’t anything new. We are probably, ballpark, 10% of the way into the $1.5-2T+ of spending shifting to the cloud, and cloud services are likely to be a case where the best products win rather than one in which enterprises decide to lock themselves into proprietary stacks of tools at Amazon, Microsoft, or Google. Amazon is actually increasing competition by using open source, not hurting it. The size of the market will be so large that this is going to be an “and” not “or” situation: Amazon, Google, and Microsoft will have their tools AND competitors will find ways to add value in a multi-cloud world. I’m still laughing about the bit in the story describing seven open-source-software CEOs gathering for dinner at a Silicon Valley VC’s house to decide if they should accuse Amazon of monopoly behavior for using open-source software – the same free code, written largely for free by developers, that their own businesses are built off of! I can imagine the whining: “I think I should be the only one who can make money from free code other people wrote!” Silicon Valley and the Sulzbergers – always keeping it real for our amusement. For what it’s worth, I believe if an open-source-based software company is adding value and providing a good multi-cloud solution, they have little to fear from Amazon using the same open-source project.

Walmart Super-Data-Center
Walmart wants to turn supercenters into edge computing nodes for autonomous cars and other businesses. I generally think Walmart is playing the long game correctly in ecommerce, and I don’t fault many of their failed experiments along the way; however, this foray into the data-center business is way off base. Data centers need large quantities of power, cooling, and interconnects from every telecom provider – they are unique assets in many ways. If Walmart thought owning IT infrastructure was necessary (and I don’t see the logic at all), they would be better off buying an existing data center company or partnering. Playing to their strengths in grocery and providing a broader, Prime-like bundle would be a much better focus for the company. Walmart “Prime” that included Disney+, Spotify, and Lyft rides would be an enticing value proposition for their customers.

iBuying Tipping Point in Near Future
iBuyers have hit over 10% of transactions in some neighborhoods according to Redfin. What happens when iBuying crosses 50% in certain neighborhoods or zip codes? It’s likely to be a completely game-changing tipping point that will turn buying and selling homes into a highly liquid transaction.

Establishment Preventing Banking Revolution
Earnin is a digital payday lending service that asks users to “tip” money out of their paycheck advances instead of paying interest. Earnin has constant access to your checking account transactions and can adjust how much they will loan you at any given time. Earnin is part of a class of new, ‘friendlier’ payday-advance companies that won’t impact your credit or employ predatory tactics. However, this Atlantic article points out that friendlier doesn’t necessarily imply better for borrowers: “In states where payday loans are allowed, lenders are still required to disclose APR and limit borrowing amounts to a certain percentage of a user’s income. Earnin isn’t. (If it did, would-be borrowers might be alarmed: $9 on a $100 loan over two weeks is over 400 percent; states like New York and Nevada cap the interest rates on loans at 25 percent.)” In a similar vein, this article discusses how fintech lenders like LendingClub increasingly look and act like traditional lenders. There are a host of companies that seem to be trying to build a better, information-based banking/lending system, but a true revolution remains thwarted for now by the establishment of big banks, lobbyists, and regulatory capture.

30-Something Sneaker Wave in Single-Family Housing Stats
Speaking of houses, new, single-family housing starts surprised the market this week by hitting a 12.5-year high. In case you missed it, last week I discussed the reasons behind this trend and why it will continue for around another half decade: The 30-Something Sneaker Wave. Interestingly, this wave of births began in 1989 – the same year that America’s opinion on legalization of marijuana began turning positive, according to "19 interesting things from 2019" over at Pew Research...coincidence? Also in that Pew report: “A single person watching YouTube videos for eight hours a day with no breaks or days off would need more than 16 years to watch all the content posted by just the most popular channels [>250k subscribers] on the platform during a single week.”

Miscellaneous Stuff
Damasio’s New Laws of Robotics: Feel Good and Empathize 
Antonio Damasio argues that we should give AI a will to live. The basic idea is to give robots the same drive toward homeostasis that humans have – regulating their condition inside of a narrow range for survival. Damasio and his collaborator have shown that humans’ higher-level cognition likely came from a desire to maintain homeostasis. The neuroscientists suggest two new rules to replace Asimov’s three laws of robotics: 1) feel good and 2) feel empathy. Damasio is the author of one of my all-time favorite books, Descartes’ Error, which explains just how wrong it is to believe “I think, therefore I am.”

Blue is the New Red
Back in SITALWeek #196, I talked about how using dark mode on mobile devices might be worse for us due to how the brain is geared toward interpreting dark-on-light as opposed to light-on-dark backgrounds. Now, new research (in a mouse model) suggests that blue light isn’t the problem, but overall exposure and brightness probably is. Dusk is actually a period of bluer light, and in mouse studies, those hues are more relaxing than the warm amber tilt most night modes display. 

Frivolous 5G Fears
I know that SITALWeek readers are too well informed to fall for the tinfoil-hat brigade’s 5G fear mongering, but in case you need a story to share with your Crazy Uncle during holiday festivities, Wired magazine covered the safety of non-ionizing electromagnetic waves last week. I’ve addressed these concerns before, and if you’re scared of 5G, you’d do well to adopt the vampire lifestyle, because you should be absolutely terrified of sunlight.

Words of Wisdom from Brent Beshore
Brent Beshore had a tweet this week bringing new insight to honesty and kindness. Following up on some wise words from Annie Duke he said: “...kindness and niceness often conflict. Love manifests as truth + grace + patience. Without truth it's niceness. Without grace it's judgmentalism. Without patience it's abrasion.” Someone else I know says “don’t just tell me I’m wrong tell me I’m really f#$@ing wrong, and here’s why” because that’s the kind thing to do. Brent’s latest annual letter on adventur.es' year in middle-market PE is also a very worthwhile read.

One Year of SITALWeek Derived from 6M+ Words
Ever wonder how much reading goes into producing SITALWeek? Around half of what I read I store in the Pocket app (which I highly recommend) while the other half I don’t find interesting enough to save. A fraction of what I save in Pocket, along with books and podcasts, feeds into SITALWeek. So far, I’ve been in the top 1% of users since Pocket came to be; this year, I’ve read 43 books worth of articles, or 3.2M words, which means I discarded a similar amount as well. That’s a lot of words!

Stuff about Geopolitics, Economics, and the Finance Industry
Money + Morality = Social Change
GS wrote in this FT op-ed that it will target $750B “in ‘financing, investing and advisory activity’ over the next decade related to climate change and ‘inclusive growth’.” As a species, we’ve always risen to overcome challenges and survive, and that’s especially true when there is overlap between win-win outcomes and making money – there’s good reason to be optimistic about climate change and human ingenuity.

Moral Hazard with Private Capital-Delayed IPOs?
There aren’t enough people investing enough savings in the stock market, often because they don’t have the budget to do so, and that’s a society-wide problem. Yet, the stock market remains the best way for average investors to access the compounding returns from long-term growth investing. When companies that could go public instead stay private longer, returns can accrue in greater proportion to elite investors – general and limited partners and institutions that meet the accredited investor hurdle (in the US that’s currently $1M in net assets excluding primary residence, or ongoing $200k+ in annual income, according to the SEC). In some cases, these investors are pensions or endowments, who distribute returns more broadly; however, many profits from private investing seem to end up concentrated at the top (if you have data on this please send it my way, I am acting on instinct here). Therefore, companies who can and should go public – but choose not to – are perhaps contributing to the rise in inequality. Sometimes, the delay is warranted because companies need more time, e.g., to crystallize their path to profit; but often times, it’s simply a combination of fear, ego, or misunderstanding of how public markets work. Back in 2015, I penned this essay In Defense of Being a Public Company, and, although I fully admit NZS Capital benefits from having more great growth companies in the public markets to invest in, I think most companies are making a mistake staying private too long. Going public will up your game, lower your cost of capital, provide greater Optionality and flexibility, improve recruiting, and much more. I expect the current SEC review of direct listing changes proposed by the NYSE will likely defer even more IPOs, as companies wait to see what their options are, which would be a disappointing missed opportunity for average investors looking to grow capital for their future and retirement.
⛄✌

-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

SITALWeek #223

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, 3D printed toilet seats, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: the 30-something Sneaker Wave is coming and it brings several underappreciated demographic impacts; Tesla has zero competition in sight, and might never see any; radio merger could create a new threat to streaming; Cisco disrupts itself; stock indices destroy value for investors; the cardboard problem; fear bubbles causes investors to miss the record highs in the market; and lots more below...

Stuff about Innovation and Technology
The 30-Something Sneaker Wave
There is a wave of US household formation accelerating this year led by people in their 30s. It’s not as big of a trend as the Silver Tsunami, but it’s nonetheless fascinating, and it will be a driver of household formation and shifting consumption trends. At the end of this week’s newsletter, there’s a longer explanation on the 30-something Sneaker Wave, but here is the TL;DR:

• There was a ~5% increase in births from 1989 to 1994 – those kids are beginning to turn 30 in 2019.

• The kids born just before them, from 1984 to 1988, delayed household formation for a variety of reasons, including student debt, and they will be forming more households soon.

• Combined, this soon-to-turn-30 and 30-something group will drive a doubling of household formation compared to last decade.

• This wave is likely to accelerate the on-demand and sharing economy into the suburbs, and initiate other emergent behavioral shifts.

• Forgiving student debt would provide an economic tailwind that outweighs the moral hazard.

• After this Sneaker Wave crests, and absent an increase in immigration, the US faces decades of challenging demographic headwinds.

Participation Award for Porsche's EV
Porsche’s new, all-electric Taycan Turbo will carry an EPA window sticker range of only 201 miles. That’s the worst range of any electric car on the market. The Taycan also doesn’t match Tesla’s Model S Performance on other key metrics. Separately, Ferrari announced they would have an all-electric model available in 2025. There isn’t an automaker today who is within 3-5 years of catching Tesla, and in 3-5 years Tesla will be even further ahead. When the Information Age comes for an industry like autos, a completely new set of rules begins to apply – and data, software, vertical integration, and high-speed innovation aren’t achievable by the vast majority of companies forged in the 1900s.

When Everyone has a Cheap Chauffeur
Researchers at Berkeley gave chauffeurs to 13 random people for up to 60 hours for one week to study how inexpensive autonomous vehicles might impact behavior. The surprising find? Participants increased miles traveled by 83%! The group is expanding the survey to collect more data points and information behind the increased usage.

3D Printing a Reduced Carbon Footprint
British Airways is looking into 3D printing parts on location in an upcoming trial for non-safety related components like tray tables and toilet parts. The test is also part of BA’s goal of becoming carbon neutral by 2050. On-site manufacturing reduces transportation costs and emissions, and the 3D-printed parts are lighter too.

Same Song, Different Verse
Back in the year 2000, radio giant Clear Channel Communications purchased concert promotion giant SFX Entertainment. In 2005, Clear Channel spunout SFX as Live Nation. In 2014, Clear Channel became known as iHeartMedia. In 2019, Liberty Media, which controls SiriusXM satellite radio and Pandora streaming music – and has a 33% stake in Live Nation – is looking to own more iHeartMedia (according to the WSJ), so it looks like there’s a good chance SFX and Clear Channel will be reunited! It’s worth repeating a point I made back in SITALWeek #220 – the value of local radio might be the key to shifting the 4+ daily hours of audio to streaming. If Liberty takes local iHeart content and makes it available as “podcasts” on Pandora, this could give it an advantage over Spotify.

Competition for Adobe?
Canva is a $3.2B Australia-based Adobe challenger that’s EBITDA positive and expecting $200M in revenue this year. Canva is currently about 3-4% the size of Adobe’s design software unit, but doubling in size y/y. The lower-end product offers basic design functionality for $10/mo. According to this Forbes profile, Canva has over 20M users, a China-specific version, and backing from the founders of Australian tech giant Atlassian.

TSMC Launching 5nm in 2020
TSMC, the world’s largest chip foundry, is ready to launch 5nm in early 2020. This will turn the heat up on lagging Intel even more. Leading-edge semiconductors are in an accelerated arms race, and the equipment providers stand to do well. The new chips have a 1.84x increase in logic density – equivalent to a 30% power reduction.

RISC-V Surges
This week’s open-source processor RISC-V summit saw 2000 attendees, or about 3x the number that came to a similar conference earlier this year. This VentureBeat article is a good recap of the event. The most notable announcement I saw was Samsung, currently a major ARM partner, embracing RISC-V across several new chips. In related news: ARM China, a joint venture controlled by the Chinese government, has doubled its headcount and has internal plans to over take the Softbank-owned ARM by 2025, accelerating China’s attempts to build its own semiconductor business (at least in terms of design, if not manufacture). This is a risky situation for ARM, to put it mildly, as the partnership could jeopardize relationships in the West just as RISC-V’s global popularity is rising.

Did Cisco just Disrupt Themselves?
Networking giant Cisco made an intriguing decision this week to disaggregate sales of its hardware, software, and networking chips. Frankly, I’m still trying to wrap my head around this move for the decades-old box maker, who increasingly faces disruption from white box networking gear and merchant silicon vendors. As workloads move from on-premises data centers to the cloud, the big Internet platforms are designing their own networking boxes and software with off-the-shelf parts for both performance and security reasons. Intriguingly, this announcement from Cisco quoted both Google and Facebook representatives. Cisco has long had one of the biggest and best ASIC design teams out there, and selling standalone chips could be a challenger to Broadcom in this market. It could also enable a new set of networking competitors to challenge the disruptors, like Arista, who is currently stealing share from Cisco. 

iBuying Boom
iBuyers bought 3.1% of homes across 18 active markets in Q319, up from 1.6% the prior year. The biggest market was Raleigh at 6.8%. The fledgling industry is also getting much more efficient with days on market for iBuyer-owned properties at 28, down from 74 a year ago. A shift toward slightly-lower-priced homes vs. last year could be helping the properties sell faster as well. iBuyers are also incentivizing prospective buyers to come without agents and use their in-house mortgage and other ancillary services. Here’s the detailed report from Redfin.
 
TikTok Heralding Video-Ecommerce Wave?
TikTok discussed their most viral memes of 2019 and their focus on monetization in the NYT. Related: VC shop Andreessen Horowitz reviews the huge market for video-first ecommerce in China and why we might expect it to translate over to platforms like TikTok in the US.  

Miscellaneous Stuff
Garden-Variety Silicon Carbide Superior for Quantum Computing
Common silicon carbide diodes are proving useful for quantum information processing. Unexpectedly, quantum signals are free of noise in this substrate compared to other silicon materials. And, the signal emitted is in the visual wavelength range, which makes it suitable for transmission over fiber optic cables. This is a very small step forward, but we still remain a very long way off from quantum computers.

Evolving a Friendlier Human
The first animals humans domesticated were...humans. It seems uncontroversial, yet not well understood, that we selectively bred ourselves over time to favor appearance and emotional characteristics that facilitate social behavior and cooperation, especially after the cognitive revolution around 150,000 years ago. Our domestication is still going on today (and I’m not talking about the crazy genetic-superiority nonsense, there just seems to be a long arc of more favorable characteristics, like compassion and tolerance, that’s distancing ourselves from our more wild ancestors; think doe-eyed, floppy-eared puppy dog vs. predatory wolf). Luckily, we haven’t created the human-doodle or chihua-human yet.

Cardboard Packaging and Doorstep Delivery Due for Upgrades
The glut of cardboard boxes from ecommerce deliveries is making it uneconomical to recycle cardboard, which will eventually lead to more trees being cut down. The faster the ecommerce industry moves to more locally-sourced items, which can be bagged in reusable totes or containers (to be picked up when the next delivery is made) and even placed inside homes, garages, or secure lockers, the better. Today’s big shippers – UPS and FedEx with their trucks full of stacked boxes – will have a harder time adapting to this vertically-integrated, “local” ecommerce growth compared to Amazon and Walmart.

Can More Gov't = More Freedom?
Could more government mean more freedom? It’s the opposite intuition of any card-carrying Libertarian, but in Finland, and other Nordic capitalist countries, it might be the case. This NYT article reports on the benefits of living in Finland, the business-friendly environment that scores higher on free market metrics and has higher levels of personal freedom. Also enjoy this new, delightful 3-part video series from Bloomberg’s Ashlee Vance on Finland.

Stuff about Geopolitics, Economics, and the Finance Industry
Index Fund Miasma
Al Gore takes on Vanguard and other index fund giants for “[financing] the destruction of human civilization” in FT’s Moral Money newsletter. Gore, who runs a large and successful socially-responsible investment firm, would like to see passive shareholders engage with companies and not blindly prop up shares in destructive companies just because they are in indices. He’s not wrong. 

Speaking of index funds, the reality is that index providers like MSCI are negative-sum propositions – they are creating value for themselves only, while enabling an ecosystem of value destruction. There is some value in having an official, real-time record of various groups of stocks that provides data to grease the market for traders; however, I think that could be easily replicated with a free, open-source alternative. For the vast majority of investors, index fees are a pointless tax. What’s worse for investors is that these passive, market cap weighted indices can be increasingly backward looking as larger companies become subject to higher rates of digital disruption going forward. Add in Gore’s complaints, and you can see why NZS Capital isn’t lining up to buy shares in the index providers, and we will encourage our clients to ditch them as well. Morningstar, who has its own “open index” initiative, published a paper this month on the problems with the oligopoly price-fixing in the index business. And, here is yet another article on the index tax in the FT, which discusses DIY indices...anyone see a pattern here!? It’s time for active investors to shut down the negative-sum, monopoly index tax.

Non-Transparent ETFs Gain Traction
The SEC has given approval for T. Rowe Price, Fidelity, Natixis, and Blue Tractor, in addition to Precidian (previously approved), to offer non-transparent ETFs. An open question for investors and RIAs is whether the lack of transparency would enable higher performance, enough to offset the higher costs, which might be perhaps 10-20bps? The answer could favor a vertically-integrated provider, like T. Rowe, if they were to absorb those costs. The real question is: which mutual fund platforms will be bold enough to convert existing strategies to ETF structures and cut fees to benefit their investors?

Direct Listing IPO 2.0 Proposal from NYSE
The back and forth between the NYSE and the SEC continues over hybrid direct listing IPOs that would allow for raising direct capital. The Information recaps the events, covering the NYSE’s recent, amended-proposal resubmittal and the SEC’s concerns that hybrid listings need to both protect individual investors and not create an informational advantage for private holders (like VCs) selling on the direct listing. It’s likely 2021 before a new framework is implemented, which may mean we see a delay in the slate of 2020 IPOs for companies that both want to raise capital and enable their insiders to sell bigger chunks of stock on day one.

Fear Bubble Causes Record-High Outflows while Market Surges 
Investors pulled more money out of the stock market this year than in any previous 27+ years – $135B yanked as the fear bubble continues amidst the strongest market rally since 2013. According to this WSJ article, $220B has left active managers while $85B has flowed into passives. What’s driving the market? Perhaps the $480B in share buybacks this year, according to GS.
------------------------
The 30-Something Sneaker Wave
All numbers discussed below include both native US births as well as subsequent immigrants who were born in those same years; data cited are all available at the CDC’s Vital Statistics Site. In addition to the CDC data, many of the trends below, including this chart I've annotated, can be found in ‘The Big Shifts Ahead’ (thanks to a SITALWeek reader for the great book suggestion!). If you interested in demographics, I also dove into aging and birth waves in SITALWeek #206.

Let’s orient ourselves on this birth graph: Baby Boomers crested at 4.5M in 1960, followed by a generally downsloping birth trend and then an ~8-year trough (“Gen X Lull”), which bottomed out in 1973 with 3.9M births (these are my people – the lost Generation X!). Starting in 1979, births began to pick up, and slowly rose before accelerating in ~1989 (beginning of the “Sneaker Wave”) to cross back over the prior 4.5M peak. Births stayed relatively elevated before dipping back below 4.5M in 1993 and then proceeded to decline (purple arrow) to below 3.8M in 2018. 

The 30-Something Sneaker Wave Comes Ashore:

• There are ~23M folks aged 26-30 (born 1989-93, blue). That’s almost 5% (1M, or ~200k/yr) more than the 5-year group born before (1984-88, red) and almost 10% (2M, or ~400k/yr) more than the 5-year group born after (1994-98, start of purple arrow). 

• But, there’s more: the ‘red’ group (now aged 31-35) born just before our Sneaker Wave accelerated the trend of delayed marriage, family, and household formation: in 2013, 54% of people in their late-20s were single without children vs. 44% in 2006 (10% increase over 7 years = 1.4% per yr). Compare those numbers to the prior ~2 decades: In 1987, only 36% of the late-20s population was single without children (8% increase over 19 years = 0.4% per yr). These data strongly suggest that there is a wave of delayed household formers joining the ‘Sneakers’ entering their higher consumption years. There were multiple reasons for this delay, but student debt seems to be an explanatory factor – this group of folks bears the biggest burden of student loans, which rose from $260B in 2004 to a peak of $874B in 2011 (as a reference point, people born in 1988 would be 23 in 2011). As we’ve discussed in the past: the moral hazard of student debt forgiveness could be far outweighed by the huge economic multiplier effect if relief enabled this cohort of folks to form households.

• Consumption: historically, people aged 25-34 spend around $60,000/year, which grows to nearly $80,000 when they are 35-44 (sorry I can’t find the 5-year increments, but here is the source with many more details and breakouts). Some of the bigger increases are: food spend rising from $6000 to $8000, housing from $17,200 to $20,600, and entertainment spend going from $2200 to $3000.

• This double swell of the delayed household formers and the 30-something Sneakers will drive accelerated household formation – a shift to living in houses (either owned or rented) from apartments (and/or still living with parents!), and all the lifestyle changes that come with having kids and spending on diapers, cable TV, and trips to Disneyland, etc.

Contrasting the Sneaker Wave and the Silver Tsunami:

• Downsizing/selling homes – in SITALWeek #221 we discusses the extra 500k homes/yr up for sale in the next decade. It will be interesting to see if this supply of houses creates attractive prices for 30-something Millennials to move into “older” neighborhoods.

• Decreased retiree consumption (dropping from a peak of $60k/year to $46k/year and declining with every year of age thereafter).

• Retiring, which creates job openings; because the smaller Gen X has fewer people to fill in, it could create more employment opportunities for the 30-something swell.

The Boomer retirement wave and the 30-something sneaker wave are two unrelated phenomena (well, technically they are very related because many of this wave of 30-somethings’ parents are Boomers!); however, combined, they will be the two of the bigger impacts to the US economy over the next ~5 years. For the 40 years up until ~2005, the US had household formation ranging from 12M to 14.7M in each decade. Then, between 2006 and 2015, this number dropped to 6.7M. It should get back on trendline of more than 12M through 2025 before tailing off again. 

The Silver Tsunami and the economic impact from rising household formation from the 30-somethings could reverse several suburban-to-urban trends in the coming years. Further, this digital-savvy set of household formers are likely to accelerate many trends underway in the economy as the Internet further disrupts legacy business models. For example, they won’t be queueing up at Walgreens to wait on prescriptions for their sick kids (prescriptions that probably won’t even be ready after waiting in line for 20 minutes!); instead they will get 1-hour delivery.

On the flipside, it’s possible that the forces of the housing recession and student debt will linger; and, perhaps the record low birth rate (now 1.73, down from 3.6 in 1960) is more structural than circumstantial. This is a key point: this Sneaker population is the last big bolus in the population pipeline for the foreseeable future and, when combined with the severe dropoff in immigration, sets the stage for significant economic stagnation, perhaps a decade from now, all else equal. This will likely put even more weight on policy decisions and political outcomes that focus less on economic growth and more on economic distribution. But for the next ~5 years, 30-something Millennials could accelerate the digital economic transition as they drive an increasing portion of consumption.
✌

SITALWeek #222

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, bovine VR, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: NZS Capital partners with Jupiter Asset Management; debt fuels Chinese ecommerce; Google’s risk of a lost decade; non-ergodicity goes mainstream in the journal Nature Physics; concentrated funds underperform while gaining share; cows wearing VR headsets; and lots more below...

Stuff about Innovation and Technology
NZS Partners with Jupiter Asset Management 🎉
NZS Capital is excited to announce our partnership with Jupiter Asset Management, an investment company based in London with £45.9B (~$55B) in assets as of 9/30/19 across equity and fixed-income strategies. Jupiter is home to talented and genuinely active investors, and we’re looking forward to launching with them early next year! More from the press release:

“Jupiter is pleased to announce that it will take a minority stake in US-based investment firm NZS Capital and enter into a strategic partnership with the company in Q1 2020. NZS Capital was co-founded by fund managers Brad Slingerlend and Brinton Johns who worked together for 14 years at Janus Capital prior to setting up on their own. They both have long and successful track records of managing global equities portfolios on behalf of institutional and retail investors.
As part of this partnership, Jupiter will be the exclusive distributor of NZS’s global growth unconstrained-styled investment portfolios. This includes launching Jupiter-branded mutual funds based on these strategies in the future. Initially, the priority will be to target institutional investors, including those in the US where Jupiter will begin to have dedicated sales resource for the first time.”

Bovine VR: Ignorance is Bliss
Cows could produce more milk if they are living in a virtual pasture using VR headsets (the link has photos!) tuned to their eyes. Or, at the very least, the VR reduces anxiety in preliminary trials. So, in the bovine Matrix: “There is no...grass?”

AWS to Power Fox Content
The CTO and President of Digital at Fox, Paul Cheesbrough, posted a great recap (Twitter thread) of Amazon’s big user conference AWS re:Invent. Paul is one of the most forward-thinking tech leaders I know, and he was at AWS to announce a big streaming infrastructure deal for Fox’s content. AWS Media Services will power Fox’s production facilities and stream Fox’s sports, news, and other video content. It's interesting to roll this partnership into the future and ponder how NFL broadcast rights might enter into the mix. Notably, Fox will run AWS’ Outpost and Local Zone technology in their own facilities as the cloud moves back on premises for data-intensive applications.

Bringing High Fashion to a Hotel Near You
Rent the Runway, which offers access to designer clothing, is partnering with W Hotels to make clothes available at four hotels. For $69, guests can pick four outfits to wear during their stay. Broadly, this bundle of apparel and travel is an interesting example of two separate businesses combining to create a compelling value for consumers – I think we’ll see more disconnected services bundle together in the future.

Zero-Rate Borrowing Behind Singles’ Day Growth
Alibaba’s Ant Financial played an unexpected role on Singles’ Day (Alibaba’s big one-day ecommerce event) by extending credit via its Huabei lending division. According to an external estimate, half of Singles’ Day purchases were made using credit at a zero-interest rate. Historically, credit has not been a driver of Singles’ Day sales (according to the US-China Economic Review Commission’s December report, page 8 of the PDF). Unrelated, but in the same report, is an update on the aggressive but successful 5G roll out in China, which is well ahead of the US.

Back to Basic Cable
The geniuses behind South Park are at it again with another episode – which appears ripped from the pages of SITALWeek – titled “Basic Cable.” The shift to streaming has become a broken value proposition of fumbling multiple apps, passwords, user interfaces, restrictions, lack of universal search, etc. Now, the pendulum has swung back to where basic cable, when bundled with broadband, will give most folks in the US more for less. We’re back on Comcast video in our house - it’s a better UI that integrates Netflix and Prime Video, plus we’re saving a lot of money. South Park Season 23 Episode 9, “Basic Cable,” lampoons the disarray of streaming apps while also poking fun at the cable companies AND ripping on AT&T/HBO for overpaying for streaming rights...like the $500M they paid for South Park! Here’s a short clip (with NSFW language, depending on where you work – sorry, it might require a VPN if you’re outside the US).

Google Chrysalis?
The Google founders stepped down from their management roles at Alphabet and Google X this week. Pattern recognition is useless in most cases, but the situation seems somewhat analogous to the lost decade and paralysis that Microsoft faced. As an outsider, I can only speculate: Google's heightened regulatory risks, combined with a tense internal cultural moment (at least according to various press leaks), and a series of game-changing paradigm shifts on the horizon with AI, augmented reality, etc. feels like Microsoft circa 2000 when Gates became chairman and the company subsequently missed the shift to mobile. It took a visionary leader, Satya Nadella, to steer Microsoft to new heights. By all accounts, Sundar Pichai could be that type of leader for Google (he’s certainly not a Steve Ballmer!), but it’s likely to be a cultural turning point requiring emergence of a new identity. The next few years at Google could be marked by an inability to stack new S-curves due to the forward regulatory fear that accompanies regulatory capture (which is likely to cement their current monopolies) and a possible self-imposed breakup of the company – spinning out properties like Waymo and YouTube. The range of outcomes widens when a culture shifts away from that established by its founders.

TikTok’s Ad Ambitions
TikTok is targeting to build a big-brand ad business with the help of a former Facebook head of advertising. This FT article discusses TikTok’s new office in the former WhatsApp building and their poaching of several FB advertising execs. Efforts will focus on marketing products featured in short videos. But, brands are hesitant to jump aboard given the regulatory and broad US scrutiny of TikTok. For example, a lawsuit in California alleges that TikTok is syphoning off data, including biometric data from uploaded video, and sending it to servers in China as well as sharing with Alibaba, Tencent, and Baidu. This lawsuit joins a chorus of accusations (which may or may not be true) against the Chinese company as it faces scrutiny from CFIUS as to whether it can operate in the US under Chinese ownership. Meanwhile, the musical-meme app continues to win the time and hearts of America’s teens. I suspect the efforts to make it independent won’t be enough and, ultimately, it will need to completely change hands via sale to an American buyer (Snap or Twitter make the most sense because Facebook or Google would likely face regulatory scrutiny themselves).

Look Out!
Speaking of apps putting you at risk: hospital visits and serious injuries are spiking from staring at TikTok and other addictive phone apps. This report suggests that there are possibly upwards of 76,000 head and neck injuries from trips and falls related to looking at phones instead of what’s in front of you. Be careful out there – SITALWeek does not assume responsibility for falls while reading on your phone!

Semiconductor News Roundup: Imagination’s “GPU of Everything”, China’s Recruiting Efforts, Light-Speed Computation, and Shortcomings – and Promise – of FPGAs
Imagination has launched the “GPU of Everything” targeted at distributed AI and graphics workloads for any IoT, smartphone, or connected device outside the data center. Imagination use to provide all of Apple’s iPhone/iPad graphics processors until Apple insourced. That move sent Imagination on a path that involved buying MIPS (a processor licensing company that competes with ARM) and ultimately selling to a Chinese private equity fund called Canyon Bridge. Traditionally, Imagination has had very good technology, and they now have their sights set on the rest of the market that’s not already covered by a vertically-integrated solution (Softbank’s ARM has its own GPU engine, as does Qualcomm).

3000 engineers have left Taiwan to join China’s domestic effort to build semiconductor independence. This isn’t a new trend, having started 20 years ago, but there have been a series of high-profile departures from TSM and UMC over the last few years according to this Nikkei article.

Researchers have developed the first nano-scale chip that harnesses both electrons and photons. The electro-optical device tries to solve the problem of designing a single device capable of accommodating two types of wavelengths: light has a much longer wavelength than electrons, therefore requiring bigger chips. Their workaround: “They created a design which allowed them to compress light into a nano-sized volume through what is known as surface plasmon polariton.” (I don’t know what that means either!)

FPGAs are struggling to gain share in the AI market for a few important reasons. One of the biggest problems remains the dearth of programmers who are familiar with their unique languages compared to other products like NVIDIA (Cuda or C++) or new ASICs like Graphcore (C++). FPGAs also have to run all at once alongside an x86 server chip, whereas AI ASICs can turn parts of the chip on and off, thus conserving power. While GPUs from NVIDIA remain dominant in machine learning, this article discusses the potential role that FPGAs, from companies like Flex Logix and Microchip, might play in the more heterogeneous inference market.

Miscellaneous Stuff
Ole Peters’ Non-Ergodic Economic Model Gets Well-Deserved Attention
Traditional economic theory has no utility and zero basis in reality, in large part because economists have always assumed that the expected outcome for an event is equivalent to the average of all outcomes. However, at the individual level, all that matters is the path through time – a point thoroughly ignored by economists. This glaring oversight has led to a failure of economic theory for hundreds of years. Even behavioral economics, which aims to improve upon the theory, has shortcomings for the same reasons. However, there’s a better way to do the math: model using non-ergodic systems! We’ve been praising (and implementing) Ole Peters’ groundbreaking theory ever since we wrote about it in Complexity Investing back in 2014. Peters published a detailed article in Nature Physics this week, or you can also read this approachable synopsis of the article posted by the Santa Fe Institute:
“Instead of averaging wealth across parallel possibilities, Peters advocates an approach that models how an individual's wealth evolves along a single path through time. In a disarmingly simple example, he randomly multiplies the player's total wealth by either 150% or 60% depending on the coin toss. That player lives with the gain or loss of each round, carrying it with them to the next turn. As the play time increases, Peters' model reveals an array of individual trajectories. They all follow unique paths. And in contrast to the classical conception, all paths eventually plummet downward. In other words, the approach reveals a fray of exponential losses where the classical conception would show a single exponential gain.”
(SITALWeek #197 and SITALWeek #202 have a little more color on ergodicity as well.)

The Universe? It’s Just a Math Equation
Physicist Max Tegmark was on Sean Carroll’s podcast this week to talk about his view of the universe as a purely mathematical system. Max and Sean have a back-and-forth discussion of some nuanced arguments about the multiverse and possible simulated reality. It’s an approachable conversation; and, if you like it, I recommend Max’s book Our Mathematical Universe, which requires a little more effort on the part of the reader, but is filled with interesting cosmological concepts.

Through the Looking Glass
A mirror doesn’t flip images left or right (or up or down), but it does flip depth as a result of specular reflection, which means things that are further from us (and closer to the mirror) appear larger than an object right next to us (and farther from the mirror). That’s what creates the illusion that a mirror is a window into another place. Confused? Check out this short video from Minute Physics on YouTube.

Self-Storage Boom: Two Possible Explanations
Back in STALWeek #217, I posted a popular story from the WSJ on the 5x increase in new self-storage buildings in the US over the last four years; I suggested it might be a result of free money looking for a place to invest rather than actual demand for outsourced closet space. Since then, I’ve been looking for alternate explanations. The first I’ve come up with relates to a topic I’ve discussed recently: people aren’t moving. Average time spent in an owned home is 13 years, double what it was 20 years ago. We clean house when we move, but when we sit still, junk piles up around us, and renting a storage unit avoids the emotionally/mentally taxing effort of critical stuff “editing.” The second explanation is related to the first, and it’s simple demographics: People over 65 are a growing percentage of the population, and they are staying in homes longer and are likely downsizing when they do move. This interesting NPR interview with the author of a book on second-hand goods discusses how only 1/3 of items donated to Goodwill are sold and reasons to buy second-hand instead of new.

False Advertising Improves Reef Health
Piping the sound of a healthy coral reef into a dying one attracts fish necessary to repair it.

Stuff about Geopolitics, Economics, and the Finance Industry
Concentrated Portfolio Construction Exacerbates Cognitive Bias Pitfalls
The number of active mutual funds with under 35 holdings more than doubled from 149 in 2007 to 310 today (making up just over 9% of all active equity funds). Assets across the concentrated funds have tripled to $161B. The shift in portfolio construction seems to be an effort to differentiate active management from cheaper passive alternatives, which tend to hold more positions. However, the results are distinctly underwhelming: the concentrated funds are lagging the S&P 500 by ~6% annualized over the last decade (total performance of 244% compared to 322% since 2008). Running concentrated positions requires an especially strong control for cognitive bias risks. Position sizing, “conviction,” ego, and the brain’s incredible ability to make us buy into our own BS all conspire to introduce unnecessary risk into concentrated portfolios. (Here at NZS Capital, we have a few solutions for these bias problems. 😉)

Active Fundholders Incur Greater Tax Burdens as Money Shifts to Passives
As investors move from active to passives, they leave the remaining active mutual fund owners holding a higher tax burden. As funds sell shares to redeem investors exiting, the remaining owners pay higher than their fair share of taxes – highlighting the tax inefficiencies of traditional US mutual funds compared to ETFs (which workaround the double-taxation problem).

Blackstone CEO’s Visions of Grandeur
PE giant Blackstone has $554B in assets under management, but another $148B in commitments to invest in real estate and other private businesses. The CEO recently commented – while on his book tour – that smaller PE shops will see inferior returns as they compete with each other for deals while bigger firms can buy bigger deals with less competition (the article cites 8,000 shops investing $4T). The logic here isn’t at all clear to me – why would larger assets have better returns or fewer bidders in today’s free money environment?

Calpers’ Alternative Reality of 7%+ Returns
The $387B California pension Calpers has cut external public equity investments from $30B to $5B, reduced the number of management firms from 17 to three, and virtually eliminated emerging managers (firms with less than $2B under management). The firings will save $100M of the $119M spent on outside managers. It’s not clear if that $100M is net of what Calpers will spend to manage this money, or if the money is even staying in the public equities category. Maybe it will be going toward more of those levered, private assets that the Calpers CEO is seeking? Hopefully she has double checked those EBITDA assumptions (see next paragraph) and she understands the moral hazard of some PE investments as Joseph Stiglitz recently pointed out.

Corporate Debt at New High, with Loans based on “Fake EBITDA”?
$2.43T of corporate debt has been issued so far this year, surpassing 2017’s record with a few weeks yet to go. Aggregate corporate debt is now near $10T – 47% of the US economy (with some comments from our friend and brilliant bond investor Gibson Smith in the WP article!) However, concerns are building over the quality of many of the levered deals funded over the last few years: “More than half the companies that were part of a leveraged buyout in 2016 missed their earnings projections by more than 25% last year” according to Alan Waxman of TPG Sixth Street Partners who also warned of “fake EBITDA” underlying many loan assumptions.

SEC to NYSE: “No”
That was quick: the SEC has already shut down – without comment – the NYSE’s request to allow companies to raise primary capital in direct listings. This response is a blow to VCs hoping to cash out fast in IPOs. Here is a great down in the weeds analysis on direct listings if you're interested in this topic from Non-GAAP's newsletter.
✌

SITALWeek #221

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, a 5th Force of Nature, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: a modern milkman would have big implications for food delivery and potentially packaging waste; the future is in...Africa; the Super Bowl sells out; what Mister Rogers teaches us about time’s passing; you can’t predict stocks even with perfect information; the problems of aging global demographics; direct listings back in the new; and lots more below...

Stuff about Innovation and Technology
Robot Beekeepers
Beewise in Israel uses NVIDIA AI to identify bees infected with mites. The robot tech can isolate and sterilize the problem bees in real time before a hive is further infected.

When AI Wins, Humans Retire
Former Go champion Lee Se-dol retired from the game after declaring the AI from DeepMind unbeatable. Last year’s Netflix documentary AlphaGo offered insight into the painful emotions humans experience when they realize machines are better, and even possibly more creative, at a given task.

Into Africa
Twitter and Square CEO Jack Dorsey will move to Africa next year for 3-6 months because the continent will “define the future” of technology usage.

Just Say No...To Plastics
“I want to say one word to you. Just one word...Plastics.” Well, that was 50 years ago, and today this classic quote from The Graduate requires a makeover: Just three words: anything but plastics! This WSJ article discusses how big brands are struggling to get off the plastic but will keep trying. For any young engineers out there, I might suggest a career in material science and package design – there’s a huge market ripe for disruption as single-use plastics (for non-medical purposes) will likely become illegal across the globe over the coming years. As we have more and more food and products delivered to our houses directly, it also sets up a big opportunity to reuse packaging – maybe those Amazon vans can take back the old containers as they drop off new ones (just like the Milk Man did!).

Zero-Waste Grocery Delivery with Factory Robots
Speaking of the modern milkman: Amsterdam-based grocery delivery service Picnic raised a EUR250M round of venture capital. The company uses EVs to deliver food on scheduled routes, and is working on a robotic zero-waste fulfillment center. Picnic delivery is free, which is actually like a rebate because it saves you time and transportation costs going to the store yourself! This seems like a great early proofpoint of some of the trends I discussed in my piece Evolution of the Meal.

Live Sports and Content Fragmentation Support the Old Cable Bundle
As consumer attention continues to fragment among increasing entertainment options, the scarcity value of live sporting events is driving increasing advertising demand. Fox has already sold out the Superbowl ads for as much as $5.6M per 30 second spot – the earliest sell out since 2011. Over the last several years, the spots weren’t completely sold until right before the game aired. In general, I think investors remain too pessimistic about sports-rights values and the TV bundles that support them.

Around four years ago, Comcast introduced a monthly fee of $3.25 on bills to pay for broadcast TV “retransmission” costs levied by CBS, ABC, NBC, and Fox. After a couple of price increases, this fee will leap 50% to $14.95/mo in December. On the one hand, you could argue this will cause people to cut the cord faster; on the other hand, you could argue it’s evidence of the ‘power of the bundle’ and how underpriced it is relative to the increasingly expensive (and frustrating) option of signing up for and navigating 5-10 disconnected apps.

Privacy According to State Gov’t: Do As I Say, Not As I Do
The California DMV is making over $50M, or about $2/licensed driver, selling data to pretty much anyone who wants it, including private detectives. At the same time, the state is pushing its own restrictive consumer-privacy rules for Internet companies. Selling DMV data seems like common practice – recall back in SITALWeek #202 I discussed the same issue in Florida to the tune of $77M/year (>$5/licensed driver). California should work with Google or Facebook to try and close that shameful monetization gap with Florida! There is a broader issue worth mentioning here – States are set to lose lots of revenue over the next two decades as 1) more people choose to use ride-share services instead of owning cars (even if people keep their driver’s license, fewer cars will get registered), and 2) the loss in gas taxes as cars shift to electric. Both will likely spur significant new taxes on ride-share companies to pay for roads, etc.

Open Source Relocates to Neutral Territory
RISC-V is moving to Switzerland amid rising US trade and tariff concerns. China is one of the biggest leaders and beneficiaries of the open-source processor movement led by RISC-V. This seems like a smart move for ensuring global access to the tech, but US and European software and tools are still required to design and manufacture the chips, which keeps a Western grip on China’s increasingly-challenged homegrown semiconductor industry.

Miscellaneous Stuff
"Jupiter's Great Red Spot Storm Isn't Dying Anytime Soon"...there is no evidence that the vortex that powers the cloud formation is changing.

Standard Model of Particle Physics Leaves Room for Improvement
There was a lot of press this week around a possible new 5th force of nature. It’s an exciting topic, and if it’s of interest, this article does a nice job explaining the background for why there might be an additional force and why the new experiment may or (likely) may not demonstrate it.

Nature Of Time: From the Universe to Mister Rogers
Brinton and I have been talking a lot about the nature of time lately. It’s at the center of our latest paper “Redefining Margin of Safety” (at the end of this week’s email is an excerpt about time from that essay). I was recently intrigued by the idea at the end of Sean Carroll’s book, Something Deeply Hidden on quantum mechanics and gravity, that time might be an emergent property of the Universe rather than a foundational one. It’s possible that all times past, present, and future exist at once. Each configuration of the universe might be entangled with a certain time, and perhaps that’s where the feeling of time passing, and the arrow of time, comes from. Entropy, or the concept that matter spreads out and cools down over time and contains less information, is integral to the passage/arrow of time. Yes, I’ve seen Interstellar a couple dozen times!

One of the fascinating qualities of time to us is how you can do certain things to slow it down. In the early years of children’s television, shows were often focused on superheroes, race cars, and pie-throwing antics. They were fast paced, with a chaotic – often frantic – energy. Then along came Mister Rogers, with his unique ability to slow down time. On one episode, Mister Rogers set a timer for a minute and just watched it in near silence, sitting next to his friend Mr. McFeely. In another episode, he simply watched a turtle move. One of Fred Rogers many insights seems to have been that time moved at a different pace for children. When you are constantly learning novel concepts, time actually appears to pass slowly. As we age, we know more and learn less, which causes the feeling of time flying by. This effectively translates into a life philosophy, as well as a business and investing strategy: do whatever you can to slow time down, and you will find all kinds of opportunities to learn and adapt.

Stuff about Geopolitics, Economics, and the Finance Industry
AAPL Root of Active Underperformance?
Fundamental active mutual funds underperformed by 154bps in Europe and 106bps in the US while quant mutual funds trailed benchmarks by 214bps. I haven’t seen the analysis, but I suspect systematic underweighting of Apple stock, which is a large outlier in most benchmarks and is up 72% year to date, could be a factor here. AAPL stock has gone from around 3.3% to around 4.3% of the S&P 500 this year, meaning it outperformed by 100bps at an equal weight. An underweight position would have accentuated this pressure. (Apple is also now 17.4% of the US technology index!)

Silver Tsunami of Population Decline
China’s aging population will make it increasingly harder for the country to maintain its growth lead over the West. By 2050, about 1/3 of China will be over 60. The massive shift from workforce to retirement with a much smaller replacement generation will be a global common theme as we hit peak population for humans much sooner than everyone realizes. It will require a big adjustment in thinking about the economy, growth, and inequality: under capitalism, when the pie stops growing, it tends to get distributed according to power law, making wealth inequality the 2nd biggest problem facing the world today, alongside global warming.

The “Silver Tsunami” has its own implications in the US as well – the WSJ writes this week about Zillow research indicating that one quarter of homes in the US will be up for sale in the next 20 years as Boomers age. Gen X is too small to buy all those homes, but Millennials are at the beginning of a trend of increasing home ownership. Boomers staying in their homes longer is one of the explanations for the average time between moves going from 6 years to 13 years since the early 2000s. Over the next decade, an extra ~500,000 homes per year will be for sale (vs. the prior decade) as a result of the aging population. The excess supply could put pressure on prices, which might open up big demand from Millennials. And, iBuyers and institutional homeowners could provide needed liquidity for the changing market. The flipside of the Boomer home market is RVs and retirement-focused communities, which should see another decade of secular growth. If you like demographics, you’ll enjoy the WSJ article linked above; I wrote in more detail about demographics and the big potential shifts coming in SITALWeek #206.

Even with all the Data, it’s Still Hard to Predict the Future
Here’s an amusing analysis of a group of hackers who had access to 150,000 earnings press releases before the market: “The informed traders had “perfect foresight” from stolen earnings announcement press releases, but they were only able to enjoy mixed success in predicting next-day stock returns. Their poor performance implies that capital market participants have difficulty mapping earnings information to stock price reactions.”

Option to Raise Capital with Direct Listings?
The NYSE is seeking SEC approval that would allow companies going public to simultaneously do a primary share direct floor listing and a secondary shareholder direct floor listing. This change would allow insiders/previous investors to sell AND the company to raise money at the same price. This plan would certainly improve one of the biggest problems of direct listings, which require excessively-dilutive pre-IPO financing for companies that need to raise capital. However, this proposal from the NYSE doesn’t address any of the other important issues around direct listings related to information asymmetry (insiders sell with more knowledge of the company than new public holders have), costs (which are comparable to traditional IPOs), etc. Setting the price of a company at a given point in time is near-impossible even with perfect information, and information is far from perfect. There is no evidence that direct auction listings will be better at finding a fair price that takes into account the future risk of new, high-growth businesses. For now, they serve only to provide inflated exits for prior holders while keeping long-term institutional investors patiently watching from the sidelines. I wrote more extensively on this topic in The Great IPO Debate.

Fidelity Frowns on Schwab’s AMTD Ambitions
Fidelity had a good take on Schwab’s proposed purchase of TD Ameritrade as the multi-trillion-dollar asset aggregators get bigger: “‘Unfortunately for investors, the combination of Charles Schwab and TD Ameritrade means they will likely be doubling down on revenue practices that directly disadvantage investors, including paying extremely low cash sweep rates and taking significant payment for order flow,’ Kathy Murphy, president of Fidelity’s Personal Investing business, said in a statement Monday.”

Time for More Time!
Our latest paper “Redefining Margin of Safety” argues adaptability is the new “cheap”...below is an excerpt from that paper on the nature of time:

Time Dilation: Slowing Down The Game Clock
Ultimately, what highly nimble companies are able to do is act in a way that slows down time relative to their competitors. The world is moving and changing at an accelerating pace, but with a Quality company operating in a long-duration, slow-growth industry dynamic, it’s possible to operate in a bubble in which time appears to move more slowly than in the frantic world around you. Imagine two paths connecting two points in time, 2020 and 2021: one short path, where time is normal, and one long path, where time is stretched and slowed. Because time moves slower on the longer, time-dilated path, you have more time to react and adapt relative to your competition on the direct route, so when you both arrive at 2021, you have out-thought and out-innovated your competition.

In physics, Einstein discovered two ways to think about time dilation. The first way is described by Special Relativity: as objects move at higher speeds, their “clocks” will appear to run slower to outside observers. Second, in General Relativity, your “clock” will run slower as you approach large masses (black holes being an extreme example). In fact, since your feet are closer to Earth than your head, they are actually younger than your brain, which is less affected by our planet’s gravity. Luckily, the effects are negligible at these scales!

If you are a competitor at a poorly run company looking across space and time at a high-Quality business, you will be running around putting out fires and focusing on the wrong things while the Quality business will be calm and functional, buying themselves time to focus on their customers, products, etc. When your clock runs slowly, you have far more time to react to change and disruption. Quality is a way to slow down time; it’s like a black hole that allows you to focus on the long term.

Access to data concerning customer needs and future disruptions is another way to effect time dilation, expanding the reaction time window and facilitating early adaptation. Likewise, innovation also slows down time. Think of data/innovation in terms of Special Relativity – if you can anticipate customer needs and innovate more efficiently, that’s like a moving clock; it buys you time relative to the fast moving clocks of your competition, essentially like time traveling to the future!

Tesla is a good example of how to think about time dilation. The company has out-innovated every automaker, which has bought them at least a five-year headstart – the watch is ticking away quickly for legacy car manufacturers wasting their time on combustion engines and failing to develop the electric drivetrain, batteries, software, data, and sensors they need to build a modern car. But, at Tesla, they’ve enacted a paradox: by quickly innovating around the needs of their customers, they’ve slowed down time and pulled years ahead of the competition. If Tesla continues to gain market share, they will be like a gravity well, or a back hole, allowing them to operate far into the future ahead of their competition.

Amazon is another great example – for years, the company innovated to stay ahead of the competition in retail and cloud computing, buying themselves time along their way. And now they have created such large, defensible gravity wells of network effects around logistics and technology that they exist years ahead of their competition.

We’d be remiss if we didn’t extend our physics metaphor by talking about time’s arrow itself: entropy. Entropy is a measure of disorder: around the start of the Universe (at least the part that’s visible to us) ~14B years ago, matter and energy were very organized – i.e., there existed an extremely low entropy state. When you have information (a.k.a. order) entropy is very low. As information (or matter and energy) become disordered, entropy grows over time.

Life, as it turns out, is uniquely suited to taking ordered, high-information matter/energy and turning it into disordered, low-information states; indeed, this seems to be the vector of the Universe and life’s role in it. For example, take sunlight, plants, and animals: sunlight is highly-ordered electromagnetic rays that help plants grow through photosynthesis; then animals eat those plants (and sometimes animals eat the animals that eat those plants); and then animals (e.g., humans), turn that energy into all sorts of interesting things, ultimately scattering that neat, organized solar energy into myriad disorder around the planet and surrounding space.

Much of what society has done is to try to create temporary order despite the long-arching trend toward disorder in the Universe. We build buildings, cities, communities and companies – we take organized energy and reshape it into all sorts of literal and figurative structures. But, it’s only a temporary, local increase in order, and, in the long run, the information value is lost and entropy rises. The trend toward more disorder means that predicting the future is very hard, if not impossible; therefore, companies that can slow down time don’t need to operate with rigid views of the future. Thus, they are more adaptable and durable.
✌

SITALWeek #220

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, holograms inside of holograms, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: our new whitepaper redefines “Margin of Safety” in terms of adaptability; will the $40B radio business shift to streaming? Solar power comes to high-heat manufacturing; the low cost of EV fleets; inside a TikTok hit; blending John Malkovich; mammoth poop; and lots more below...

Stuff about Innovation and Technology
Solar Powers Industrial Manufacturing
Industrial manufacturing of materials like cement and steel requires very high temperatures and accounts for 20% of global emissions. Heliogen is a new company backed by Bill Gates that uses concentrated solar power (CSP) – an array of mirrors that focuses reflected sunlight to power a steam turbine. The system uses four cameras and software (and computing power that is greater than what was commercially available just five years ago) to constantly adjust the mirrors. Heliogen gets to 1000 ℃ now and could reach above 1500 ℃, which opens up lots of new markets. I recently read that manufacture of a single aluminum can requires the same energy as running a TV for two hours or the equivalent of burning 1/4 of the volume of the can in gasoline. While the Vox article doesn’t mention aluminum, I suspect this tech could apply to it as well, possibly creating a near-zero carbon container? I also wonder if there could be tiny Heliogens on buildings and houses to more efficiently heat water and supply heat?

EVs offer Cost-Effective Alternative for Fleets
Electric vehicles may dramatically lower the costs for fleet vehicles, a 12M unit annual market in North America and Europe. The operator of a California-based shuttle service, Tesloop, is seeing Teslas operate without degradation well into hundreds of thousands of miles driven. Fleet vehicles are typically sold off before they hit 100,000 miles. Tesloop’s Teslas operate around 6c/mile, which is comparable to gas cars; however, the all-in costs are 18-25c/mile over the lifetime of the car compared to standard gas sedans at 32-35c/mile. The EV numbers could improve even more if battery swaps become easier in the future. I think this is an underappreciated angle on Tesla’s “truck” launch this week. Some version of the Tesla truck could be the ideal fleet vehicle for maintenance and construction fleets. Tesla has logged over 140,000 pre-orders for the truck so far.

Streaming Ears and Radio Ad Dollars
At Liberty Media’s analyst day this week, Greg Maffei discussed the radio advertising market (estimated at $18B a year in the US) and how the “ear is under-monetized versus the eye” at $25 cpm (cost per 1000 listens) on podcasts. Maffei said 121M Americans listen to spoken word content daily – most of that on traditional radio. Many companies are working on building exclusive podcast content (this long Hollywood Reporter interview with Spotify founder Daniel Ek dives into that very topic). But for now, the value to podcasters lies with their audience size, and it doesn’t yet make sense to get locked in to one distribution platform. What will change that? Data. Data created the Netflix flywheel that funded their expansion into original content and the rest is history (of course I am over-simplifying – great user experience, distribution, and many other factors were at play too). Data could create an audio flywheel as well. This is true, to a smaller degree, for music, but to a larger degree for talk programming – podcasts, news, sports, local, etc. The Hollywood Reporter article mentions a $40B radio market (I think that’s global, but it’s not cited). I suspect, at an average of over four hours per day of listening, that $40B vastly underestimates the market for audio advertising content, if data can improve matching programming to consumer preferences and target fewer, but more impactful ads. Here is a fun thought exercise: for someone like Spotify to get massive data scale in a hurry on streaming talk programming, why not buy an asset like iHeartRadio and turn all of their programming into streaming? The heart of the problem is how best to achieve escape velocity on the flywheel of listening hours+talk content+ad dollars: would acquiring local advertising knowhow and talk radio content achieve it faster than the current path the streaming audio world is on?

A Voice Assistant that doesn't Gossip
Sonos has acquired a voice assistant technology called Snips that can run music-focused AI queries locally without the need to process the request in the cloud. There’s probably a good market for a smart speaker that offers privacy and hands-free operation, or could one day provide other conversational answers without going to the cloud. Sonos smart speakers are now filling 9M homes with streaming audio.

TikTok’s Quirky Authenticity Seems at Odds with Monetization
Pitchfork explains the Anatomy of a TikTok Hit. The viral Chinese music meme-ing app, which is taking US teenagers by storm, is now moving songs, often obscure, up to the top of the Billboard hits list and driving huge streams across Spotify and other apps. According to the magazine, songs that become viral on TikTok tend to have an abrasive, homespun vibe (like “something was created on the cheap in someone’s bedroom”), and are heavy on imitation, outrageous lyrics, ‘drop’, and distortion “...to work with viral dance moves, the beat has to be loud, energetic, and visceral, as if a supernatural current is jolting the dancer awake.” In case that’s not enough information: "TikTok hit songs “‘Pumpkins scream’ and ‘Asshole’ gathered momentum, in part, because of e-boys—chain-sporting, black nail polish-wearing, Timothée Chalamet-types who serve as a digital update of previous generations’ goth mopes. They film their TikToks in dark bedrooms lit by colored LED lights, where they pout, mimic choking themselves, and roll their eyes while tapping their temples.” On the monetization continuum for social networking sites, Facebook and Instagram are the easiest followed by Twitter, and then there’s a big gap to Snap (which struggles to generate revenue above its cost to operate). And then there’s TikTok, which is so organic and viral it seems impossible to effectively monetize without destroying its authenticity. For now, TikTok is just a machine that turns money from its parent company Bytedance in China (Bytedance is now the 2nd largest advertising platform in that country) into ads on Snap and Facebook. This NYT fluff PR piece on TikTok says it remains independent of Chinese control, but it’s highly likely CFIUS (committee on foreign investment in the US) will demand it be separated from Chinese control for security reasons.

FedEx CEO Challenges NYT Publisher to Debate
I often get pushback for saying FedEx has no reason to exist (SITALWeek #211), but this NYT article tried to one-up me with its criticism of FedEx for passing tax cuts onto shareholders last year instead of investing in their business. FedEx faces significant competition as the package business evolves into vertically-integrated, locally-sourced (shipments originating in local cities rather than being flown/driven cross-country) platforms. The upstream sorting and other advantages the FedEx network had in the past are rapidly evaporating. FedEx responded to the NYT article, which I don’t believe they actually read, by challenging the NYT’s controlling family to a tax debate - maybe they could have a tax duel at high noon? 🤣

RBC Takeaways: VCs Cooling their Heels, Data Advantage, Transportation as a Service, and iBuyer Liquidity
As I read through transcripts from the RBC Technology Conference this week, a couple of things stood out. The freezing (or chilling) of private capital is likely to help companies that are already public and have a path to growth and profits (see below for real estate and ride sharing examples). Another theme was data advantages: I think that we will see more and more vertical integration as the Internet infiltrates more and more legacy, 20th-century businesses; a key driver of that vertical integration is privileged access to data. For example, Zillow gets 100M signals a day from its consumer portal that can be used to understand the housing market on a very local, real-time level. (See also data comments on Spotify above.)

The average car in the US costs $9,000/year to own and operate, which provides a significant pricing umbrella for transportation as a service. Speaking at the RBC conference, Lyft is also seeing availability of drivers as less of a gating factor today (which is interesting given the tight labor market and concerns over wage inflation) – which allows them to raise the bar on cars to require built-in advanced safety features, which improves rider safety and lowers insurance costs. (Also lowering insurance rates is Uber’s use of video recording, as the NYT reports.) Lyft remains focused on harvesting share in verticals, like healthcare and business, while Uber is taking a broader, horizontal “super app” approach.

RBC Internet analyst Mark Mahaney interviewed Zillow CEO Rich Barton, who discussed the “buy box” for the iBuyer market getting coverage to over 50M homes in the US in the future. Next year, Zoffers will be live in 26 markets, allowing Zillow to shift their large marketing budget to the product. Over the last 20 years, the average time homeowners stay in one home has ballooned from six years to 13 years (discussed in SITALWeek #218). Could new liquidity from the iBuyer market reverse this trend? If it drops back to <10 years, the market for iBuying and other real estate services will boom. With the benefit of the Zestimate and its large audience, Zillow is moving into pole position for iBuying just as the startup funding environment is likely to keep new entrants at bay. A lot of this applies to Redfin as well, who might even have built a better mousetrap today than Zillow – to be determined!

BERT Trending, but too Energy Intensive?
BERT (Bidirectional Encoder Representations from Transformers) was a hot topic at the Super Computing conference in Denver this week. NVIDIA explained BERT and its massive demand for GPU-accelerated inference of conversational AI on their earnings call last week: “Google's breakthrough, introduction of the BERT model, with its superhuman levels of natural language understanding, is driving a way of neural networks for the language understanding...training these models requires V100-based compute infrastructure that, in orders of magnitude, beyond what is needed in the past. Model complexity is expected to grow significantly from here.”

But, can the planet afford the energy burden of you talking to your BERT smart speaker? The Guardian states that the latest NVIDIA natural language model was 24x larger than its previous version yet only 34% better – and training the model took nine days on 512 V100 chips at an energy cost equal to the yearly usage of three Americans.

Homegrown Semiconductors Remain a Dream for China
Junko Yoshida at the EE Times went digging to see how successful China’s “Big Fund” – of nearly $30B to spur the domestic semiconductor industry – has been. “Thus far, results from the first round are mixed. Pressed to name the Chinese semiconductor champions the Big Fund helped build, most executives have no answers.” As I’ve mentioned a few times recently – the resolution of the US-China trade war is heavily dependent on the reality that China will not be able to create a viable, leading-edge chip capacity for decades.

Machine Learning Comes to Semiconductor Design
Google’s head of AI Jeffrey Dean posted a paper discussing how machine learning could dramatically change the process of chip design: “By having a reinforcement learning algorithm learn to ‘play’ the game of placement and routing...it may be possible to have a system that can do placement and routing more rapidly and more effectively than a team of human experts working with existing electronic design tools for placement and routing.” As Moore’s law slows and the IoT explodes demand for all types of chips, this could greatly accelerate innovation and dramatically increase the scale of the semiconductor market over the next couple of decades. Chips designed with the aid of machine learning are likely to advance artificial intelligence faster than many other efforts underway today.

Ex-Amazon Employees Carry Culture to Seattle Startups
This article in the Seattle Times, which interviews Amazon veterans who now have local startups, discusses the difference between having leadership values and actually living them. “The leadership principles at Sears, as articulated, were almost identical to the leadership principles at Amazon.” This ability for values to actually be in the blood of an organization is very difficult to accomplish. One of the key things that Amazon’s values maintain is speed: most companies grind to a halt as they grow; fighting that inertial weight is a challenge for every company.

No Shoes, No Shirt, No Cash Register
As restaurants move to turn their locations into delivery/pick-up only, their tech stack changes a lot. In particular, with no need for cashiers, there is no need for cash registers, point of sale systems, etc.

Miscellaneous Stuff
Holographic Information Escapes from Black Holes
We generally think of a black hole as a place where gravity is too strong for anything, including light, to escape. But, there is another way physicists view them: as a holographic projection of 2D quantum waves with no gravitational force. We know information escapes black holes (known as Hawking Radiation), and this new work suggests it might do so via a hologram within a hologram, which projects out of the black hole back into our slightly more understandable part of the universe.

Blending John Malkovech
John Malkovech has been blending cabernet and pinot noir grapes at his Southern Rhone vineyard in France. It’s a combination of two grapes out of their original homes that, traditionally, are never mixed. “It’s like any other form of self-expression,” he says. “I have very specific taste in wine. These are reflections of what I like.”

Winter Weather may have Spurred Feather Evolution
Dinosaurs near the South Pole had downy feathers to keep warm. The discovery is the first to suggest that dinosaurs and early birds lived in regions of extreme cold with “months of polar darkness”. As Jamie Woodward said on Twitter this week: “When you hunker down tonight in your warm cosy bed - spare a thought for those feathered dinos in the polar south 100 million years ago working hard on the prototype for your duvet filling.”

Ancient, Frozen Bacteria Get New Lease on Life
Scientists have revived 40,000 year old bacteria from mammoth poop in an effort to glean potential new antibiotics.

Avocado Cartels are Deforesting Mexico and Terrorizing its Population
The LA Times reports on the bloody cartel war for Mexico’s “green gold” avocado industry.

Marie Kondo’s Crafty Retail Scheme
Marie Kondo rose to fame largely through a Netflix documentary that said to throw away all your crap that doesn’t bring you joy (I haven’t seen it). Now she’s gone into business to sell you crap to fill the void left by all they crap you threw out. One of the items is a tree branch, er, sorry, a Shiatsu Stick, being sold for $12.

Stuff about Geopolitics, Economics, and the Finance Industry
A new whitepaper from me and Brinton: Redefining Margin of Safety. The classic Ben Graham term gets a fresh analysis as we think about adaptable companies and their ability to slow down time. And, we couldn’t help but explain how special and general relativity can help us understand this concept. Below is a summary/excerpt, and the entire paper can be read here.

Ben Graham posited the idea of “margin of safety” in The Intelligent Investor back in 1949. At its core, the concept is about investors’ inability to predict the future. We heartily agree with Graham – we don’t believe it’s possible to accurately predict the future with any meaningful degree of precision. Instead, we’re always looking for situations where we can make predictions with the broadest range possible, thus giving us higher odds of being correct.

Over the years, however, investors seem to have placed too high an emphasis on valuation for determining margin of safety, and tend to use the concept to justify ownership of dying businesses. As explained in Complexity Investing, we’ve found that a company’s ability to adapt is a much stronger indicator of a wide margin of safety. We’ve always observed a strong correlation between adaptability and quality management; but, as we explain in the new paper, adaptability doesn’t seem to be determined exclusively by the management team per se, but also by the time constraints under which the management team has to adapt, which is governed by the speed of their business. Specifically, slow, long-duration growth allows for timely innovation, decelerating the game clock so managers can make smart decisions and maintain their lead through adaptation. Hallmarks of gentle sloping ‘S-curve’ businesses that we look for are negative feedback loops, tight-knit customer relations, and positive NZS.
✌

Redefining Margin of Safety

Redefining "Margin of Safety"

How the Nature of Growth and Adaptability Informs Investing

A PDF of this paper can be downloaded HERE.

Sign up for our weekly newsletter SITALWeek here.

At NZS Capital, we don’t believe it’s possible to accurately predict the future with any meaningful degree of precision. As far as we can tell, no one is very good at it. A few people, most notably economists, are embarrassingly bad at it. The prediction game has such low odds of winning (as it favors blind luck over innate foresight), that we prefer to play a different game.  

Ben Graham posited the idea of “margin of safety” in The Intelligent Investor back in 1949. It was so important to him that he devoted the entire final chapter of the book to the concept: Chapter 20 - "Margin of Safety" as the central concept of investment. Graham’s ideas have since been popularized by Buffett and become the cornerstone of value investing. Here’s Graham’s definition:

“The function of margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.  If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.” 

We agree, but approach the question differently. Using value investing as an example: given a stock’s current market valuation, we focus on the type of predictions we have to make for forecasting the company’s future prospects. If the valuation is expensive, then we have to make more narrow (i.e., highly precise) predictions. If the valuation is cheap, then we have a bit more leeway and can make broader (i.e., less precise) predictions about the future. Since we don’t believe it’s possible to predict the future with a high degree of both precision and accuracy, we’re always looking for situations where we can make predictions with the broadest range possible, thus giving us higher odds of being correct – what Graham would call a ‘large margin of safety’. 

We don’t expect successful business managers to be fortune tellers either. So what do you do if you can’t predict the future, and don’t want your company caught off-guard as you navigate an uncertain, ever-changing economic landscape? We’ve found that nimble, adaptive companies tend to be successful over the long term and offer investors a wider margin of safety. Indeed, we would argue that relying exclusively on valuation for safety, especially given the accelerating pace of disruption in the Information Age, is downright dangerous. Age-old concepts such as mean reversion and intrinsic value now have become misleading, and using valuation alone to determine margin of safety is akin to the bumper sticker we used to see around Silicon Valley after the dotcom crash: “Please God, Just One More Bubble”. ‘Value traps’ seem to be a symptom of the digital paradigm shift, occurring when Industrial Age companies fail to adapt to the Information Age – hoping the world will cycle back to a bygone era is not a productive business model and an even worse investment strategy. 

The lifecycle of a company: most new ventures start off as gambles. As the products/services gain in the marketplace, they become Optionality businesses with positive asymmetry. Over time, adaptable companies can build Resilience. However, eventually most companies lose their market position and become classic Value Traps, and may even end up becoming gambles at the end of their lifecycle.

As with predicting the future, picking companies with eroding profits that will have a eureka moment and successfully pull out of their death spiral is a low-probability game we’d rather avoid entirely. Companies that are caught on the wrong side of time tend to focus capital allocation on share buybacks, debt repurchase, or dividends rather than R&D and innovation, hastening their decline.

We’ve previously detailed our investment philosophy, centered around deep analysis of Quality, Growth, and Context (with valuation factoring into Context), in Complexity Investing. Here, we advance the idea that ‘nature of growth’ is a critical factor in determining a company’s ability to adapt, and explain why long-duration, slow-growth companies offer a desirable margin of safety. 

Quality Management and Slow Growth Confer High Adaptability 

In Complexity Investing, we wrote at some length about the importance of management team Quality for fostering a culture of adaptability. Quality is easy to spot but hard to define. Pirsig, in Zen and the Art of Motorcycle Maintenance, offers the best definition of quality we know of: 

“Any philosophical explanation of Quality is going to be both false and true precisely because it is a philosophic explanation. The process of philosophic explanation is an analytic process, a process of breaking something down into subjects and predicates. What I mean (and everybody else means) by the word ‘quality’ cannot be broken down into subjects and predicates. This is not because Quality is so mysterious, but because Quality is so simple, immediate and direct.”

The key factors we identify with Quality management are: long-term thinking, decentralization, and ability to foster a culture of adaptability/innovation. What we’ve come to realize, however, is that Quality management is only part of the story – necessary but not sufficient – because a company's ‘nature of growth’ also factors heavily into adaptability. 

Investors often celebrate brilliant managers and criticize those that fail to see future pitfalls. But perhaps investors have put too much emphasis on management teams. It seems likely that success isn’t determined exclusively by the management team per se, but also by the time constraints under which the management team has to adapt, which is governed by the speed of their business.  

When we look at classic, gentle sloping ‘S-curve’ businesses, the managers tend to look like geniuses when it comes to adaptability; however, maybe management teams running long-duration, slow-growth businesses are adaptable because they have adequate time to see and react to change. In other words, perhaps brilliant managers don’t necessarily have exceptional foresight and instincts, they just have the luxury of a longer reaction time (or an apparent longer reaction time...more on that idea later).

In this example of a gentle sloping S-Curve, a company has time to adapt and innovate – stacking on new S-Curves to become Resilient with Out-of-the-money Optionality (ROOTMO) – rather than slowly dying as a Value Trap (where most Investors equate “cheap” with “margin of safety”).

Imagine a driver following a car in front of them at a two-second distance versus a driver tailgating a car. If the car in front stops suddenly, the tailgater is highly likely to crash whereas the two-second follower may avoid the accident. It’s not that the safe follower has any better adaptability genes than the tailgater, they simply have more time to make course corrections before it’s too late. Perhaps that’s the genius of management teams that are seen as brilliant adapters: slower growth, dictated (intentionally or unintentionally) by their business model, gives them WAY more time to react. Of course, nowadays, many cars have integrated collision-avoidance technology, which provides hazard data to the car far more quickly than can the human driver. In the same manner, Quality data can serve as an advanced warning system for economically-relevant changes ahead, thereby expanding a company’s reaction-time window. 

Faster-growth businesses with shorter product cycles generally don’t offer managers any advanced warning of change and allow only a narrow window for adaptation. These managers often end up as the ‘One Hit Wonders’ of the corporate world: they lead businesses to explosive growth only to be blindsided by sudden change. Groupon, Zynga, PortalPlayer, Synaptics, GoPro, FitBit – history is littered with these victims of disruption. 

This challenge of adaptation faced by fast-paced businesses brings a Buffettism to mind: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it’s the reputation of the business that remains intact.” We might adapt this saying to something like: When a Quality manager with a long-term track record of adaptability takes the helm of a fast-changing, steep-S-curve business, they may not emerge with their reputation intact. No traditionally-defined margin of safety would have been enough to protect investors from the downfall of these seemingly promising companies; however, by considering the window for adaptability, it becomes clear that businesses exhibiting rapid growth are much more likely to be shooting stars rather than sure bets. 

Characteristics of Slow-Growth, Long Duration Businesses: Governors, Necessity, and NZS

In addition to conferring improved conditions for adaptability, slow growth has the benefit of elongating the duration of growth, with time acting as a magnifier through the magic of compounding. Long-duration, slow-growth companies tend to have a governor, or negative feedback loop, that tamps down the magnitude of their short-term growth. Given a sufficient TAM (total available market), this rate limitation means that a company can expect positive returns for a very long time. 

For example, a software company might offer a new process (e.g., virtual simulation instead of physical prototyping) that radically changes the nature of R&D at a product company. Upgrading to the virtual simulation would allow for a quicker design process with more iterations. However, in order to implement this process, the entire R&D department would have to be restructured around the new software platform, a high hurdle that most companies would be slow to tackle. Over the long term (barring disruption), every company in that industry would have to eventually modernize to stay relevant. As a result, the software company is unlikely to experience explosive growth in any one year but could post reasonable growth over decades. 

A common thread with most long-duration, slow-growth companies is that they have become so ‘mission critical’ to their customers that tight integration develops between producer and consumer. R&D becomes a collaborative effort with prototypes, refinements, and tailor-made products. As a result, the producer has so much (essentially real-time) aggregate data on customer requirements, complaints, and challenges, that they are able to anticipate what the next-generation products should be, layering on new capabilities often before individual customers even fully understand their own needs. This data-driven foresight virtually eliminates guesswork on the part of the producer, dramatically reducing the chances of being blindsided by shifting customer demands. In this type of environment, adaptation becomes second nature.

Now, contrast that scenario with steep S-curve growth. Mercurial customer demands and new disruptions come fast and hard, often because companies don’t have access to meaningful, predictive data. To adapt, management teams may have to upend their entire business model. They might only have one shot to get it right – and within a relatively short time frame as well. If the company survives one round, the nature of their business leaves open the possibility they’ll have to do the same thing over and over again. Successful adaptation in this type of environment goes way beyond manager skill and skews heavily toward luck.

Another hallmark of a long-duration, slow-growth company revolves around something we call NZS or non-zero sum. We look for companies that are delivering more value to their constituents (customers, employees, society at large, the environment, etc.) than they do for themselves – the essence of NZS. We explored the topic of NZS and its beneficial effects on businesses in a previous white paper: NZS - Non-Zero Outcomes in the Information Age. Briefly, in the world today, the increasing transparency and velocity of information make it challenging for companies to extract high margins from their customers/constituents. While traditional investors may seek businesses with ‘high barriers’ and ‘wide moats’, these can rapidly become vulnerabilities exploitable by a higher-NZS competitor (who, by definition, will be more attractive to customers). In contrast, companies focusing on maximizing NZS become invaluable to their customers and less vulnerable to disruption. These types of companies overwhelmingly exhibit long-term thinking, as shorter-term sacrifices are often required (which effectively act as negative-feedback loops, slowing and elongating growth). 

Time Dilation: Slowing Down The Game Clock

Ultimately, what highly nimble companies are able to do is act in a way that slows down time relative to their competitors. The world is moving and changing at an accelerating pace, but with a Quality company operating in a long-duration, slow-growth industry dynamic, it’s possible to operate in a bubble in which time appears to move more slowly than in the frantic world around you. Imagine two paths connecting two points in time, 2020 and 2021: one short path, where time is normal, and one long path, where time is stretched and slowed. Because time moves slower on the longer, time-dilated path, you have more time to react and adapt relative to your competition on the direct route, so when you both arrive at 2021, you have out-thought and out-innovated your competition. 

In physics, Einstein discovered two ways to think about time dilation. The first way is described by Special Relativity: as objects move at higher speeds, their “clocks” will appear to run slower to outside observers. Second, in General Relativity, your “clock” will run slower as you approach large masses (black holes being an extreme example). In fact, since your feet are closer to Earth than your head, they are actually younger than your brain, which is less affected by our planet’s gravity. Luckily, the effects are negligible at these scales!

If you are a competitor at a poorly run company looking across space and time at a high-Quality business, you will be running around putting out fires and focusing on the wrong things while the Quality business will be calm and functional, buying themselves time to focus on their customers, products, etc. When your clock runs slowly, you have far more time to react to change and disruption. Quality is a way to slow down time; it’s like a black hole that allows you to focus on the long term. 

Access to data concerning customer needs and future disruptions is another way to effect time dilation, expanding the reaction time window and facilitating early adaptation. 

Likewise, innovation also slows down time. Think of data/innovation in terms of Special Relativity – if you can anticipate customer needs and innovate more efficiently, that’s like a moving clock; it buys you time relative to the fast moving clocks of your competition, essentially like time traveling to the future!

Tesla is a good example of how to think about time dilation. The company has out-innovated every automaker, which has bought them at least a five-year headstart – the watch is ticking away quickly for legacy car manufacturers wasting their time on combustion engines and failing to develop the electric drivetrain, batteries, software, data, and sensors they need to build a modern car. But, at Tesla, they’ve enacted a paradox: by quickly innovating around the needs of their customers, they’ve slowed down time and pulled years ahead of the competition. If Tesla continues to gain market share, they will be like a gravity well, or a back hole, allowing them to operate far into the future ahead of their competition.

Amazon is another great example – for years, the company innovated to stay ahead of the competition in retail and cloud computing, buying themselves time along their way. And now they have created such large, defensible gravity wells of network effects around logistics and technology that they exist years ahead of their competition.

We’d be remiss if we didn’t extend our physics metaphor by talking about time’s arrow itself: entropy. Entropy is a measure of disorder: around the start of the Universe (at least the part that’s visible to us) ~14B years ago, matter and energy were very organized – i.e., there existed an extremely low entropy state. When you have information (a.k.a. order) entropy is very low. As information (or matter and energy) become disordered, entropy grows over time. 

Life, as it turns out, is uniquely suited to taking ordered, high-information matter/energy and turning it into disordered, low-information states; indeed, this seems to be the vector of the Universe and life’s role in it. For example, take sunlight, plants, and animals: sunlight is highly-ordered electromagnetic rays that help plants grow through photosynthesis; then animals eat those plants (and sometimes animals eat the animals that eat those plants); and then animals (e.g., humans), turn that energy into all sorts of interesting things, ultimately scattering that neat, organized solar energy into myriad disorder around the planet and surrounding space.

Much of what society has done is to try to create temporary order despite the long-arching trend toward disorder in the Universe. We build buildings, cities, communities and companies – we take organized energy and reshape it into all sorts of literal and figurative structures. But, it’s only a temporary, local increase in order, and, in the long run, the information value is lost and entropy rises. The trend toward more disorder means that predicting the future is very hard, if not impossible; therefore, companies that can slow down time don’t need to operate with rigid views of the future. Thus, they are more adaptable and durable.

Conclusion: Beyond valuation. Slow-Growth, Long-Duration Companies with Adaptable Management Maximize Margin of Safety

Graham offered a helpful lens by introducing ’margin of safety’ as the central concept of investment. At its core, the concept is about investors’ inability to predict the future. We agree that humans are terrible at accurately and narrowly predicting the future, but question the over-emphasis on valuation. We posit that value-based margin of safety is all too often used to justify ownership of dying businesses. While cheap, these value traps do not control their own destiny, devoting resources to life support and/or blind attempts at reinvention; and, all too often, it’s too late. Instead, the ability of a company to adapt – which, in turn, is dependent upon management Quality and nature of growth – is critical to any formulation of margin of safety. Hallmarks of gentle sloping ‘S-curve’ businesses that we look for are negative feedback loops, tight-knit customer relations, and positive NZS. Slow, long-duration growth allows for timely innovation, decelerating the game clock so managers can make smart decisions and maintain their lead through adaptation. 

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

SITALWeek #219

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, the albedo effect, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: vertical integration of digital platforms are much higher than legacy businesses; libertarian marketplace tactics enable network effects; self driving groceries; can a robot own its creations? Mister Rogers and the search for “graciousness at the heart of creation”; SEC approves non-transparent ETFs; and lots more below...

Stuff about Innovation and Technology
“What a Piece of Work is...Robot”
Can AI own copyrights and patents on its own creations? The US patent office wants to know, so it’s asking for feedback. No word yet on whether the opinions of AI bots will be considered. For now, if a machine creates something with no human input, it’s not granted authorship of the creation, which seems a little sad to me at some level. We’re reminded of how well Gene Roddenberry anticipated and tackled some of these human vs. AI topics in Star Trek: The Next Generation 30 years ago; one great example is the 1988 episode The Measure of a Man.

Solar Power gets a Reflective Boost
Bi-facial solar panels, which rely on the albedo effect – the reflection of photons off the underlying surface back to the underside of the panels – generate about 8-20% more power, depending on the surface.

The Inevitable Vertical Integration of Information-Based Platforms:
As the global economy transitions from the capital-intensive Industrial Age to the data-intensive Information Age, is vertical integration more inevitable, and perhaps even more necessary than it was in the past? Before I dive deeper into the ramifications of this idea, here are a few examples of digital businesses vertically integrating:

• Netflix has turned watching video into an information-based business, and in doing so, has vertically integrated the making of original content, thus feeding their data value and network effects. They have also built their own content delivery network (CDN). Infrastructure providers like telcos and cable companies have also vertically integrated by buying media companies like Warner, NBC, etc.

• Amazon has turned buying products into an information-based business, and in doing so, has vertically integrated logistics/delivery, product design (private label), video content production (Prime Video), etc. The company has also gone into physical retail with Go Stores, Whole Foods, and plans for a new chain of grocery stores.

• Google has turned information itself into an information-based business (we used to have just a library full of physical books!), and in doing so, they have built enormous data centers and designed their own specialized semiconductor called the TPU. They have also built scores of custom and open-source software code. Oh, and they build autonomous vehicles leveraging their own mapping data.

• Zillow and Redfin have turned searching for a home into an information-based business, and now they are building a marketplace and putting up capital to buy and sell homes themselves alongside services such as mortgage, title, and other vertical integrations of the buying process.

• Tesla has turned a car into an information platform, and in doing so, has built its own autonomous data platform and custom semiconductors for autonomous AI. And, Musk’s other company, SpaceX, is launching its own communication service with Starlink and building its own ferry to Mars. (Here is a cool deep dive on Starlink for anyone interested.)

• Uber has turned taxi rides and food delivery into an information-based business, and in doing so, they are also building maps, logistics, cloud kitchens with their own food brands, etc. (Also, the only successfully-scaled and profitable food delivery company today is the vertically-integrated Domino’s Pizza, whose scientists concoct its cheese in laboratories and whose own drivers deliver the ‘za!).

A lot of these examples come with asterisks, and I’m also aware of many Industrial-Age businesses that were heavy vertically integrated as well – it's been nearly 20 years, but I still remember marveling at the Forest City, Iowa Winnebago plant, where they had craftsmen custom milling cabinets for RVs! So, I think it can be stated more generally that platforms of any type that have a data or informational advantage and network effect tend to vertically integrate. Vertical integration might be a necessary enabler of increasing network effects. What does this vertical integration trend suggest regarding other businesses where information is beginning to impact legacy, Industrial-Age sectors like healthcare, finance, and energy?

Curious counter-examples to this trend also exist. Spotify (which is not currently vertically integrated) continues to grow market share despite vertically-integrated offerings from Amazon (Alexa hardware in the home), Apple (iPhones, AirPods, music app), and Google (home speakers, Android, YouTube Music). Spotify is trying to vertically integrate as a label and podcast producer, but it doesn’t yet hardware – is that a vulnerability or is music different? (Here is an excellent podcast Patrick O'Shaughnessy posted with Spotify’s founder/CEO Daniel Ek this week.) Video games are another industry where despite some vertical integration of studios, distribution, and/or hardware (Microsoft, Sony, Tencent, and new efforts by Google with Stadia), there remains many large players that are not vertical. Will these two industries inevitably fall to vertical integration or bundling?

As platforms become bigger with more and more vertical integration, they eventually begin to create negative externalities and invite the regulators to come knocking. Standard Oil itself was the pioneer of vertical integration! Often, the outcome of regulation is to cement existing monopolies via regulatory capture and limit their abilities to further vertically integrate or expand horizontally. There is a tipping point where platforms, whether vertical or horizontal, are taking too much value for themselves vs. what they create for the world, and they become neutral or negative sum as opposed to having positive non zero sum. Platforms can avoid this eventual handcuffing or breakup by constantly increasing their NZS, or win-win value creation. I’ll leave this section with more questions than answers, but it’s an interesting trend that information platforms enable, and/or perhaps feed off, vertical integration more than their Industrial-Age predecessors.

Internet Giants' Laissez-Faire Attitude Creates Fraudster Paradise
While I’m on the topic of platforms, I couldn’t help but notice this other repeated pattern: spam and abuse cycles. It seems like there is always some fast-growing, multi-sided marketplace or Internet platform that grows unbounded with libertarian values, then faces massive fraud, spam, or other problems, which is remedied in-part or in-full by the platform/marketplace with little negative impact to usage and growth. This happened in both organic and paid search, as Google seemed to spend much of the 2000-2010 period in a race against spammers. And, now Google is fighting the same battle with YouTube videos and folks gaming the algorithm. Social networks are obviously a good poster child for this problem, as they claim to not even be able to police the content that users upload. We’ve seen the same issues with Amazon's 3rd-party sellers and counterfeit products, eBay, Yelp, Grubhub, Groupon, AirBnB, Uber, Lyft...is there any Internet platform or marketplace that hasn’t taken a laissez-faire attitude towards policing content, which subsequently blew up on them? Is it laziness on behalf of the companies? Would more regulation break the businesses too early and sever the network effects? Or is this just the way things work in the Information Age with the race between algorithms and fraudsters?

The WSJ reported this week on the rampant fraudulent items on Amazon’s marketplace sold by Chinese sellers. Nike will stop selling shoes on Amazon perhaps related to fraud on the platform as well. Free startup idea: create a service that verifies goods sold on Amazon. Vendors can pay you to verify the items. Consumers can search on your site, and you can affiliate link over to Amazon to purchase the items.

Self-Driving Groceries
Autonomous startup Nuro’s grocery delivery partnership with Kroger in Houston is spotlighted in this WaPo article. In other delivery news, Doordash’s successful journey to 35% share of the US food delivery market has hinged on its dominance in the suburbs, previously only home to pizza delivery. It’s also hinged on raising $2B, as there continues to be no sign of profitability in food delivery – beckoning for vertical integration (see above!). This article also makes the interesting point that Papa John’s Pizza is experiencing a shortage of drivers as they switch to working for on-demand service apps.

Now You can Soundscape your Augmented Reality
Spotify comes to augmented reality as it launches on the Magic Leap headset. Developers can also integrate Spotify streams and controls into their other apps developed for the ML1. I tried it out on my Magic Leap this week, and it’s very slick.

Microsoft Launches New Machine Learning Chip into the Cloud
The FT reports that Microsoft is offering Graphcore AI workloads on Azure. Recall Graphcore is the AI chip startup with VC backing from Microsoft. As I understand, Graphcore’s native language would allow the six million C++ developers around the world to write machine learning models. NVIDIA’s core network effect around its AI chips is their large base of CUDA programmers (CUDA can also be programmed with C++).

ViacomCBS Casts Itself as Content Arms Dealer
Further fueling my 'crystallization of the media landscape' thesis (see 2 weeks ago for details and diagram), ViacomCBS increasingly looks like an arms dealer of content as they sign an agreement to bring library and new Nickelodeon content to Netflix. I think this is a smart move – ViacomCBS doesn’t own theme parks, cable/telephone network, they don’t run an e-commerce site or deliver packages, and the don’t make cell phones; therefore, they should pursue AVOD (advertising-based streaming apps) and selling content to other OTT platforms as well as new-age and legacy video bundlers. I'll admit that it's a challenge to fit this concept into my vertical integration comments above.

Miscellaneous Stuff
Universe is an Entangled, Super-Galactic Web
Large-scale structures appear to link the Universe is massive patterns:
“These dim structures are made of hydrogen gas and dark matter and take the form of filaments, sheets, and knots that link galaxies in a vast network called the cosmic web. We know these structures have major implications for the evolution and movements of galaxies, but we’ve barely scratched the surface of the root dynamics driving them.”

Aftermarket E-Mods
Classic cars are being outfitted with electric drivetrains and battery packs:
“They found that putting maintenance-free electric drivetrains into vintage vehicles eliminated a lot of mechanical babysitting that classic cars demand of their owners. ‘There are people who are in love with the design of these classics, but they don’t want to do the wrenching on them,’ Benardo said. ‘They just want to spend more time driving.’”

Mister Rogers Left a Legacy of Kindness with no Successor
Here is a moving new story by Tom Junod about Mister Rogers, and what he might say today, were he alive.
“...because we all long to know that there’s a graciousness at the heart of creation.”
“He wanted us to remember what it was like to be a child so that he could talk to us; he wanted to talk to us so that we could remember what it was like to be a child. And he could talk to anyone, believing that if you remembered what it was like to be a child, you would remember that you were a child of God.”
This is heartbreaking:
“[Mister Rogers] lost because the great conceit of the internet is that it has unveiled and unmasked us, that it shows us as we really are and our neighbors as they really are, and that hate is more viral than love.”
But, to end on an upbeat note, here is the delightful PBS remix of Mister Rogers’ memorable moments on YouTube.

Pale Red Dot?
Elon Musk did a short podcast with Lex Fridman this week covering some great topics around consciousness and AI. At the end, Lex asked Elon to read Carl Sagan’s Pale Blue Dot speech, and Elon of course had an amusing response to it.

Will Jet Setters be Grounded?
Flight shaming is taking off as some in the UK are calling for a ban on private jet flights by 2025, which, in the UK alone, are purportedly responsible for the equivalent of 450,000 cars on the road. It’s likely a safe prediction that flight travel, private and commercial, could be taxed at industry-crippling levels in the future.

Stuff about Geopolitics, Economics, and the Finance Industry
Steve Milunovich, head of tech strategy at Wolfe Research, had me on their webcast this week to discuss complex adaptive systems and various topics across the tech sector. SITALWeek readers exclusively can read the transcript of the interview here.

Non-Transparent ETFs get Qualified Nod from SEC
The SEC approved applications this week for non-transparent ETFs from T. Rowe, Fidelity, and others following the approval of Precidian in May. If these products take off, it will be a massive win-win for the active-management ETF industry – consumers get better tax advantages in ETFs vs. mutual funds, and, ultimately, fees should be lower and liquidity higher. The problem remains: how do you provide fair, real-time pricing without burdening the cost structure or creating unnecessary risk? The SEC’s approval this week comes with a bit of an asterisk, as two commissioners expressed concerns about the products, especially in times of market crisis. T. Rowe plans to compensate for this risk by printing a daily portfolio that trades like their ETF, but isn’t their actual holdings (PDF). From the SEC:
“Nontransparent ETFs come with real risk that, in moments of limited liquidity, ordinary investors will face wider spreads and hence get prices that do not accurately reflect the value of their shares. By targeting largely liquid assets and adopting guardrails to address these issues, these applicants have helped mitigate that concern. But we would be skeptical of nontransparent funds focused on different asset classes that lack those characteristics.”

PE Sees No End to PE Cycle
The chief investment strategist at Blackstone's private-wealth solutions division called sovereign debt the “mother of all bubbles,” which can only make Blackstone the child of all bubbles!?

In related news, PE-giant Brookfield had the following to say in their earnings commentary this week (PDF):
“With interest rates in Japan and Europe now negative for all maturities, we seem to be in a new phase with global rates in the range of –2% to +2% for the next five to seven years. This is particularly relevant for us and will positively impact on all asset values and businesses that generate cash. Should this interest rate environment continue to prevail, and with institutional capital growing, we expect that capital will increasingly be allocated to alternatives. We think that institutional investors will continue a push towards 60% alternatives allocation in their portfolios—from a global estimate of 25% today.”
This logic appears to be a classic example of what we would call a narrow set of predictions that rely on an unknowable, emergent outcome of a complex adaptive system that is inherently unpredictable. Could it happen? Sure, but it’d require more than a healthy dose of luck!

Pensions Struggling Despite Decade of Market Outperformance
Despite a tripling of the stock market over the last decade, many public pensions have become MORE underfunded in the same time period. For example, the Illinois State Pension Fund has gone from a $78B shortfall to a $137B shortfall, and that’s without facing the reckoning of realistic expected returns, which still remain stubborn in the face of negative sovereign debt rates. Illinois is the 3rd-worst underfunded pension at 38%. Chicago Fire and Police pensions sit at only 18% and 24% funded, respectively, creating a significant future tax burden for the population.

Public/Private Market Mismatch Explained
There are two main reasons why the private markets are more illiquid and carry more risk compared to public markets – beyond the obvious increased debt loads: 1) there are fewer buyers and only one seller, which makes price discovery much more of a guess than in the public markets, and 2) related to point 1, there are no short sellers for private assets, thus “the price gets set by the optimists” as this WaPo article suggests. The same problems make pricing VC rounds difficult as well, and it’s often why private valuations can be wildly mismatched with public market expectations.

✌-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

SITALWeek #218

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, flaming water fountains, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Russian robots; Chinese batteries; streaming the “bundle”; disruption be damned for PE investors; the shape of the Universe; US housing market rebounds as people stop moving; the hot new trend in Silicon Valley: becoming a monk; Ray Dalio's sky is falling; and lots more below...

Stuff about Innovation and Technology
Adversarial Fashion Hits the Runway
Adversarial fashion makes you invisible to AI. The apparel is “meant to ‘trick’ object detection algorithms into seeing something different from what's there, or not seeing anything at all. In some cases, these designs are made by tweaking parts of a whole image just enough so that the AI can't read it correctly. The change might be imperceptible to a human, but to a machine vision algorithm it can be very effective”.

Russia’s Yandex Shows Path to Profits in Rideshare and Delivery
Russian online platform Yandex has launched a new autonomous delivery robot based on self-driving vehicle technology (Yandex has over 100 autonomous test cars on the road as well). The briefcase-sized bots called Yandex.Rover will be used for meals, grocery, and package delivery. Yandex.Taxi, the company’s rideshare division, turned EBITDA positive in Q219 on $140M in net revenue. Meanwhile Yandex.Eats, which launched early 2018, has over 50% share of the Russian food delivery market at over 1M orders a month and a ~$50M revenue run rate (data from recent Yandex investor presentation PDF).

China’s Supercharged Battery Manufacturing
China’s CATL has become the largest maker of electric car batteries in the world aided by high domestic demand (China's home to 60% of EV sales globally, compared to the US at just 13% share). Even Tesla, which previously made all their own batteries in partnership with Panasonic, is using CATL to supply batteries for Model 3 production at their Shanghai-based Gigafactory 3 (that deal is split between CATL and LG Chem).

Wal-Dryl, Wal-Mucil, Wal-Zan...Wal-Gone
Following 12 quarters of declining retail sales, the Walgreens Boots Alliance (WBA) is apparently considering a PE-bubble-topping (or toppling? Or popping?) attempt to take itself private. We’ve long discussed WBA as a poster child for mortgaging the future of a company in order to create short-term financial earnings today. The company has funneled billions upon billions into share repurchases while whistling past their own future tombstone in the Internet victims’ graveyard. Walgreen's is an example of a company that failed to become a platform, and will therefore be buried by a competitor (see the section here for more: “Platforms as a lens on the global economic transition from Industrial to Information”). At NZS Capital, we like this thought experiment: what would happen to the world if a company went away overnight? In the case of WBA, effectively nothing would happen. In nearly every location, there is an alternate retailer for those people who want or need to interact face-to-face with a pharmacist. I imagine not a single customer of WBA appreciates having to go to their stores, wait in endless lines (with other sick customers) for prescriptions that aren’t ready yet, and pay high prices for the same general merchandise available cheaper at other stores or online. Amazon, or someone else, is coming with free speedy delivery of medicines. Costco and Instacart are testing a free, one-hour Rx delivery in California and Washington. UPS is testing drone delivery of medicine in North Carolina. In 10 years, if Walgreens doesn’t exist, no one will notice, so best of luck to everyone who thinks the massive debt they raise will ever get paid off. Maybe pensions will fund purchase of Walgreens by PE shops, who in turn will increase margins by raising prices on prescriptions their pensioners are buying. (We discussed the paradox of pensions investing in PE last week.) There is a clear, growing need for health clinics and medical services that short circuit the difficult-to-navigate medical system in the US, but it’s highly unlikely an incumbent drug retailer wins that battle, especially if they are engaged in raising prices and participating in fixing the system against consumers (like CVS is).

Zoffers are Spot On as Zestimate Improves
Zillow’s nationwide Zestimate median error rate has dropped to 1.9%, which is an amazing feat of data science. Zillow also analyzed the sale price of 3200 homes that turned down Zillow offers and found that they subsequently sold for 0.22% higher than the Zoffer. The prices compared were Zillow’s Zoffer (which includes a 7.5% service fee – comparable to a broker commission plus the cost of repairs for inspection items, staging, carry time, etc.) and the net sale price (assuming a 6% commission).

US Homeowners are Staying Put as Housing Market Rebounds
According to Redfin analysis, the average time between moves for homeowners has stretched from eight to 13 years since 2010, which is more than double the (six-year) average that existed for much of the 1990s and 2000s. Staying in a house for more than twice as long as we did before the financial crisis is a remarkably big shift in consumer behavior that begs for a better explanation. In other Redfin research, luxury homes over $1.5M bounced over 3% in price after three straight quarters of decline. (Note: I know folks frequently ask for my view on Redfin and Zillow stocks, and both reported earnings this week: overall, I get the sense that the housing market rebound, which Redfin also mentioned on their earnings call, was the main driver of better-than-expected core business results for both companies. Q319 didn’t yield much new data of significance regarding the transition of the industry to a transactional marketplace except general optimism that irrational VC money is going to take a breather, giving Redfin and Zillow a leg up in the all-important land-grab phase. Increasingly, the input funnel Zillow and Redfin have thanks to their leading websites/apps seems like a key advantage that would be difficult to replicate without significant cost.)

The Re-Bundling and Rising Value of Content
As content continues to gain power over distribution and we see the emergence of new app bundlers, streaming apps like Netflix could/should demand higher “carriage fees” from video distributors like Amazon Fire TV, Roku, Apple, and even legacy bundlers like Comcast. The way it works today, Netflix pays a cut to Amazon if Amazon signs up a new Netflix subscriber. But, if I am more valuable to the Amazon Prime flywheel as a Fire TV user, and I will only use Fire TV if it has Netflix and Disney+ (which I think is true of many households), then those two companies should get economic benefit from Amazon for making themselves available on the distribution platform, especially given the myriad ways consumers can watch streaming content. A good example of this is the recent spat between Disney and Amazon over the carriage of Disney+ on Fire TV boxes. I suspect it was Bezos who caved to Iger last minute, allowing the Disney+ app to be available to Prime users. If I sign up as a new video subscriber on Comcast today, they will bundle the $12.99/mo Netflix into my pay-TV channel lineup. Apple, Amazon, Roku, and others are just new bundlers of channels, and they are nothing without the apps (with apps = channels in the streaming world). This thought exercise shows the growing power of content, which is concentrated at Netflix, Disney, Warner, and ViacomCBS. The situation is due for a complete inversion of who pays who, or, at the very least, the distribution platforms' cut should be zero.

The new reality is that consumers are better off with a bundle than a bunch of disparate streaming apps. Right now the best bundle is the legacy one on cable. In the future, I expect there will be digital bundles that mimic the analog ones, but all the analog ones will include the digital apps as well. Previously, cutting the cord was more about hating cable than it was about loving the alternative. However, today it makes less sense to hate cable and more sense to be displeased with streaming experience: lack of common UI and search, fragmentation, subscription management, etc. Simple surfing functionality, like watching one thing on Netflix while browsing on Prime and Hulu for something different, are now easy features on legacy cable video, but frustratingly impossible on streaming platforms. As I wrote in more detail last week, I think the path forward for media and distribution is becoming much more clear.

Blanketing US Schools with Costly, Unproven Surveillance
Gaggle is a software tool used by schools paying $10,000’s a year to monitor over five million US students. The apps checks email and other communication on school systems for signs of problems. “Gaggle operates by a ‘three strike rule,’ meaning that mild rule violations could be flagged to school administrators if a student does it repeatedly. For instance, if a student said ‘fuck’ three times, school officials would be alerted.” Well, now all the students know how to jam the system up! Given how little student communication takes place using school email addresses, it seems obvious that Gaggle is an immense waste of hard-to-come-by US education funding.

Putting Memory to Work
This interview with the head of advanced computing at memory maker Micron is mainly interesting for the various anecdotes from Pawlowski’s long career at Intel. Pawlowski argues that analyzing massive datasets, like particle data from CERN or self-driving car data, might be ideal for in-memory AI. Micron recently acqui-hired folks to work on AI technology for their chips, but I think it remains hypothetical for now. If you are a semi buff, you’ll enjoy this article.

YouTube Pits its Algorithm Against Twitch and Mixer
As Microsoft Mixer and Twitch battle for exclusive, live, video-game-streamer content, YouTube wants to remind you that 200M people watch gaming content DAILY on the site, and its sheer volume of traffic gives it a huge ability to promote live streamer content. YouTube’s head of gaming Ryan Watt says the platform is focused on live gaming this year; the Verge also has more on the story of YouTube signing exclusives with streamers, who collectively have 3M followers on Amazon’s Twitch.

Rearranging Deck Chairs on Printing and Mail Titanics
Xerox, a company from the 1900s and maker of machines that repeatedly deposit ink on trees that are cut down despite consequences to the future of humanity, declared this week that the printer industry is “long overdue for consolidation, and those who move first will have a distinct advantage.” Personally, we here at NZS Capital wish for all Xerox and HP products to meet Ron Livingston’s bat.

In related news, the USPS, the insolvent purveyor of items printed on trees that are cut down despite consequences to the future of humanity and operator of gas-guzzling vehicles laboring to doom the planet, announced their new relationship to use NVIDIA GPUs on HP Enterprise boxes to better sort your anachronistic mail.

Miscellaneous Stuff
Asceticism is Becoming Trendy in the Valley
Dopamine fasting!? I can’t tell if this article in the NYT was a joke on the reporter, a joke on the reader, or a joke on the year 2019. It describes the new fad in Silicon Valley of fasting from everything that is potentially stimulating – food, screens, music, conversation, etc. Historically, of course, this has been called “becoming a monk.”

Get Ready to Get Wet!
Wet is the creator of the Bellagio fountains and hundreds of other projects around the world involving lots of water, fire, lights, and of course: laminar flow. Ashley Vance's tour of the facility with Wet’s founder is stunning – everything you’d hope the creator of the Bellagio fountains lair/lab/production warehouse would be. At the end, Wet’s founder indicates they are working on backyard fountains for your home too!

A Peek at the Edge of our Cosmic Bubble
Our little solar system orbiting around our little star is cruising around the center of the Milky Way at 450,000 miles an hour. About a year ago, the Voyager 2 probe went past the heliosphere – the roughly spherical expanse of electrically-charged particles thrown off by our sun (a.k.a. solar wind) – that extends 11 billion miles beyond our planet and constitutes our solar “ecosystem”. According to NASA, newly-published reports parsing the data collected at the interface “help paint a picture of this cosmic shoreline, where the environment created by our Sun ends and the vast ocean of interstellar space begins.” As Kilgore Trout said: “The universe is a big place, perhaps the biggest.”

Parallel Lines may Meet After All (at least in this iteration of the Universe)
And, speaking of the big universe: is it flat and expanding, or a closed loop that goes back in on itself? In other words, do two parallel lines stay parallel forever, or do they eventually cross? For a couple of decades the flat, inflationary model of the universe has reigned, but new interpretations of the cosmic microwave background (CMB; the same CMB from last week’s paragraph on Hawking Radiation and ghost blackholes) has enlivened the debate. This new research was presented in the journal Nature, and it remains open to active debate. The ultimate answer has no bearing on our current situation here in our little corner of the Milky Way galaxy, but could help resolve a number of unanswered questions in cosmology. And, as we see more and more data collected around us – and more and more AI and machine learning applied to it – it’s a great time to remember that the lifespans of many truths tend to get shorter and shorter. I posted the following quote a few weeks ago (from Robert Pirsig’s Zen and the Art of Motorcycle Maintenance): “Instead of selecting one truth from a multitude you are increasing the multitude. What this means logically is that as you try to move toward unchanging truth through the application of scientific method, you actually do not move toward it at all. You move away from it!”

Data Brokers Fuel Manipulation of College Admissions Stats
The adminstrator of standardized high school test in the US, the College Board, sells student data to “elite” colleges who then market to “dumb” students who don’t have a chance at getting in, so those same colleges can report lower admission rates and boost their national rankings. College is fast becoming a caricature of itself and desperately needs to evolve in the Information Age.

Stuff about Geopolitics, Economics, and the Finance Industry
TGI...Thursday?
Microsoft saw sales per employee rise 40% in a month-long experiment with four-day work weeks. One of the more obvious solutions to AI job displacement is reducing hours per employee, but if that generates another 40% productivity, it could make things even worse! Maybe try a one-day work week?!
“The 'Work-Life Choice Challenge Summer 2019' saw full-time employees take off five consecutive Fridays in August with pay, as well as shortening meetings to a maximum of 30 minutes and encouraging online chats over face-to-face ones. Among workers responding to a survey about the program, 92% said they were pleased with the four-day week...The summer trial also cut costs at Microsoft Japan, with 23% less electricity consumed and 59% fewer pages printed.”

When Chips are Down, China Gives
Semiconductors are now the largest import in China, even bigger than oil. Modern communism’s command-and-control surveillance economy depends on those chips. When it seemed clear that the US was willing to pressure semiconductor king TSMC in Taiwan to halt shipments to China, I think that could have been the breaking point for China to realize they need to submit for now. A couple of weeks back, I discussed how China was backing off its commitment to homegrown semis, and this week news hit that Tsinghua University, a key backer of chip development, is having a little trouble with its debt payments. Despite the seeming ceasefire, and China’s offer to make it easier for Taiwanese companies to do business in China, Taiwan remains concerned about potential for military conflict. The island’s Foreign Minister recently said: “We need to prepare ourselves for the worst situation to come...military conflict.”

Funds Downgraded after Morningstar Reads Fineprint
Morningstar began implementing their new rating system accounting for expenses, which resulted in around one quarter of funds analyzed being downgraded – largely from Bronze and Silver to “neutral” and “negative” while Gold-star funds were largely unchanged.

Someone Tell Ray ‘it’s Going to be OK’
What happens when your worldview doesn’t seem to account for the role of luck or emergent properties in complex adaptive systems, AND you have a tough performance year in the markets? You apparently become yet another economic and political pessimist. Thus was the case of Ray Dalio last week, who went on what I would describe as a crazy LinkedIn rant titled “The World Has Gone Mad and the System Is Broken.” The post envisions central bankers are drug dealers “pushing” money onto investors who in turn are drug dealers “pushing” money onto poor, victimized companies (I discussed Dalio’s analytical blindspot in more detail in SITALWeek #209.) It seems clear that the world is in a monetary-policy blackhole, and we need to either accept the reality of the Information Age's impact on inflation and rates or try to escape the event horizon. This monetary cosmic phenomena is causing dangerous bubbles to pop up (especially in private assets) while increasing and exacerbating inequality and uncertainty.

The economy is increasingly data based, not asset or capital based, and productivity, even though it can’t be accurately measured, is rising – we are all constantly getting more for less. Lowering rates via monetary policy and fiscal spending are both forms of “printing money.” There are two options for the years ahead that don’t depend on lowering rates: 1) tax the rich and redistribute moola, or 2) ramp up fiscal spending and pay for healthcare for all, universal basic income, and fund pensions/retirement savings, etc. (Actually, there’s a third option because you can do a combination of 1 and 2). Either way, there is not much use for Dalio’s sky-on-fire “buy gold!” rants – humans are smart, and progress moves in only one direction. There have been cynics ever since Homo sapiens first mustered a grimace, but they’ve never been right in the long term. If you want to signal optimism and restore hope (see the end of last week’s newsletter), then you can pull rates out of the black hole through spending. So yeah, I think gold will underperform the broader economy over the next century. As I said on Twitter last week, if anyone finds themselves near Ray, pull him off the ledge, offer him a warm piece of pie, and tell him everything will be ok.✌

-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

SITALWeek #217

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, Hawking Radiation, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: increased allocation to private assets by institutional investors might make their constituents, and the economy, worse off; the surprising outcome if the government prints money for healthcare; the half-baked trends in food delivery; Hollywood is making a lot more sense; speeding up Netflix; human brains need a lot more time to adapt to the Internet; the NZS of Uber and Lyft; and lots more below...

Stuff about Innovation and Technology
ICYMI – NZS on The Stock Podcast
If you’re new to SITALWeek, or in case you missed it: Brinton and I were on The Stock Podcast in September discussing process and outlook – you can listen or download the transcript here.

The Irony of Increasing Private Equity Investing?
Most pensions are increasing their allocations to private equity funds, which, among other things, are buying up healthcare companies and driving up the cost of healthcare for everyone, including pensioners! 🤦 This little irony made me chuckle until I realized that it might represent a bigger and more insidious problem: shifting more and more businesses into the hands of sometimes short-sighted financial managers probably isn't the best thing for society, and could continue to widen inequality. The trend is being fueled in no small part by institutions like pensions that represent a lot of employees who could end up being negatively impacted. There have been examples of questionable behavior by private equity in retail, real estate, newspapers, and healthcare. Just this week we saw the demise of Deadspin owned by the PE firm Great Hill Partners. I don't mean to paint the situation in too broad of a brush stroke here – I know there are responsible PE shops and many examples of acquisitions where companies have greatly benefited. Debt, low rates, and risk seeking is the fueler of this private investing bubble (more on that in SITALWeek #216 last week), and according to a report I saw from Empirical Research, trillions of dollars of leveraged private deals have seen debt/EBITDA deteriorate to 6x from 4x over the course of the current economic expansion. Using excessive leverage to drive asset price inflation, price increases, and worker layoffs might happen at an accelerating rate due to institutional demand for increased returns in the illiquid private asset market. Elizabeth Warren this summer unveiled the colorfully named “Stop Wall Street Looting Act” vilifying private equity (in many cases unfairly). I wonder how much of Warren’s own Federal pension (FERS) is allocated toward private assets? Information on that $600B fund is hard to come by online. I don’t think there is any sort of calculated, Flintheart Glomgold-type evil behind any of this, but it’s certainly worth connecting the dots and examining the potential consequences.

What's Behind the Self-Storage Boom?
And, speaking of private investment bubbles, this WSJ article describes the 5x increase in building of self storage facilities in the US over the last four years to $5B! I don’t know the industry well, but I have a hard time thinking that this trend is anything but excess capital looking for a home by creating assets that will one day be worth...less. If we do need all these storage buildings, then so much for the post-financial-crisis theory that people would want less “stuff”!

Wildfires Endanger California's Economy
Redfin reports that over $2T in real estate is at risk in four counties in California due to ongoing wildfires and that homeowners are starting to move away from impacted areas due to surging insurance premiums, power shutoffs, and evacuations.

Vintage Nuclear System Gets A Solid Upgrade
The Strategic Automated Command and Control System for nuclear weapons launch just updated from floppy disks to solid state storage. It’s easy to joke about this vintage system, but it’s somewhat reassuring that the nostalgic hardware doesn’t have an IP address.

Emotion Recognition Software Coming Despite No Evidence that it Works
According to the FT, emotion recognition software was on display at China’s largest surveillance trade show. There isn’t any comprehensive research to support the notion that you can accurately deduce human emotions based on facial expressions, body language, etc.; however, that’s not stopping many companies, including the big US Internet platforms, from developing the technology (perhaps because some of their management teams need help reading human emotions themselves! 🤣). The FT article mentions its use by Chinese customs as well as limited use at Chinese schools. China also uses the technology to control the Muslim population in Xinjiang, which is a region that produces a wide range of Western-branded products, like tomato paste for Heinz ketchup (the Guardian suggest we consider boycotting). Speaking of surveillance, the US Interior Department will heavily curtail the use of Chinese drones over Federal lands.

Tough Road Ahead for ByteDance’s HK IPO?
TikTok parent ByteDance is said to be planning a $75B IPO in Hong Kong early next year. I can imagine the risk factor highlights: 'Western governments may force us to divest a large portion of our business in a fire sale; the rest of the company is controlled by the CCP; the home country of our IPO exchange has permanent protests.'👌

The Smoke is Clearing in Hollywood, and it Looks a lot Like 2007!
After several years of blurring lines between video content and distribution, I think it’s starting to become more clear what the US (and ultimately global) media landscape will look like in five years – and it looks a lot like it did 10 years ago before the confusion set in. I see four buckets of video content creators today:

• (A) Netflix

• (B) ViacomCBS, NBC Universal (Peacock), and a long tail of smaller studios

• (C) Disney (Disney+) and WarnerMedia (HBOMax)

• (D) non-traditional, subsidized bundlers like Apple and Amazon (which combine content with hardware or Prime, respectively), or carriers like Verizon, T-Mobile, and AT&T.

On the distribution side, Netflix (A) is obviously its own platform, but its app is increasingly available in non-traditional bundles (T-Mobile) or on multichannel video program distributors (MVPDs) like Comcast. Then we have ad-supported streaming (AVOD) led by (B) and subscription-based streaming (SVOD) led by (C). The content arms dealers (B) will supply to Netflix, AVOD, SVOD, and MVPD (e.g., Comcast) and vMVPD (e.g., Hulu, YouTube TV) bundles. The SVOD platforms (C) will also continue to participate in the MVPD/vMVPD bundlers. Lastly, the non-traditional bundlers will continue to experiment by buying content while they distribute “channels” including traditional networks as well as AVOD and SVOD apps. Clear as mud, right?

Significant crystallizations are occurring around the delineation between the AVOD vs. SVOD playbook, as well as the conclusion that the traditional bundle is the BEST consumer value proposition for the foreseeable future. This harkens back to my call last week to “solder the cord” back together for those that cut the cord over the last few years. In my view, this remains a “have your cake and eat it too” for most of Hollywood – especially the arms dealers (B) selling to all four distribution buckets. Content will continue to experience inflation in value for the next several years, and likely well into the future as 5G connectivity gives everyone more screen time; however, right now it seems to be becoming overbid by groups A, C, and D and to a lesser extent B. I love South Park, but HBOMax (C) paying $500M+ to Viacom for US-only streaming rights (with a 24-hour delay for new episodes) over the next few years seems like a whole new level of cost inflation for library content. Indeed, it’s better than ever to be a content arms dealer. The Viacom studio head said recently, in this great Hollywood Reporter interview with seven major studio heads, that he is making movies for Netflix “Every chance we get.” Thus, the question of whether to be an arms dealer or direct to consumer platform in video appears to be becoming more clear (I’m betting on the former). I suspect we will see the content owners continue to gain leverage over the MVPD/vMVPD bundlers, as well as increased targeted advertising driving value for all participants, but there is no reason to blow up the bundle as it exists today. It hasn’t looked this appealing in a decade for consumers to subscribe to only Cable+Netflix. We’re right back where we started when Netflix announced streaming in 2007!

No Fastpass for Streaming Consumers as Directors Mandate the Scenic Route
I welcomed the news that Netflix was testing a 1.5x playback. But, the backlash from directors appears to have squashed it. Let’s call a spade a spade here: the righteous indignation from Hollywood directors over this news is because, deep down, they know that last 10-episode streaming series should have been somewhere between four and six episodes at most. This new concept of a 10-hour movie on streaming apps has created some seriously lax editing. Art exists within constraints (money, time, etc.), and streaming has taken too many constraints away.

High-Speed Digital Information Overwhelming for Our Species
I think the only thing to say on election ads and free speech is that the velocity of information and the ability to manipulate human neurons has far exceeded the brain's ability to adapt. The plasticity/adaptability of Homo sapiens is incredible, but it has met its match with the Internet. We were able to adapt to radio and TV within a couple of decades, but assimilation for the latest media revolution appears more like the advent of the printing press, which took society a couple of centuries to adapt to. We’re experiencing a super-fast moving, positive feedback loop of information crashing into a slow moving evolutionary process. The brain is able to mitigate some of that, but not enough. In that sense, I think Jack Dorsey’s insight that “democratic infrastructure may not be prepared to handle” the reach of online messaging is spot on – so I think it’s fine to take a timeout while humans figure out how to deal with the Information Age before more damage is done.

Future of Food Delivery Still Looks Half-Baked
In the future, food will increasingly be sourced and prepared in vertically-integrated facilities, tailored to customer tastes and diets (in some cases healthcare- and employer-subsidized), and arrive on preset delivery routes to subscribers' homes/offices. Grocery stores, chain restaurants, and mom & pop eateries are in vast oversupply as we transition to food-as-a-platform in the Information Age. Well, at least that’s the gist of my essay “The Evolution of the Meal” that I posted a few weeks ago, and it’s an example of a combination of 1) a broad prediction (i.e., because the way we produce and consume food today seems to have unsustainable negative externalities, it's highly likely to change in the future) with 2) a series of nested, narrow predictions and parlay bets with wide ranges of outcomes. Will the exact scenario I described above come to pass? It's anyone's guess, but the odds are high that the food landscape looks radically different 20-30 years from now. In rapidly evolving industries, we try to be good Bayesiansn by always adjusting our credences up and down as new information comes in, and this week we had a few news items that support my current view of the evolving food world. Grubhub gave a frank and welcome birdseye view of the problems with food delivery in their quarterly shareholder letter. Specifically, they discussed the problems of point-to-point delivery and the lack of operating leverage that it creates; in other words, it’s probably not a viable business model to have decentralized food delivery. And, this WSJ article implies that many Whole Foods locations exist mainly for on-demand delivery shoppers to battle it out in the aisles for delivery orders a la Supermarket Sweep (I used to love that show!). Lastly, the NYT reports on the congestion in NYC from the rise of delivery agents for food and ecommerce – underscoring the need for a winner-takes-most, vertically-integrated, and routed delivery provider. So what’s to become of today’s grocery stores and restaurants when food sourcing, prep, and delivery centralizes? There’s a lot of fixed costs and relatively low margins, so I would posit that most of them won’t survive; however, the future of food is far from determined.

Uber Eats' new delivery drone has six rotors and an 18-mile (18 minute) range carrying food for two adults. The drone is set to take flight in San Diego mid-2020, and it would be perfect for taking off en-masse from the roof of an Uber-owned central kitchen facility.

In the escalating grocery delivery wars, Amazon Fresh is now free for Prime members – the grocery delivery service previously cost an additional $14.99/mo.

How do Rideshare Companies fit into our NZS, or Non-Zero-Sum, Framework?
This question came up in a discussion of Lyft and Uber on Twitter this weekend. I consider both Lyft and Uber to be far out on the Optionality spectrum in our investing framework – there is significant asymmetry, lots of risk, and it’s still possible the stocks are “gambles” as opposed to investments, although I think there are good arguments why they have moved past the gambling phase of investing. These stocks are very fun to analyze because of the nature of the businesses, the disruption, and the crazy thought exercises (e.g., what if Amazon bought Uber and bundled rides, meals, and local delivery all into Prime? Or what if Google bought the rest of Lyft it doesn’t already own and integrated/bundled it with Waymo, Maps, local merchandise delivery via search product listing ads, YouTube premium, etc.?); and, it’s completely ok to have an official opinion of “I don’t know”. I first invested in Lyft in our prior fund when it was a private company in early 2016, so I’ve spent some time thinking about the industry. I have one broad prediction: transportation/logistics as a service (TLaaS) will be a large market over time; and I have several interdependent, narrow predictions (concerning duopoly structure, path to profits, rising prices, rising driver pay, regulatory capture, bundling, subscriptions, etc.) that would need to come together for the stocks to work. Here are some specific thoughts on NZS, or win-win. The core premise of NZS is that, in the Information Age, long-term successful companies will provide more value for their various constituents, including society and the environment, than for themselves. At a high level, ride sharing exhibits significant NZS today with its increased convenience/value for riders along with driver job flexibility, albeit with significant problems that need to be addressed including driver pay, rider safety, traffic congestion, etc. If I think of this industry on a 20-year time horizon, a manageable rise of TLaaS – specifically fleets of EVs that are partially or fully autonomous moving people and goods around locally and regionally – will eventually reduce car ownership, pollution, and resource use, while ultimately providing greater flexibility in the economy and productivity gains that are likely to offset the long-term disruptions to the existing industries that are (directly or indirectly) involved in transportation logistics. So, odds favor an all-around win, but it remains to be seen how it will all play out.

Miscellaneous Stuff
Toxins Catch a Cathartic Wave While We Sleep
Waves of cerebrospinal fluid wash over the brain during deep sleep (before REM) to clear out toxins that can lead to Alzheimer’s and other diseases. Wave generation requires coordinated firing of groups of neurons (to modulate blood flow), which is why we can't clear toxins while we're awake.

Ghosts of Universes Past
A group of cosmologists believes we can see echoes of other Universes in the cosmic microwave background (the radiation footprint that shows the birth of our Universe, effectively the energy left from the Big Bang). The theory, which I should add is controversial but thought provoking, claims that Hawking radiation emitted from decaying black holes can leave an imprint into the next universe that forms. Again, this is not a mainstream view amongst physicists, but it’s too cool to ignore.

Humor Still a Plucky Survivor at PE-Owned The Onion
“Silicon Valley Leaders Sit Down With Wildfire At Investment Meeting After Being Impressed By Its Rapid Expansion” – a perfect article from The Onion, owned by private equity firm Great Hill Partners.

Stuff about Geopolitics, Economics, and the Finance Industry
Want to Solve the Healthcare Crisis and Restore Hope? Just Fire Up the Printing Presses!
Here’s a fun thought exercise: what if Elizabeth Warren’s “Medicare For All” plan was paid for directly by the government printing money? The math here is pretty simple. The economic structural setup for the foreseeable future is low rates and low inflation. Healthcare is one actual source of inflation, and it’s a meaningful part of the economy that’s currently completely broken. Printing money for single payer healthcare could improve the out-of-control inflation driven by insurance, private equity, and other problems in the broken health system with a more controlled inflationary increase. If there’s too much inflation, the Fed can raise rates, which wouldn’t be a bad thing. Indeed, managed inflation (in addition to resolution of the healthcare crisis) could be a net positive – inflation and hope are tied together (see below). (For additional context, Jeff Spross in The Week talked about some of the economic pros and cons of deficit spending).

Regarding the relationship between interest rates and hope mentioned above, here is an excerpt from SITALWeek #205 that discusses the idea in more detail:
Lending and borrowing grew dramatically after the scientific revolution because humans started to believe in progress. This was fuel to the development of capitalism, which, as originally defined by Adam Smith nearly 250 years ago, broadly depends on two driving forces: productive reinvestment of capital and a growing population. You could say that lending depends on a brighter future where debts can be paid – a future built on progress. In other words, it depends on a growing pie, or something beyond a zero-sum game (Harari has a good discussion of this framework in Sapiens). So, it’s worth exploring the relationship between interest rates and hope for the future. Technology, power laws, and inequality are perhaps shifting pie filling, so to speak, from ‘the many’ to ‘the few’ instead of growing the overall pie. If that’s the case, then it represents a much less hopeful future: a pie that won’t be getting bigger. Moreover, the slower-growing pie combined with lower birth-rate trends would imply a future of less demand and therefore less inflation. A future of lower inflation, combined with technology-driven deflation, and a shift toward an economy that is driven more by information than commodities and hard assets is a prescription for low rates. That sounds like one plausible explanation of the global situation today. Therefore, low rates may be a direct reflection of less hope for growing the pie and the way that pie filling will be distributed. Further, what's more pessimistic than negative interest rates? I'll give you a dollar today and I only want 99 cents back in the future. It's a rather bleak explanation; however, it would suggest, rather speculatively, that redistribution in the form of higher wages, lower consumer debt burdens, and even direct government subsidies would create more hope, more inflation, and higher rates along with a stronger global economy. This FT article discusses the idea of central banks giving citizens money directly instead of lowering rates – both options “print” money, but the former would put it the hands of more people directly. The loss of hope and low rates is a paradox that strikes me as worthy of deep analysis.

-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

SITALWeek #216

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, cotton candy meat, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: slowing US fintech innovation; why aren’t music streaming and podcasts killing the radio star? Is it time to solder the cord back together and get cable TV again? China backs off its semiconductor investments; could Snap or Twitter end up owning TikTok? Risk seeking in private assets could go off the rails; Reader Q&A; and, lots more below.

Stuff about Innovation and Technology
Making Cotton Candy...Meat?
A so-called “cotton candy” machine for lab-grown meat spins at 30,000 rpm and constructs a lattice of gelatin to create more tender meat fibers. The gelatin serves as a scaffold for growth of cow or rabbit cells. Mmmm. This methodology is very early in development and hasn’t undergone the all-important taste test, but it’s nonetheless great to see innovation in this key market.

In-Home Delivery Brought to You by Walmart
Walmart launches in-home delivery for 1M households in Pittsburgh, Vero Beach, and Kansas City. For $49.99, Walmart will install a special lock on your door for delivery agent access; agents don body cameras, which allow you to watch your delivery. The delivery service is $20/mo with a $30 minimum per order.

More Health Care Initiatives for Amazon Employees
Amazon continues to expand into the healthcare market with the acquisition of Health Navigator, a service for virtually connecting employees with nurses and doctors after attempting to determine the best course of treatment. The service will be integrated with the pilot Amazon Cares health clinics for Amazon employees.

Amazon’s Search Advertising Share Gains, but Customers and the Supply Chain Lose
According to eMarketer, Amazon’s share of US digital advertising will climb to 8.8% this year (from 6.8% last year) while Google will see a dip to 37.2% (from 38.2% last year). In the search-advertising segment, Google took 73.1% share while Amazon grew 30% to 12.9%. It’s anecdotal, but when I search on Amazon, I see a lot of ad fraud problems similar to what Google experienced 10-20 years ago. Recently, I searched in the Amazon mobile app for an item that I purchase frequently – the first result was an ad for the most expensive purchase option, the second was an organic search result that was a little less expensive, and the third choice (which on a mobile screen may as well not exist) happened to be the cheapest Prime option, and it was the one I had last ordered a few months before. Obviously, this seems like prioritization of profit maximization instead of putting customers first.

Amazon’s “profit maximizing algorithm first, people second” Libertarian free-market philosophy is also evident in their apparel sales. The marketplace of 3rd-party sellers is filled with apparel going up for sale that is made in dangerous factories long-abandoned by other clothes makers (and not even used by Amazon’s own private-label apparel brands). This follows previous problems with toxic children’s items for sale on Amazon. Broadly, Bezos’ dedication to profit maximizing algorithms and technology is leading to harm despite his prime directive of putting customers first, and the free market is reacting slowly to correct the mistakes.

Government-Sponsored Cryptocurrency Coming to China; Meanwhile in the US...
In China, the government is readying a cryptocurrency version of the Yuan, which is likely to be successful at spurring further fintech innovation in the country. Meanwhile in the US, I am still writing out paper checks, putting them in envelopes, placing a stamp on them, and dropping them at the post office. The US government is increasingly stifling financial innovation. In my opinion, this is no doubt due to the credit card networks and established mega banks lobbying behind the scenes. This maneuvering seemed evident to me in the Congressional grilling of Zuckerberg on Libra this week. The reality is that the fight over Libra is much more about the big financial institutions’ desperation to keep tech companies from bringing the money industry into the Information Age. In another example of innovation-stifling news, the fasttrack path for a tech company to get a bank charter was cut off this week by a federal judge.

Microsoft’s Cloud is Becoming a Mega Cumulonimbus
After recently announcing a broader partnership with Oracle, this week Microsoft announced a new, wide-ranging SAP partnership AND a $10B Pentagon cloud computing contract (which many thought would go to Amazon; the deal was also hotly contested by Oracle). Azure has become the de facto cloud migration path for a large number of enterprise workloads, and is now likely to take share in the Federal segment as well. As a side note, I would speculate that the path to partnership in the cloud is likely to result in significant margin expansion for SAP and Oracle in coming years as they abandon their efforts to sell their own cloud offerings and re-orient their sales people back toward more practical objectives.

Is it Time to Solder the Cord Back Together?
In our house, we cut the cable/satellite cord completely eight years ago in October 2011 (yes, we don’t watch a lot of sports!). Since then, everything has pretty much played out as many people predicted in the video ecosystem. Today, however, depending on who your cable or satellite video provider is, I am not sure I see a compelling case to cut the cord. In the near future, HBO Max, Disney+, and Peacock (along with a long tail of existing and new niche apps) are launching and withdrawing content from Netflix and to a lesser extent Hulu. So, in order to recreate the bundle, you would need to spend as much or more on multiple apps with various user interfaces that range from horribly unusable to barely usable. The amount of juggling, mental gymnastics, time, and frustration involved in navigating the video ecosystem today far exceeds the pains and cost of cable a decade ago. Recognizing the cord cutting threat, cable in some cases is partnering to bring apps like Netflix to their set-top boxes and working to improve their own technology platforms. The vMVPDs like YouTube TV, Hulu Live, AT&T Now etc. are raising prices to the point where they offer little advantage over cable, so if you watch live sports or news, the traditional video providers are adequate. So, why would anyone cut the cord today? I'm being provocative, but the point is we need a rebundling that gives the content owners and creators what they want (direct customer data access, pricing power) and consumers what they want (a convenient, usable interface/search for all available live and on-demand content). Keen readers will note the view I express here is in opposition to what I wrote last week...well, as I've paraphrased Penn Jillette in the past: it's good to be a hypocrite because it doubles your odds of agreeing with me!

Is Streaming Video Becoming a Loss Leader?
Another interesting development is the wireless subsidization of video apps: Verizon will now give you Disney+ if you are an existing unlimited wireless subscriber (or new subscriber to other Verizon services), AT&T might bundle HBO Max if you are a subscriber, and T-Mobile bundles Netflix for many customers. At a high level, what’s happening is that companies providing data service (like 5G or home Internet) are using free video content as a way to reduce churn and likely raise data prices over time. The logic is clear, but how far can this go if you only get some content for free, depending on your service provider, and meanwhile the industry continues to fragment into the intractable multi-app mess?

Will Podcasts Kill the Talk Radio Star?
People always describe video streaming as the digital version of TV, but they often compare digital music streaming to historical physical media sales (CDs, records) instead of traditional radio. Radio was free to consumers while CDs cost money, but why are people seemingly reticent to pay for streaming audio and podcasts compared to the ease with which they open up their wallets for streaming video apps?

In the radio analogy, podcasts are the digital version of talk radio (and sports radio, drive-time radio, NPR, etc.). Therefore, it seems plausible that we eventually see a large chunk of the multi-billion dollar radio advertising market map over to podcasts. In order to capture the ad dollars, you would want to maximize podcast distribution instead of locking content into certain streaming platforms. However, the existing wide distribution of podcasts has made metrics collection and ad targeting elusive, and it’s easy to fast forward through podcast ads. Paradoxically, this problem could argue for a single platform to win in podcasts, e.g., Spotify, could create a power law, winner-takes-most-ad-dollars podcast distribution platform. Disney struck a deal this week to bring Marvel podcasts exclusively to SiriusXM. So, there seems to be real demand and real value for well-produced audio programming, but in terms of generating revenue, the ecosystem is still in flux.

I’ve struggled in the past with the loss-leader nature of the music streaming industry and the leverage wielded by the music labels given the importance of the historical catalog of artists to listeners. If we can really mentally reorient to “streaming = radio” from "streaming = physical media sales," I think it changes the outlook for capturing more listening and more revenue. And, it opens up a wider debate on royalties and advertising revenue shares which are vastly different for streaming than radio.

One final point on the "streaming = radio" analogy: terrestrial radio used to have a very human feel to it – DJs, local news- and sports-casters, etc. Algorithms crept in over time, and today much of local radio seems like programmatic drivel. I think there is a real opportunity to bring back that local, human radio feel to streaming. I am probably dating myself here – some people tell me what they love about streaming is no DJs interrupting with traffic, news, weather, and local concert updates! Combining algorithms and the human touch feels too absent in streaming today (Spotify in the past has called this algotorial, which is a portmanteau that I love). The reality is that there is no algorithm running on any theoretical quantum computer that knows which song would be “best” for me to listen to next, even if it had all the information on every single atom in the Universe that my existence is entangled with going back 7,500 generations to the dawn of the cognitive revolution. That’s the beauty of human creativity and art: you can’t know. Given the importance of local sports and news to the popularity of radio even today, I can’t help but wonder if that’s where Spotify should be focusing its content budget. But again, maybe I’m living in the past.

VCs are Feeling the Heat from the Public Market’s Rebuff
Over the last few years, private funding in Silicon Valley has slowly become more irresponsible and overvalued. I first discussed this publicly in early 2016 (interview in The Information), but the past few years have been one heck of a low-rate, risk-seeking, capital-oversupply mania – far more than I could have anticipated. This risk-seeking private capital joyride is now colliding with public markets, whose investors are still very willing to invest in companies with good management and paths to profitability, but won’t take shoddy investments off the hands of increasingly desperate VCs. I’m a big fan of companies going public even before it’s not completely obvious they are ready, and there all sorts of reasons it’s a good idea, as long as their business operates within the constraints of planet earth. But when the public markets balk, the very investors who created the shell game need to provide life-support by investing more money in the already over-valued companies – as Softbank did with WeWork this week. Similarly, Peter Thiel is raising a $3B fund to plow more money into companies that should already be mature enough to be public. Low rates and the doubling down on bad investments is a sign this bubble will be sustained for a while longer.

Quantum BS
Longtime readers know I am quantum computing skeptic. I think the commercialization of the tech in the next 10-20 years is hype, and maybe even in the next 30+ years. That doesn't mean that there aren’t important milestones and interesting scientific progress to be made. However, Google did not achieve any meaningful quantum supremacy, as was widely reported, and we don’t need to be fretting about encryption being broken anytime soon. Here is a levelheaded but still optimistic article on the Google achievement from the professor who coined the term quantum supremacy several years ago.
“In the 2012 paper that introduced the term 'quantum supremacy,' I wondered: 'Is controlling large-scale quantum systems merely really, really hard, or is it ridiculously hard? In the former case we might succeed in building large-scale quantum computers after a few decades of very hard work. In the latter case we might not succeed for centuries, if ever.' The recent achievement by the Google team bolsters our confidence that quantum computing is merely really, really hard. If that’s true, a plethora of quantum technologies are likely to blossom in the decades ahead.”

China Paring Back its Semiconductor Ambitions?
Back in 2014, the China Integrated Circuit Industry Investment Fund launched a $22B effort to spur activity in the country’s lagging and highly Western-dependent chip industry. This followed a decade of largely failed attempts to fund homegrown semi capabilities. Then last year, as trade tensions rose, China announced plans to launch a $47B fund. But, that never seemed to materialize, and now the WSJ is reporting the 2nd fund might be happening, but at a much diminished $29B. Perhaps China is facing the reality that it would take a lot more money, effort, time, and luck to wean itself off of US and European semiconductor intellectual property and know-how. This is the reason I’ve said in the past that Taiwan, home to TSMC – the most advanced semi fab company and touchpoint of 70% of the global semi supply – is the ultimate chess piece in US-China tensions. Despite the US dominating the semi tech landscape, there is concern we don’t have enough domestic leading-edge chip manufacturing. TSMC is considering opening a fab in the US for the first time; however, it would require heavy subsidies (I’ve previously floated the idea that Google, Amazon, Microsoft, Apple, Qualcomm, NVIDIA, etc. should create a manufacturing joint venture on US soil).

Semi News: Non-Traditional Substrates, Heterogeneity, and Ongoing Open-Source Disruption
There were three articles in Semi Engineering this week that are of interest to all the chip followers:
-Silicon Carbide and Gallium Nitride continue to gain share against traditional silicon as a substrate for making chips for high power applications (such as in autos, solar, power supplies, transportation, etc.).
-Distributing data and computation across billions of processor chips in the IoT world is effectively fueling a rise in heterogeneous compute and lowering the need for complex SoCs (systems of chip) which contain many compute cores in one semiconductor. (The article has less meat to it, I’ve summed up most of its content here).
-This panel with several RISC-V-based (my explainer on open-source semis is here) companies discusses the virtuous circle the new processor movement is seeing right now. I continue to think the market is underestimating the negative impact of RISC-V on current ARM licensees, especially given the momentum for the cheaper, more customizable architecture in China. My 2 cents: If you are a chip company with a big ARM-based business, you could risk your customers building their own custom RISC-V chips or Chinese companies copying your ARM versions for far less money.

Miscellaneous Stuff
The Gall of Wasps!
I recently became acquainted with a very interesting botanical phenomenon created by gall wasps. Galls are growths formed by a plant/tree in response to gall wasp (or other insect) eggs. The egg delivers special instructions to the tree, causing the protective (and nutritious!) growth to form around the egg, from which a larva hatches and eventually eats its way out. The galls come in remarkable shapes and sizes, as this short YouTube video explains.

Patagonia Dreams Small
I enjoyed this interview with Patagonia’s founder Yvon Chouinard:
“Look at Amazon. Amazon doesn’t make a profit. They don’t pay any taxes. Nothing. But they’re growing like crazy. It’s all growth, growth, growth—and that’s what’s destroying the planet. I’m dealing with that myself. We’re a billion-dollar company, over a billion, and I don’t want a billion-dollar company. The day they announced it to me, I hung my head and said, “Oh God, I knew it would come to this.” I’m trying to figure out how to make Patagonia act like a small company again.”
I loved it when Patagaonia earlier this year decided to not sell corporate logo gear to companies they felt weren’t ecologically aligned, quickly cutting off the supply of VC-branded puffy vests in San Francisco!

Tricking the Immune System with a Trojan Horse
A phase 2 trial at Northwestern Medicine looks promising for reducing gluten intolerance and controlling celiac disease. The tech uses a nanoparticle containing an antigen to trick the immune system into thinking the offending protein is safe, a technique that could be broadly applicable to other autoimmune diseases with known triggers.

A Carbon Sink that Rocks
The Deep Carbon Observatory project aims to understand the long-range carbon cycle that involves geochemical transformations deep within the earth’s mantle. So far, studies have yielded insights into how carbon could be stored in rock formations at large scale going forward. And, there’s this cool discovery: “The DCO has also boosted optimism about the possibilities of life on other planets. Pure diamonds are made of nothing but carbon, but most contain small impurities. They may make poor jewelry, but they’re priceless in research. These impurities, called inclusions, have revealed "abiotic" methane as an energy source for life deep inside Earth.”

Stuff about Geopolitics, Economics, and the Finance Industry
Regulating US Internet Platforms and the Threat of China’s Innovation
At the WSJ Tech Live conference this week, the head of the US DoJ said breaking up tech giants was “perfectly on the table.” As we’ve written in the past, “breaking up” a technology platform is a misguided Industrial Age view of regulation in need of a fresh perspective. I am reminded of Mark Cuban’s warning nearly two years ago that over-regulating US Internet platforms could cause an irrevocable gap in the AI race between China and the West. It’s a fair argument, and it’s been used by others since – most recently, Zuckerberg made similar claims in front of a regulatory hearing in D.C. this week. (Cuban’s provocative suggestion to de-list Chinese companies from US markets also got some attention recently from Trump.)

Will TikTok be Domesticated?
There has also been a rising bipartisan chorus to investigate TikTok, which is owned by China (technically it’s owned by Chinese Internet giant Bytedance, but there are no completely independent companies in China) because of the alleged risk of Chinese censorship of the US teen social app (TikTok denies this is happening). TikTok is also a big ad spender on social networks like Instagram, Facebook, and Snap. If CFIUS or some other government body were to force out foreign ownership of TikTok, Bytedance cold shut it down or choose to sell it. It’s unlikely Facebook would be allowed to buy another social network, but it could be an intriguing and inexpensive acquisition for Twitter or Snap (thought it would hurt Snap’s ad revenues short term to lose revenue from this the big spender).

Investmenting in Illiquid Assets is Getting Out of Control (or I'm Crazy)
The hunt for risk, errr...I mean returns, continues as half of BlackRock’s institutional clients plan to increase their allocations to private assets. The firm’s new $12B fund, targeted at private company ownership, is called “Long Term Private Capital” (does anyone else think that’s a bad name?). Let's be honest: 7-8% long-term returns no longer exist at the same risk levels for institutions like pensions because of 1) decelerating population growth, 2) technology-driven deflation, and 3) the shift to an information-based economy that, by definition, requires less capital. I watched these two interviews with private investing giant Brookfield's CEO and pension giant CalPERS' CEO on CNBC over the last two weeks, and all I could do was think of Kurt Vonnegut: "a sane person to an insane society must appear insane." I perhaps appear insane. I would argue that the global stock market is a liquid asset that approximates the returns available in the global economy. In the hunt for higher returns, investments in illiquid assets could theoretically surpass the return of the public markets with the *significant* added risk of much debt and much less liquidity. Would a better approach be to take return assumptions down, and communicate to constituents that they may not receive all of their future benefits because the world has gone through a paradigm shift with the arrival of the Information Age? It’s a problem that likely needs to be solved at the government level with taxes and income redistribution.

Twitter Q&A:
This week I queried Twitter followers for SITALWeek Q&A. I got many great topics and will tackle a few of them here. I will probably do this again in the future, but if it’s something you want to see become a regular feature, let me know. I have paraphrased and combined some of the questions. (If I didn’t answer your question, it's probably because it was outside of my knowledge domain.)
What are your base case and best/worst case outcomes for tech regulation?
This is tricky, and I am going to fall back on my main base case, which is: the range of outcomes has clearly widened, but the high odds of regulatory capture is likely to cement the current Internet platform positions while making it harder for them to expand into adjacencies. The worst case would be paralysis that causes companies to curtail investment and ultimately hamper innovation in the US and hurt free cash flows. Paradoxically, the best case for investors could involve breaking up the companies, which might unlock hidden value and possibly allow the new, smaller entities to expand into adjacencies like fintech; however, this scenario involves numerous parlay bets, so odds are low.
What is your updated view on Zillow and what metrics are you looking at?
I don’t have a big change in my views on Zillow in terms of the business (articulated here in detail) – the range of outcomes is wide, but the asymmetry is high, which informs a potential small Optionality position for now using our framework. However, two things have changed recently: 1) the stock has gone down and is closer to what I estimated their core media platform business to be worth, which causes much of the other opportunity to be OOTMO (out of the money optionality); 2) IF we see more rationality coming to the VC market, this will help the public companies who have better access to capital (e.g., potentially Zillow and Redfin) to win in the iBuyer market.
How are you thinking about SaaS valuations?
Well, I am thinking a lot about them. Cloud software has typically scored very high in the Quality, Growth, and Context framework of Complexity Investing. However, an important part of the Context filter is valuation, and many great SaaS companies have gotten way too far ahead of themselves. Historically, very few software companies have outperformed once they pass a valuation of 10x revenues, and this generation is no different. That said, several great companies have pulled back to 6-8x enterprise value/forward sales, which can be a more attractive entry point.
What’s your 10-year view on the paradox of rising car ownership while food delivery and ridesharing simultaneously are taking off?
I would consider both of the following broad (or safe) predictions: transportation as a service and meal delivery will both grow dramatically, but the range of outcomes for individual businesses as that happens remains very wide – it’s a classic setup of a long tail of Optionality investments.
I think car ownership is cyclical and tied to the tight labor market. I suspect over time car ownership, especially in cities, will transition to fleets of on-demand services. On food delivery, I have a much more bullish view: our current system of agriculture, distribution, grocery stores, and at-home cooking is going to be entirely disrupted (more on that in this piece from September).
Could AI startup Graphcore become a challenger to NVIDIA?
I think this is likely to be an “and” not an “or”; in other words, we are in the very beginning of an explosion in heterogeneous workloads driven by data, AI, machine learning, 5G, IoT, cloud etc. All of this is happening because we’ve dropped off of Moore’s Law, and it makes sense to have more custom architectures (a reason to be bullish on RISC-V). There will be a lot of winners. NVIDIA’s efforts to turn their GPU into a much broader system that incorporates other features, as well as their strong network effect around the CUDA language, appear for now to be growing in strength. Graphcore has attracted a lot of interest, importantly from Microsoft and Google (via DeepMind’s founder). The risk for all AI startups today is that the landscape is evolving fast, and so optimizing for any one language or process may be a costly mistake when it costs hundreds of millions of dollars to make each chip.

-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.