SITALWeek #284

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, ouroboros, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: electric tankers; rise of Chrome OS; Texas freezes fabs; reverse-digital taxes and the synthetic news/social economy; pain is more in your head than you think; machine learning physics without models; million dollar virtual goods and the human nature of scarcity; and lots more below...

Stuff about Innovation and Technology
Seafaring Electric Vessel
Developed by a consortium of Japanese shipping/maritime companies, the “e5” tanker will be the first all-electric vessel of its kind. At 60 meters long and powered entirely by lithium ion batteries, its power is equivalent to 40 Tesla Model S vehicles. Asahi Tanker plans to employ the e5 primarily to carry diesel fuel for traditional boats over short ranges. For longer range ocean transport, Corvus (which supplied the e5’s batteries) is working on a combined hydrogen fuel cell/lithium ion battery system they hope to debut in 2023.

Chrome OS now 2nd to Windows
Pandemic-fueled Chromebook sales surged to 14.4% share of the global PC market in Q4 2020, up from 5.3% in Q1, according to IDC. For the year, Chrome rose 4.4% to 10.8% share, a much larger gain than for Apple, which went from 6.7% in 2019 to 7.5% in 2020. Microsoft, which still dominates PC operating systems, is working on a new lightweight version of Windows. The new Windows 10X bears a resemblance to Chrome OS and is slated to launch this year in an attempt to regain lost share, particularly in the education market.

Kia’s Connected Car Network Outage
The upside of connecting everything is you can use an app on your phone to remote start and check on the status of your car. On the downside, when your car company has a systemwide outage, you can’t use your app and dealers can’t order parts, update software, and have a lot of angry customers on their hands. This happened last week to Kia, which is still trying to get their systems online. They claim the outage isn’t a result of being hacked. The rising importance of having world-class software and security remains under appreciated by many legacy companies.

Texas Deep Freeze Derails Chip Fabs
While I am usually ranting ad nauseum about the fragility of the global semiconductor supply chain related to the extreme concentration of manufacturing in Taiwan, now Texas is in the crosshairs. The brutal cold caused Samsung to take down all of its Austin capacity at a time when the industry is already experiencing significant chip shortages. You cannot simply reboot an advanced chip fab, so the capacity could remain offline beyond the current inclement weather in Texas. The WSJ reported that Austin represents 28% of Samsung’s chip capacity (according to a Citi analyst), but that number strikes us as much too high of an estimate (this report in Semi Engineering puts it at 5%). Samsung is mulling a $17B capacity expansion in the state, but they might want to look West for warmer weather. Regardless of how much capacity Samsung (not to mention many other chip companies) have in Texas, the point remains the same: the world is too exposed to an overly fragile semi supply chain.

Hazards of Digital Taxation
Maryland state legislature passed a 10% tax on all revenues from digital advertising shown in the state for any company with over $100M in yearly income from ad sales. I’ve discussed the rise of digital taxes in the past as the economy transitions from analog to digital, and, if this type of tax spreads, it would represent a meaningful negative impact to large companies like Google, Facebook, and Amazon (the three companies are backing a lawsuit against Maryland). Australia has been in the news for looking to tax Google and Facebook by forcing them to pay when news shows up in search results or is shared on Facebook. Google caved and struck a global deal with News Corp to pay for news, while Facebook just banned users in Australia from sharing any news across their social networks (and blocks any news from ‘Australia’ from being shared anywhere around the world, which raises the question: if a Koala does something cute Down Under, and no one shares it on Facebook, did it really happen?). Maybe every time someone searches for NZS Capital and clicks on our website, Google could give us a dollar? Or, when someone shares SITALWeek on Twitter, maybe I should get a dollar from Twitter too? My sarcasm here should tell you on which side of this “link tax” debate I stand.

If we step back and look at this issue from a higher level, it seems like a pretty decent chunk of the Internet economy today is a snake eating its own tail. Advertising drives app downloads and news (or more often ‘news’) consumption, which drives advertising for more games/social apps and news with more ads... On the one hand, I disagree with the way Apple is approaching their privacy changes with IDFA (I think customers should be able to clearly choose whether they want targeted advertising, and Apple’s products shouldn’t be treated as special). On the other hand, a world without an ever-bloating fake news/advertising ouroboros seems nice. I am pro-ads – combining useful ads with content can be a win-win. I also live off of and heavily support quality journalism; however, only a small fraction of the news that is feeding the snake is quality. Pardon me as I wistfully dream of how much better the world was before Facebook.

Engineering Legend Talks with Lex
Jim Keller, who recently left Intel and landed at Tenstorrent to pursue deep learning, was on Lex Fridman’s podcast last week (YouTube video version). I think the key concept that drew Keller to Tenstorrent is the general idea that instruction sets and faster processors don’t matter as much as advancements in AI and scaling of simultaneous workloads. It’s a wide ranging conversation covering many interesting topics.

Shopify Staying Seller Focused
I revisited the topic of Shopify and why I think they should NOT start a marketplace in this tweet, which includes some comments from the Shopify CEO on their recent earnings call.

Miscellaneous Stuff
Modulating Pain Perception
The feeling of pain in the human body is a complex interaction of the brain’s prediction of potential pain, feedback from damaged tissue, and the activity of neurons throughout the body. Pain itself, like all of the brain’s attempted interpretations of reality, can be conceived as a simulation. Simulating pain before feedback of real damage has the advantage of increasing endorphins, the body’s endogenous painkillers. The evolving view of pain raises the question about how big of a role the brain can play in pain relief, and VR opens up the potential to reconstruct reality in a way that can decrease the perception of pain, according to this BBC Science Focus article.

ML Throws Theory Out the Window
Inspired by the theory that the universe we inhabit might be a simulation, Hong Qin of the Department of Energy’s Princeton Plasma Physics Laboratory created a new type of machine learning algorithm to predict the nature of physical systems without any theory, e.g., predicting the motion of planets without knowing physics or Kepler’s three laws. If the universe is or acts like a simulation, then space can be broken down into discrete units, and interactions can be analyzed using discrete field theory. The algorithm may be useful in controlling the plasma in fusion reactions (something I noted in SITALWeek #277 that Google’s DeepMind is also striving for a breakthrough on). “‘In a magnetic fusion device, the dynamics of plasmas are complex and multi-scale, and the effective governing laws or computational models for a particular physical process that we are interested in are not always clear,’ Qin said. ‘In these scenarios, we can apply the machine learning technique that I developed to create a discrete field theory and then apply this discrete field theory to understand and predict new experimental observations.’” The question remains open as to whether it’s helpful to have theories of how things work, or if it’s better to just have data and be able to make predictions without theories.

Did Magnetic Reversal Force Neanderthals into Caves?
New evidence theorizes that Neanderthals retreated to caves to protect themselves from increased radiation caused by the dramatic flipping of the Earth’s magnetic field 42,000 years ago. The period also coincided with a low point of solar activity, which would have exacerbated the increased cosmic radiation and UV exposure (from shifting/reduced ozone cover). One of the more speculative, but interesting, postulations tied to this theory is that red ochre cave paintings largely came about because humans started using the medium as a form of sunscreen, and sheltering from the harsh atmospheric conditions afforded time and opportunity to create art.

Stuff about Geopolitics, Economics, and the Finance Industry
Rarifying Digital Assets
A certified version of the epic Nyan Cat meme sold on Friday for 300 ETH (worth around $590k at the time of the auction) via the Foundation app. Recently, the CryptoPunks 4156 digital avatar sold for over $1.2M. The new owners of these digital assets are in possession of a bit of code certifying they own the virtual item. These are examples of non-fungible tokens (NFTs), and they use blockchain technology to create verifiable ownership (in part or whole) of physical or virtual items. They enable the rise of collectables marketplaces like Rally Rd (see SITALWeek #265), and are increasingly used to create ownership of less tangible items like digital artwork or even tweets. I’ve talked in the past about the collision of abundant capital and scarce assets, and this trend is hitting overdrive right now as the price of everything with any sort of scarcity is rising at a rate that should also raise eyebrows. When excess liquidity is the most abundant force in markets as a result of fiscal and monetary policy (enabled by technology-driven deflation, which may just be getting started – see SITALWeek #258), and you are penalized for holding cash, the idea that money is literally burning a hole in your wallet is real. The marketplace seems to be responding with “why not” – expressed clearly by Elon Musk last week in this tweet: “When fiat currency has negative real interest, only a fool wouldn’t look elsewhere. Bitcoin is almost as bs as fiat money. The key word is ‘almost’.”

Some items have inherent value because they can be used to produce objects that create even more value, e.g., semiconductor chips that run AI that creates billions of dollars in revenue for Google. Other things are valuable because of a shared fiction that they should be valuable. Art can sometimes be uncategorizable. I tend to agree with Penn Jillette who characterizes art as the high velocity collision between the intellectual and the visceral - an explosion of thoughts and feelings. With NFTs the intellectual part is clear, but the visceral feeling for digital goods is perhaps harder to grasp.

The concept of scarcity can perhaps contribute to a visceral feeling about a digital item, and there seems to be a human desire to manifest scarcity out of abundance. I was struck by the framing of Rony Abovitz, the visionary founder of Magic Leap, on the topic of NFTs in these tweets: “in the physical world scarcity is the norm, and getting something amazing to everyone is really hard and expensive. In the digital world everyone can in theory enjoy from the cornucopia of plenty - and it is hard and somewhat tricky to make digital things scarce - because they naturally like to be free. Yet we take great pains to bring in the problems and scarcity of the physical world into the digital world. Somehow the utopian notion that everyone can easily partake in digital things is something we can not deal with as a society. It really feels like old economic theories colliding with something bigger, and the outcome is not yet clear.”

Tim Sweeney, founder of Epic, which created the popular game Fortnite, opined on NFTs in reference to this long post: Into The Void: Where Crypto Meets The Metaverse, tweeting: “This is the most plausible path towards an ultimate long term open framework where everyone’s in control of their own presence, free of gatekeeping” while also noting that the current state of the art for NFTs “is far from the 60Hz transactional medium needed for 100M’s of concurrent users in a real-time 3D simulation.”

It seems that excess liquidity in the real world has made scarcity even more scarce, and the next logical maneuver is to go from scarce analog assets to scarce digital assets. The sky appears to not be the limit, at least for now. Paradoxically, the democratization of asset ownership via NFTs may ultimately just replicate and reinforce the same concentration of wealth and scarcity dynamics seen in the analog world.

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Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #283

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, ketchup, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: billion dollar machine learning models; NFL up for grabs as streaming services increasingly need to bundle and provide more value; Jack Dorsey on regulatory capture and algorithm curation; glasses vs. goggles tech battle for augmented reality; lower power 5G; thoughts on blockchain technology; Taiwan in the spotlight; and lots more below...

Stuff about Innovation and Technology
You Say Tomato, I Say Semiconductor
Heinz has introduced their new Keystone Automatic Condiment Dispenser. Most people will see a sanitary way to perfectly proportion out 0.5 ounces of ketchup, but, as semiconductor investors, we see a new use case for an optical sensor, a safety switch, a microcontroller, and a motorized pump! Now, it really is a matter of national security that we increase US chip production. Keystone comes in ketchup red or mustard yellow.

Digital Humans Made Easy
Epic’s Unreal Engine released their MetaHuman Creator, “a cloud-streamed app designed to take real-time digital human creation from weeks or months to less than an hour, without compromising on quality. It works by drawing from an ever-growing library of variants of human appearance and motion, and enabling you to create convincing new characters through intuitive workflows that let you sculpt and craft the result you want.” The first video on this product page is a good way to see how easy it is to use and how realistic the results are.

Autonomous Lettuce Weeders
A new study in Salinas Valley – the “Salad Bowl of the World” – showed autonomous weed machines were effective at removing around 50-60% of weeds from romaine fields compared to 30% for standard human-based methods. In multiple trials, the machines removed as much as 85% of weeds in half the time.

Runaway Costs of Language Models
The Next Platform discussed the rising cost of language machine learning models, which could top $1B to run five years from now. “Bryan Catanzaro, VP of Applied Deep Learning Research at NVIDIA put this into staggering context when he told us that he thinks it is entirely possible that in five years a company could invest one billion dollars in compute time to train a single language model. Think about that for a moment.” The value of the output of these models could be in the billions, but, obviously, only a few companies will be able to afford them. In the AI race, small leads can compound into unbeatable and potentially concerning monopolies through the increasing returns of the technology.

Clouds Heading Green Energy Race
The massive data centers at Amazon, Google, Facebook, Apple, and Microsoft consume 45 terawatt-hours a year – similar in size to the energy needs of all of New Zealand – according to the FT. Overall, the tech sector (including consumer devices) only accounts for ~2-3% of global greenhouse gases; and, in the face of rapidly increasing demand, the tech giants are charging ahead to secure renewable energy and achieve carbon neutrality or, in some cases, net negative carbon footprints. The FT cites one report that tech companies have accounted for 38% of new renewable energy capacity in the last five years. Google and Microsoft are already 100% renewable for their data center energy needs. Facebook’s energy needs quadrupled from 2015 to 2019 as users spent more time consuming streaming video.

Top Dollar NFL Media Rights
Last Sunday’s big football game on CBS had 5.7M streaming viewers – up from 3.4M in 2020 – and more than double 2019’s 2.6M online viewers. Overall, viewing was down from 102M in 2020 to 96.4M across all venues (following a 1% viewing rise from 2019 to 2020). All of the NFL rights are effectively up for renewal, with a deal expected soon that could fetch as much as $100B over the next decade, a significant increase over the current $7.5B annual rights. With a lot of moving parts and various players jockeying for marquis games to bolster streaming platforms, it will be interesting to see how it all plays out.

Mega Media Bundle in the Works?
The Information speculates that Comcast is looking to bundle Peacock with HBO Max or Viacom’s new Paramount+. I’d take the speculation a step further and suggest there is a very high chance we will ultimately have a bundle of everything that is not Netflix or Disney+/Hulu. Combining, in a single consumer app, all the content from WarnerMedia, ViacomCBS, NBCUniversal, and the very long tail of stub content seems like the only way forward for both consumers and media companies. This would greatly simplify the situation and solidify the power squarely on the side of content owners rather than traditional distributors or the new connected-TV providers like Roku and Amazon Fire. There is the obvious joke about bundling, de-bundling, and re-bundling, but what’s changed today compared to the days of the cable bundle is the content owners have a direct connection with their customers.

Dorsey on Regulatory Capture and Algorithm DJs
Regulatory capture is a real phenomenon that happens over and over again – governments try to regulate companies with too much power, and, in doing so, entrench that power even more. Jack Dorsey’s sincere desire that regulation still allow for startups to thrive and new ideas to take hold is refreshing to say the least. Speaking at the Goldman Sachs tech conference last week Dorsey said: “That's really our focus as some of the proposals being made by governments around the world would further entrench some of the biggest players because of the resource requirements in order to operate them. And that really takes away from any start-up being able to start. Like if we were starting Twitter today versus 15 years ago, be very, very challenging given some of the requirements and proposals being made to even begin because of the operational needs and requirements in order to do so. So that's what we want to put first and foremost, is we need to optimize for more ideas, more experimentation, and that's really going to manifest in more start-ups being able to start and contribute to this space.” As I have mentioned in the past, I am a fan of Twitter’s algorithm curation efforts (a project called Bluesky), which would allow third parties to express different versions of a social feed. Commenting on Bluesky, Dorsey said: “The value of hosting content on a service like ours is diminishing greatly. The value of being able to recommend content on a large corpus of conversation is where everything is moving to. And that's why the focus on these recommendation algorithms and opening it up to third-party developers or companies to provide their own ranking algorithms and creating that marketplace for it and taking on a market-driven approach is so important.” We discussed the idea of algorithm DJs back in SITALWeek #272.

AR Overlay vs. Immersion
Based on various rumors, Apple is initially not planning on using the same nanostructure waveguide technology for AR that Microsoft uses in the HoloLens and Magic Leap uses in the ML1. The drawbacks of the waveguides are a smaller field of view and the energy needed to achieve acceptable levels of brightness. The benefits are that you actually get to see the real, three-dimensional world through the lens, which saves significant computational power required to recreate the world on a screen, and it leans on the brain’s ability to fill in the gaps (effectively outsourcing some of the AR computation to humans without us knowing it). It’s also, at least in my experience, less prone to causing nausea than full immersion. The Information reports that Apple’s first headset will use cameras to film and recreate the outside world on a completely immersive screen, and The Nikkei reports that Apple is working on a new display technology called micro OLED, created directly on semiconductor substrates to save power and space, possibly for an AR headset. It’s not clear (assuming any of this is even true) whether Apple’s plan is a stop gap or if their end game is to have AR be completely immersive, replicating the 3D world on a 2D surface. Sony has had micro OLEDs commercially available for a while as well, so Apple is playing catch up. Meanwhile, research continues to improve nano waveguide technology as Harvard scientists have overcome some of the aberration problems of red, green, and blue light passing through substrates.

Super Fast and Efficient 5G Chip
Qualcomm is showing off a new 5G chip called the X65 that can download at speeds of 10Gbps (under ideal conditions). While it’s true that wireless networks run on a finite amount of spectrum (limited by RF breadth) and must contend with noise-limited transmission rates (per the Shannon-Hartley theorem), as speeds increase into the Gbps range, we end up creating a lot more space in time – like increasing the volume of water running through a garden hose by turning the sprayer from ‘mist’ to ‘jet’. For example, if I can download an entire movie in one second vs. ten seconds, it frees up 90% of the previously allocated time for other users. So, concurrent usage can still be an issue, but the speeds are so fast you end up with fewer overlapping users. However, the bigger news in the Qualcomm announcement is the X65’s lower power requirements in both handsets and fixed wireless access points. That means that fewer access points and less power are needed to send and receive, both of which could significantly lower the cost of using 5G as a fixed-line broadband substitute or as a replacement for WiFi in buildings.

Miscellaneous Stuff
Literacy, Luther, and the LvOT
Becoming literate changes humans’ brains in significant ways as children grow, yielding a “specialized area in your left ventral occipital temporal region, shifted facial recognition into your right hemisphere, reduced your inclination toward holistic visual processing, increased your verbal memory, and thickened your corpus callosum, which is the information highway that connects the left and right hemispheres of your brain.” Human brains began this shift widely in the 1500s due to the religious view of Martin Luther that everyone should be able to “read and interpret the Bible for themselves”. Joseph Heinrich, Chair of the Department of Human Evolutionary Biology at Harvard concludes: “The story of literacy, Luther, and your left ventral occipital temporal region is but one example in a much larger scientific mosaic that is just now coalescing. Our minds, brains, and indeed our biology are, in myriad ways, substantially shaped by the social norms, values, institutions, beliefs, and languages bequeathed to us from prior generations. By setting the incentives and defining the constraints, our culturally-constructed world shape how we think, feel and perceive—they tinker with and calibrate the machinery of our minds.”

Stuff about Geopolitics, Economics, and the Finance Industry
High Fiber SPAC
Breakfast cereal maker Post Holdings is launching an SPAC “to partner with a company in the consumer products industry that complements the experience and expertise of Post’s management team and is a business to which Post’s management believes it can add value”. One of the peak signs of the dotcom bubble was large corporations setting up venture capital funds. Perhaps history does rhyme.

Nobody Puts Taiwan in a Corner
With Taiwan increasingly in the spotlight (see our op-ed and/or CNBC spot from two weeks ago if you missed it – apparently even Biden is taking our advice 😉: “The Biden administration has pledged to take immediate action to address a global shortage of semiconductors that has forced the closure of several US car plants”), the island nation is in a great position to get other countries to directly acknowledge its sovereignty, which represents a challenge to neighboring China’s view of the situation, as the FT reports: “‘Everyone sees this situation and thinks that they cannot ignore Taiwan any longer’, John Deng, Taiwan’s trade representative, told the Financial Times. ‘This is definitely beneficial to Taiwan’s trade agenda.’”

NZS’ Complexity Investing Gets a Minor Facelift and Digest Version
If you liked the Brian Arthur review article on Complexity Economics that I talked about last week, you’ll love our paper Complexity Investing, which our tireless editor has cleaned up with seven years (!) of typo feedback. And, there is a brand new condensed version of the paper that we just published. Both can be found here.

Blockchain Technology
Blockchain-based technology, which effectively decentralizes trust, represents a significant innovation for financial transactions. As the internet moves information from centralized to decentralized, pockets of closely held information are increasingly not a source of advantage over others, which continues to have a massive impact on our world. Institutions that hoard information centrally and monopolize trust will increasingly become disrupted. We therefore follow closely the potential for blockchain tech to create a new financial operating system and democratize asset ownership. That optimism always needs to be balanced with the massive regulatory complex of the banking industry, which, in part, preserves dinosaur companies and harms consumers but is also useful for tracking down criminal activity.

It’s not clear yet how the battle will play out between financial innovation and the luddite banking sector, but the fight is certainly underway (our tech regulation paper on pace layers discusses how governments eventually catch up to technological disruption, and, in doing so, often tragically cement the incumbents). If financial innovation follows other trends in the analog-to-digital economic transition, then solutions that maximize non-zero sumness, or win-win, should prevail.

We suspect that, over time, more companies will transact in Bitcoin or other blockchain-based cryptocurrencies, and it makes sense for companies to hold reserves in currencies they transact in. In that light, Tesla buying $1.5B of Bitcoin probably makes practical sense given they are going to accept it for vehicle sales. It's logical that a digital currency will rise to prominence as the economy drops its analog shackles. Whether that digital currency will be Bitcoin, and what value it will hold, are questions left to the future unknown. But in the present, there seemed to be a lot of misplaced cynicism over Tesla’s Bitcoin buy, in particular related to Elon Musk. I suspect many people are bothered by Musk because he is a real person. Many people have come to expect that famous, wealthy, and/or intellectual people are robots playing a role without personality or conflict. (Elon's 2nd appearance on Rogan last week was an enjoyable conversation covering many fascinating technology topics.) Further cynicism over Tesla buying Bitcoin is related to the environmental impact of the energy consuming currency. Those concerns might be valid in the short term, but, longer term, blockchain technology could help reverse expensive negative externalities of the analog, Industrial Age economy; and, blockchain technology could even be used to create and tax the carbon economy, which would have far larger positive ramifications than the energy costs of Bitcoin.

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Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #282

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, B. nana's, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: What is going on with Google Cloud’s money pit? The low power hurdle for commercial EVs; RISC-V GPUs; talk radio is new again; small cells for 5G; more on chip shortages; complexity economics; and lots more below...

Stuff about Innovation and Technology
Commercial EV Fleets Have Low Mileage
Amazon’s new custom electric delivery vans from Rivian are hitting the road in 15 cities this year with hundreds of thousands to come in the next few years. The vans only have a range of 150 miles, presumably because most routes are close to distribution hubs. Given that the short range should save on batteries to keep costs down – on top of the operational savings of the electric drive trains – I expect we could see a rapid transition of fleets of all types in the coming years. That might even include police cars, as this California town tests out Tesla Model Ys, which only have to cover the department's average of 26 miles a day.

The Internet of Greens
Engineers at MIT modified spinach with nanoparticles that enable the live plants to gather information on chemicals in ground water and then send that information via email. “The plants employ a pair of near-infrared fluorescent nanosensors—single-walled carbon nanotubes (SWCNTs) conjugated to the peptide Bombolitin II to recognize nitroaromatics via infrared fluorescent emission, and polyvinyl-alcohol functionalized SWCNTs that act as an invariant reference signal—embedded within the plant leaf mesophyll. As contaminant nitroaromatics are transported up the roots and stem into leaf tissues, they accumulate in the mesophyll, resulting in relative changes in emission intensity...These results demonstrate the ability of living, wild-type plants to function as chemical monitors of groundwater and communication devices to external electronics at standoff distances.” (Nature Materials PDF)

RISC-V GPU
RISC-V supporters have begun developing a GPU based on the open-source processor architecture. The idea is to add a GPU ISA (instruction set architecture) to the RSIC-V CPU ISA for anything ranging from a microcontroller (MCU) to a full scale GPU, but developers will focus on low-cost MCUs to start. The idea isn’t to displace the giant GPUs of Nvidia or AMD, but instead to enable GPU workloads where you might not expect to use them without having to strip them down and customize the instructions.

Audio Social Media Musings
Sometimes when a portion of the analog economy goes digital it transforms into something entirely new and different, but sometimes it’s just a digital version of the same old analog behavior. The more I reflect on the rise of audio social media, the more I come back to my ‘digital audio as radio’ analogy from SITALWeek #216, “Will Podcasts Kill the Talk Radio Star”, where I discussed the $40B global radio advertising TAM: “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 many ways, an app like Clubhouse could be analogized as simply talk radio with the equivalent of call-in guests or a live podcast with audience interaction (with a social hierarchy overlay). Clubhouse can also be analogized as digital industry panels. In that sense, audio social media doesn't yet feel like something new, but it could certainly evolve over time. While we’re making analogies and everyone wants to fix Section 230, maybe it wouldn’t be so bad if the FCC’s Obscene, Indecent, and Profane Broadcast rules applied to streaming audio apps as well. I of course don’t actually want that, me and the late George Carlin agree on this topic. So maybe, instead, just a little more self-censorship is in order for the people who like to hear themselves talk.

Large Deal for Small Cells
Joe chimes in on small cells: there has been a lot of spirited debate regarding the attractiveness of small-cell telecom infrastructure and its returns, but in a seminal deal announced last week, Verizon signed an agreement with Crown Castle to lease 15,000 small cells over the next four years. This move signals a change in direction for the former (who has ~14,000 small cells on air today, nearly all of which they built themselves) and much needed validation to the latter, who has had to defend their large investments in the space against peers and investors alike. We at NZS have long been believers in the shared-infrastructure business model, as it lowers the cost to customers while creating attractive returns for the infrastructure owner (a true win-win scenario). Now, with telecoms and others staring down at a $95B bill for the acquisition and clearing of C-Band (which is likely to end up on both small cells and macro towers), utilizing shared economics remains imperative in order to keep budgets in the realm of reasonable.

Tech Insiders
CTO and President of Digital at Fox, Paul Cheesbrough, has started a newsletter on technology that I highly recommend. Paul is very knowledgeable on all things enterprise software, hardware, and streaming. His newsletter, produced in conjunction with Melody Hildebrandt, kicked off with a deep dive on live-streaming challenges (Fox partners with AWS for big live events like the Super Bowl). And, Paul has some insightful thoughts on new Amazon chief Andy Jassy.

Google Cloud’s Puzzling Losses
Google’s cloud business, which includes their public cloud (GCP), as well as G Suite apps, lost $5.6B on revenues of $13.1B in 2020. In the fourth quarter of 2020, Google Cloud’s overall revenue was up 47% ($3.8B total) over the prior year with a loss of $1.2B (similar to their Q419 loss). In 2016, at around the same level of annual revenues for AWS, Amazon reported $3.4B of operating profit on revenues of $12.2B, even as they were pioneering the business of cloud computing and growing at a pace of over 50% per year. Microsoft’s Intelligent Cloud segment reported $14.6B for their December-quarter 2020 revenues with $6.4B in operating profit (it’s not a direct comparison to GCP in terms of revenue mix, but I’m just using it as a proxy for a scale cloud business). I would like to speculate that G Suite, with over 6M paying customers, should be similarly profitable; therefore, I’ll admit to not being able to get my head around the implied extreme GCP losses. On Google’s conference call, the high expenses were explained due to the company tripling its salesforce and investing in the sales channel. Amazon has a large sales and customer support effort, but it’s obviously much smaller than Google’s based on spending. Are Google’s gross margins on cloud services possibly negative? There is some indication that marquis customer (Snap, TikTok?) contracts are being delivered with extremely unfavorable economics for Google, or perhaps they are giving out very large credits to customers. Sundar Pichai’s response to a question comparing Google Cloud margins to competitors might hint at that as an explanation: “one thing I would say is...we get into these long-term deals. And so over time, as you add more cohorts, that contributes to the margin structure. It is -- the scale of the product offerings, the number of areas and the number of regions in the world, there's a much more significant investment.” This would make it difficult to estimate the real cost of cloud services for companies that rely on GCP. Maybe Twitter got a great deal on their new GCP collaboration as well? Google says they are building ahead of revenue, but it should be easy to scale cloud servers and storage in lockstep with demand. If this extreme negative profit model is what it takes for Google to grow their cloud business, I am left puzzled as to what the end game is for them. On the other hand, the cloud market will ultimately be measured in the trillions, so I don’t want to lose the forest for the trees. But, why is Google Cloud’s profitability on such a dramatically different path than that of Amazon and Microsoft?

US Housing Market Flourishing
Redfin reports that the median home sales price in the US was up 15% for the month of January compared to the same period last year, hitting a record high of $318,250. Meanwhile, inventory was down 36%. In total, 22% of sales in December 2020 were new construction, also a record high.

Miscellaneous Stuff
New Nano Chameleon is Bananas
A newly discovered species of chameleon in Madagascar is the size of a sunflower seed. It’s likely that Brookesia nana, (B. nana, for short) is the current record holder for smallest reptile; although, with swiftly vanishing habitat, its title may be short lived. Miniaturization of species is an interesting phenomenon, with size limits unknown. As vertebrates get smaller, the ratio of surface area to volume increases, which makes creatures more susceptible to water loss and provides less room to pack in all the vital internal organs.

Stuff about Geopolitics, Economics, and the Finance Industry
Semis’ Achilles Heel
Last week, NZS posted an op-ed on the importance of building leading-edge chip capacity in the US. Increasingly, the global economy runs on semiconductors – from the servers in the clouds to the phones in our pockets. However, the vast majority of these chips are made in Taiwan and South Korea. With automakers shutting down factories due to shortages, which could possibly extend to critical healthcare, industrial, and military needs, the risks are everywhere. A single strategic military action or natural disaster in one location in Taiwan could cause Apple to miss quarters – or even years of iPhone shipments. I also appeared on Squawk Alley on CNBC Thursday to discuss the topic.

Complexity Economics
We at NZS Capital have long been big fans of Brian Arthur, and he has a great new Nature Reviews Physics article on Complexity Economics. Viewing systems and their agents – like an economy and its consumers – through the lens of biology and complex systems is a complete inversion of conventional economic wisdom. In complexity economics, disequilibrium is the equilibrium state. We believe that once you realize that the economy is a complex adaptive system, you can let go of any pretense of being able to narrowly and accurately predict the future and instead focus on ensuring the resiliency and adaptability of your organization/investments. This thinking should replace all the outdated and dead wrong nonsense currently taught as economics; however, you’ll note that this paper wasn’t published in an economics journal, as the establishment is not keen to admit how wrong they are. Economics, as it is traditionally taught, relies on the simplifying assumptions of perfectly rational agents who all think alike, share the same needs, have perfect knowledge, and seek equilibrium. These assumptions have little – if any – relevance to the world we experience. Most importantly, in real life, the individual’s path through time never conforms to the average collective path of all humans, in stark contrast to yet another foundational fallacy of traditional economics. As the economy continues its transition from analog to digital – from industrial to information to AI – nonlinear dynamics, positive feedback loops, and power laws will dominate, and complexity economics and complex adaptive systems are the best tools we have for successfully navigating the present and planning for the future.
“Complexity economics sees the economy or the parts of it that interest us as not necessarily in equilibrium, its decision makers (or agents) as not super-rational, the problems they face as not necessarily well-defined and the economy not as a perfectly humming machine but as an ever-changing ecology of beliefs, organizing principles and behaviours.”

✌

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #281

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, supernovas, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: A trillion on Twitch; 5-minute batteries; voices in your head; AI on microcontrollers; kids' streaming; wasted energy; more math on SaaS growth; the problems with Wall St.’s "risk" models; and lots more below...

Stuff about Innovation and Technology
Twitch’s Trillion
Twitch reported 26.5M average daily visitors – who watched a total of one trillion minutes of video (averaging out to ~100 minutes per day per viewer) – for 2020.

Extreme Battery Charging
Multiple battery companies are working on removing the graphite anode charging bottleneck in lithium batteries in an attempt to drive charging times down significantly, to ~5-10 minutes for an EV. Enevate is a startup working on pure silicon anodes, and StoreDot in Israel is replacing graphite with germanium nanoparticles that allow ions to pass more quickly. Notably, StoreDot claims to be in commercial production of their new batteries. (Musk has previously communicated that breakthroughs are one thing, but massive commercial scale production is quite another). If any of these novel anode techniques take off commercially, the benefits are obvious for EV adoption, especially for long-haul trucking, which requires refueling with electrons along the way. Meanwhile, as part of a plan to be carbon neutral by 2040, GM will exit gas/diesel vehicles by 2035. The clock is ticking, and GM has a lot of catching up to do across a variety of technologies. Back in SITALWeek #213, I referenced the labor union problem that legacy automakers face as they shift from combustion to EV, with the latter requiring 40% fewer hours to assemble. It’s a multi-faceted set of headwinds to say the least. As I mentioned last week, car makers might end up becoming contract manufacturers for software companies.

Apps Proliferate During Pandemic
The always informative Okta report on cloud app trends came out last week showing ongoing adoption of cloud software during the pandemic. Microsoft continued its power climb thanks to Office 365’s ranking as the #1 app in all regions globally. The number of apps used by companies has grown ~22%/yr over the last four years to an average of 88 apps. However, large companies with over 2000 employees averaged 175 apps. Growth of app usage was largest for the government, at 43% versus the prior year. The full report breaks out trends for many categories of software spending. See below for more on cloud software revenue growth.

New Killer App for Phones: Talking
Clubhouse, Discord, Twitter Spaces, and various other features and startups focused on audio-only social networking have been gaining popularity. As we move into a world of ambient audio with hearables and, eventually, ambient video with augmented reality, the movie Her frequently comes to mind (still the best movie I have seen about what our future with AI assistants might look like). Once upon a time, we humans heard voices in our heads, but we didn’t have the cognitive tools to understand that they were part of our own multi-faceted consciousness. I am not sure what the value of always having other people’s voices (or unending conversations) in our heads really would be. One thing seems certain: the increasing scarcity of quiet time will put an even bigger premium on being able to disconnect.

Morass of Valuable Kids’ TV
The enormous amount of kids’ video content is fragmented across so many apps that it seems like half of my child’s screen time is me trying to figure out which show is on which app and which smart device I need to use to play that app. But, it’s also the most valuable content for any streaming platform because all you need is one show on one app that your child likes, and you'll be unlikely to churn off of it. Variety reports on the surge in kids’ TV programming and the race to capture this demographic in the post-linear TV world before they are sucked into Roblox, Minecraft, and TikTok, etc. Notably missing is Amazon, which started strong with incredibly well done shows, like Tumble Leaf, but has since largely abandoned the category.

Miniaturized AI for the IoT
Researchers at MIT have created TinyNAS, an AI engine that can optimize for various microcontroller processing and memory capabilities. The trick researchers came up with was in shrinking the engines down while maintaining accuracy, so they could be added to a variety of connected devices (which typically only have MCUs, which lag higher performance application processors) to offer locally-computed inferences against a neural net. The lines will continue to blur between processors and MCUs, and we are likely to keep seeing AI add-ins everywhere.

Ecommerce Bump Less Than Thought
US Census Bureau data shows that ecommerce share of retail grew to around 16% by November 2020 from 13% in November of 2019, and after pulling back from a 19% peak in April. If the 16% holds (some of that is likely to revert back post vaccines), that represents a pull in of a year or two versus the longer-term trend of 1-2% offline-to-online shift per year. Ecommerce gains are far less than many charts and estimates indicated in the middle of 2020. A widely shared report from McKinsey, claiming ten years of ecommerce growth was packed into the first quarter of last year (with ecommerce surging to over 30% of retail sales), appears to be completely unverifiable hype looking back at the actual data. The shift is limited by the logistics and costs of moving the economy from a retail distribution model to a home delivery model. Those higher costs are being born by people paying more for the same thing as well as companies’ and investors’ willingness to subsidize unprofitable business models, which may prove the bigger limitation over time than delivery capacity.

Miscellaneous Stuff
Texas Vineyard, Anyone?
According to a survey by Silicon Valley Bank, almost half of US winery owners (including those in Napa and Sonoma) are considering the possibility they might sell their wineries in 2021. The main increase appears to be in the groups “seriously considering” or “likely” to sell, which tally to ~29% of owners. Texas vineyard owners seem most inclined to sell, and, with the growing Northern California diaspora in the Lone Star State, I suspect some deals could get made!

Energy Efficiency Regression
The fluvial Sankey diagram is a fascinating look at US energy usage, showing energy lost and gained along the various branches and tributaries. The long-term rise in car usage and air conditioning have more than offset energy efficiency gains. Industrial energy conservation has also dropped dramatically, as that sector increasingly uses leaky electricity over direct fuel sources. In 2019, 34.5 exajoules were used while 71.2 were wasted – significantly poorer energy efficiency than in 1950! An accelerated shift to EVs could help a lot because, despite relying on the electric grid, they have approximately one quarter of the wasted energy of a gasoline car. Speaking of leaking energy, shifting from audio to video conferencing significantly increases energy consumption, with a one-hour video call equivalent to burning up to a ~1/10 gallon of gasoline.

Supercomputers Solve Supernova
Supernovas are cool as long as you aren’t right next to one: “For much of a star’s life, the inward pull of gravity is delicately balanced by the outward push of radiation from nuclear reactions inside the star’s core. As the star runs out of fuel, gravity takes hold. The core collapses in on itself — plummeting at 150,000 kilometers per hour — causing temperatures to surge to 100 billion degrees Celsius and fusing the core into a solid ball of neutrons. The outer layers of the star continue to fall inward, but as they hit this incompressible neutron core, they bounce off it, creating a shock wave. In order for the shock wave to become an explosion, it must be driven outward with enough energy to escape the pull of the star’s gravity. The shock wave must also fight against the inward spiral of the star’s outermost layers, which are still falling onto the core.” Until recently, scientists weren’t sure how the cascading explosions occurred; but, thanks to more powerful computers, they now believe turbulence behind the shock wave provides a necessary boost in pressure and extra time for the matter behind the shock wave to absorb neutrino energy, allowing the wave to achieve escape velocity.

Stuff about Geopolitics, Economics, and the Finance Industry
Projected SaaS Growth
Following up on last week’s post discussing a framework for high-growth SaaS valuations, a reader suggested we look at how big the revenues would be for today’s public SaaS stocks at various growth rates. We took a little shortcut and tallied up revenues for the top-20 SaaS companies by market cap and added in the cloud revenues from Microsoft, Amazon, and Google. We made a couple of assumptions and judgement calls, so this analysis is purely hypothetical and not meant to justify anything one way or the other. With that warning in mind, we came up with around $138B in revenues in 2021 and $173B in 2022, up around 25% using street forecasts. Over the last five years, this group has grown revenues at nearly 40% (weighted average by sales). If they were to continue that blistering 40% pace, we would have over $2T in sales in 2030, which is larger than the estimated $1-1.5T cloud software TAM. Growing at 25% would give around $1T, and growing at 15% would give $530B. If you look at the table in last week’s email, a basket of SaaS stocks growing revenues at 25% over the next decade would have a hypothetical return of 15% if they were trading at a mid-teens multiple of forward revenues and ended the period with at 30x FCF and 35% FCF margins. 25% growth for the entire group would of course be remarkable. As I said last week, this is by no means investment advice, just a framework (with lots of assumptions) to reason through potential scenarios.

Institutional Risk Assessment Failures
There are two important parts of investing: 1) finding good investments, and 2) sizing them correctly for their potential range of outcomes. Larger positions should be companies with a smaller range of outcomes and safer predictions, while smaller positions can have a wider range of outcomes and asymmetric upside dependent upon precise predictions of the future coming true. Most institutional investors can assemble a good list of investable companies, but few can size them correctly in a portfolio. This shortcoming is largely due to investors’ serial overconfidence clashing with the unpredictability of the world around us. Most investors are uncomfortable facing the reality that they can’t predict the future (a concept we cover in more detail in Redefining Margin of Safety).

The reason I mention this risk framework is due to the topic of the week: GameStop. What we at NZS Capital have learned from studying complex adaptive systems is that we should expect the unexpected and prepare accordingly. It’s surprising how many high-standard-deviation events – with seemingly astronomically low odds – happen with relatively high frequency. But, there is a reason for that – the math most investors use to calculate risk is faulty. It assumes normal distributions, doesn’t take into account that volatility is not constant over time in Brownian motion, and assumes ergodicity, all of which are false for complex adaptive systems like the economy and stock markets. I think retail investors can and should try to beat the pros. We know they have very good odds of beating the pros long term if they just invest in low-cost index funds and don’t try to time the market. And, I think retail investors are perfectly capable of doing good research on individual stocks. Learning to correctly size those positions within a portfolio should also be within reach for thoughtful retail investors.

Now let’s bring this back to GameStop: a few institutional investors did not appear to account for the outlier event of r/wallstreetbets’ impact on GameStop stock and other highly shorted securities. To paraphrase the narrator in Fight Club: I am Brad's complete lack of surprise. Maybe they were using bad math, but they certainly didn’t internalize the idea that the economy/markets are complex adaptive systems – and shift their framework from normal distribution to power law/exponential outcomes accordingly – or consider the chaos potential from multi-agent systems. What we saw with GameStop was a much bigger scale repeat of what we saw with Yahoo Finance message boards in 1999, enabled by the democratization of stock and option trading with zero commissions (and likely assisted by institutional investors jumping in on the frenzy). Democratization of asset ownership enabled by new technologies is just getting started. We have a world that has increasingly split into two economies – one where people own and benefit from appreciating assets, and one where people rent assets for higher and higher fees from the people who own assets. Any way we can democratize asset ownership – whether it’s stocks, collectables, real estate, or access to private company profits – will help redress inequality long term.

I fear that recent events could bring regulation that stifles innovation and democratization of asset ownership. Senator Warren sent a letter to the SEC on Friday remarkably asking: “What steps will the SEC take to ensure that securities markets better reflect prices that are in line with the intrinsic and fundamental value of underlying companies?” Perhaps we could create a new cabinet position: Secretary of the DCF? (Longtime readers will detect my sarcasm on DCFs!). The idea that it's possible to accurately price an asset to reflect its future value is absurd because the future is unpredictable – it's all assumptions, estimations, and guesswork, with various strategies yielding different outcomes. The increased risk for regulation of fintech startups called for by the banking lobby complex to save their legacy businesses, which are largely based on negative-sum dynamics that take advantage of customers, is concerning. Irresponsible behavior by fintech startups is particularly unacceptable as it could push back much needed innovation in the financial sector by decades.

There is a difference between long-term investment in the capital appreciation of assets and short-term investing/gambling. Clearly, there is an element of using options, leverage, and hype that is always going to be a greater fool’s game. It’s entertainment, and everyone has an entertainment budget in their spending. Gambling and investing are both ways to make (and lose) money, but they shouldn’t be confused with each other. Both are susceptible to big losses with the wrong risk framework. Many investors, including most professionals, seem unable to fully make the distinction between gambling and investing, much less apply an appropriate risk framework. While we’re on the subject of gambling, I’d wager institutional investors engage in risky behavior to a much greater degree than retail investors, and with far greater consequences. This is no time to hamstring the newcomers. On the contrary, we should be stepping up efforts to educate neophyte investors, thereby empowering them to take control of their own financial future. This is one of the big reasons we publish all of our investing frameworks and send out this newsletter.

Everything humans do involves story telling. All short-term investing is just that – telling a story. And, sometimes, through the power of reflexivity, stories end up creating a long-term narrative that actually drives a business and creates real free cash flow. Figuring out which stories are true (and which are false) over the long term is a bit trickier, but it’s within the reach of any class of investor, and I am delighted to see a new generation excited to learn about the public markets bringing us “one step closer to economic equilibrium”.👊✌

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #280

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, lightning, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Aggregating health wearable data with AI; vertical integration in the analog-to-digital shift; the “software is eating the world” memo failed to arrive for many industries; more context on Intel and its path forward; how to think about valuations on high-growth software companies – a lesson in expected returns and range of outcomes; and lots more below...

Stuff about Innovation and Technology
Skin Temp Trumps Internal Temp
Connected ring maker Oura released some interesting insights on the value of temperature data for predicting health. Health wearables measure skin surface temperature, which, surprisingly, may be more useful than measuring internal temperature. The body works hard to keep your core temp between very tight bands of 1-2 °F (0.5-1 °C), and it uses your skin to help accomplish that. As a result, your skin temperature can vary by 27 °F (15 °C) in a day. Oura measures skin temp every minute, and new study results validate the readings as being useful for a variety of potential health indicators. Deriving the most powerful future health benefits from wearables may lie in aggregating data from multiple wearables, your phone’s sensors, and third-party devices (like connected blood pressure cuffs) and running it all through a local AI inferencing model on your phone (for privacy) to detect potential problems. And, in the more distant future, imagine a smart toilet with sensors sending data to your phone-based AI health hub to diagnose more troublesome diseases like cancer.

Alto Luxury Taxi
Alto is a Texas-based ride-hailing company that operates its own vehicles, employs drivers directly, and provides benefits. In addition to providing on-demand rides, the company will also deliver food and run errands. The cost, according to D Magazine, runs around double (or more) similar rides from Lyft and Uber. Alto is expanding to Los Angeles from Dallas and Houston. I was not previously familiar with Alto, but it seems more accurate to describe the startup as a modern, luxury taxi service rather than a ride-sharing company. A common pattern that we see when a legacy business model goes digital is that vertical integration is key to creating the highest value platform. Uber and Lyft are horizontal demand aggregators with decentralized drivers using their own cars for ride sharing and third-party restaurants for food delivery. That model has so far created a lot of consumer surplus, but it has not necessarily created a lot of value for drivers or profits for the platforms themselves (and mixed results for restaurant profits). Although Alto is small (100 drivers and 60 SUVs in Dallas), I’ll be interested to watch their progress as a more vertically-integrated digital platform. In the food and grocery delivery space, I’ve long argued vertical integration and new business models (e.g., dark kitchens and purpose-built grocery fulfillment centers) will have the best chance of success, and it’s worth considering how many horizontal gig platforms would be much more successful as vertically-integrated service providers. For an extreme example of the value of data in vertical integration to improve service quality, checkout how Picnic uses genetic algorithms to schedule trucks.

It’s All Software these Days
It’s been nearly ten years since Marc Andreessen explained that “software is eating the world”; but, even with a decade to prepare, most analog, Industrial-Age businesses remain completely naive or willfully ignorant. The WSJ ran an article on the problems VW has had with software: “After years of development, Volkswagen decided in June last year to delay the launch and sell the first batch of cars without a full array of software, pending a future update, which is now scheduled for mid-February. Tens of thousands of ID.3 owners will have to bring their cars in for service to have the new software installed.” One of VW’s mistakes was to outsource its software development to parts supplier Continental, which is itself an analog, Industrial-Age business. The rising complexity of software- and AI-driven product transitions seems to require early vertical integration in order to succeed. Tesla is the obvious example of vertical integration leading to an edge in EVs. One of the most successful examples of vertical integration leading to a large platform lead is obviously Apple, which is heavily involved in phone development (including its own processors) but outsources manufacturing (which has created some supply chain human rights violations). Apple may take the same tactic in cars by using an existing car maker as an outsourced facility for a rumored Apple Car. The FT reports Hyundai may be looking at that outsourced role. The rumor raises a broader question of who is best positioned to bring analog businesses into the AI Age? Will more software leaders of the 21st century increasingly use the 1900’s roster of industrial companies as contract manufacturers across a wider range of products? It’s a basic idea of abstraction, and the heart of the issue is where the intelligence lies and where platform value is created.

Technology Taxes to Restore Local Coiffures?
As industries go from analog to digital, one unexpected result is a loss in local taxes. This issue was identified and partially resolved in ecommerce, but it’s starting to impact other areas. Gasoline taxes are one interesting area to watch as cars shift from combustion to EV – those taxes often pay for road maintenance, and the EVs are using the same roads. (Unrelated, checkout these commercialized EV batteries with nanoparticle electrodes that have a 5-minute charging time!). Another interesting example is local cable franchise fees paid by the cable operators to towns across America. As people shift to streaming, this revenue is lost, so three municipalities in Georgia are suing Netflix, Hulu, and others to get 5% of their gross revenues for people living in those districts. Overall, a “digital tax” is likely coming to many areas of the economy.

Intel: The Case Against Outsourcing
Jon Bathgate chimes in on Intel: We heard another call for Intel to spin out its manufacturing operations last week from Ben Thompson, echoing the message from Third Point's open letter to Intel last month. The fundamental problem with this argument is that, while a potential Intel foundry would be forced to survive on its own (which would certainly energize some much needed innovation), it would have no customers besides Intel's core operation, at least for several years and possibly much longer. The context is important here – Intel has dipped its toe into the foundry market several times over the last decade but never made any noteworthy progress, and its flagship foundry relationship with Altera was a disaster up until it was swept under the rug when Intel acquired Altera outright in 2016. The foundry business is all about manufacturing leadership, ecosystem, and customer centricity, and Intel is unlikely to have any of these attributes for at least the next five years.

Why would any customer choose to work with Intel's inferior technology with no surrounding ecosystem? Obviously, manufacturing on US soil is an advantage for sensitive applications like aerospace and defense, but there is very clear momentum for US chip manufacturing starting with TSMC's Chandler, Arizona fab – which they deemed "Phase 1" on their earnings call last week (hinting at plans for a much larger US footprint) – and Samsung is likely building out more leading-edge capacity on US soil as well. The US government could offer to be a demand backstop for Intel, but it would need to offer up billions of dollars in support (in the form of guaranteed demand); we feel US government support would be much better put to use supporting the broader semiconductor ecosystem – including Samsung, TSMC, and their customers – as they move towards propping up leading-edge manufacturing in the US.

In the meantime, based on Pat Gelsinger's early observations at Intel, the company is committed to the IDM (integrated device manufacturer) model. He also indicated they will work more closely with the broader ecosystem (which Intel has not done well historically) and has not shied away from the idea of licensing process technology from Samsung or TSMC (as mentioned by Bob Swan in this interview), which could be a fairly elegant, non-zero-sum outcome for all parties. The computing part of the cloud is increasingly a commodity as the data center itself replaces the server as a broader unit of compute. In that context, Intel needs to remain cost and power competitive per unit of performance against Arm, ASICs, GPUs etc. See Intel’s Paths Forward in #277 for more context.

Fake News Engine Stalls
WaPo reports that online misinformation about election fraud dropped 73% after Trump was banned across social media sites. “The research by Zignal and other groups suggests that a powerful, integrated disinformation ecosystem — composed of high-profile influencers, rank-and-file followers and Trump himself — was central to pushing millions of Americans to reject the election results and may have trouble surviving without his social media accounts.”

Miscellaneous Stuff
Stratospheric Lightning
Blue jet lightning is a type of lightning that shoots straight up from the tops of clouds up to around 50 km above the surface of the earth and lasts for several hundred milliseconds. The phenomenon may happen as a result of turbulent mixing within a cloud that causes oppositely charged regions to come within close range (~1 km) of each other. A cool looking blue jet was recorded by the space station in 2019 and recently analyzed in a Nature paper.

Stuff about Geopolitics, Economics, and the Finance Industry
Analyzing SaaS Growth Stocks
The largest forty companies that went public in the last two years have current market caps totaling $1.1T. In our year-end letter, we mentioned that some growth stocks imply a single-digit expected return over the next decade. By way of example, we created a simple matrix that yields implied expected returns of high-growth SaaS stocks. (If you aren't interested in a speculative dive into high-growth stock valuations and hurdle rates, now is the time to jump to the end for conclusions or better yet, go do something more productive with your day!) Longtime readers know how I feel about DCFs (see “Non-Ergodic Systems Bury the DCF”), and this matrix is guilty of being a type of implied DCF. The nice thing about using SaaS for this example is it has several knowns with reasonably predictable ranges of outcomes. The TAMs (total addressable markets) for various parts of enterprise software are well analyzed by the industry, and we are far enough into cloud adoption that we know the degree to which it can be TAM expanding. There are also reasonable estimates that put total cloud spending at ~$1-1.5T in ten years. We have a decent idea about mature FCF margins because it’s fairly easy to look at a category leader in on-premises software and subtract 10-20 points of margin for the cloud infrastructure tax (depending on the data intensity of the application). That leaves us with two macro assumptions in the matrix, which are the same two that make all DCFs a challenge: 1) predicting interest rates and 2) knowing the path through time (see prior link for more). On interest rates, what I did for the purposes of this table was to assume that, in ten years, a quality compounding-growth company would have a similar multiple of FCF as it has today, which is around 30x forward FCF (I realize that’s a completely debatable statement on multiple levels!). I would also advise that, if you do an exercise like this one, you use the real, fully-diluted share count and adjust ten-year growth rates by several percent in dilution per year for stock option grants.

With those assumptions and warnings aside, I’ll give one final cautionary note: this is not meant to be stock advice. I am not talking about any specific stocks, and this is just a tool to think about implied expected returns for high-growth stocks. For this matrix, I assume an FCF multiple of 30x in ten years, an FCF margin of 35%, and I start every company at $1B in revenues today because many SaaS stocks are around that level (or will be approaching it soon). Let’s pick a couple of examples of hypothetical stocks out of the table based on those parameters. All multiples below are EV to forward-1-year revenues.*
-A company that can compound revenues at 10% per year from today will give you a 5% expected return if it’s trading at 15x, or a 12% expected return if it’s trading at 8x. In ten years, it would have $2.3B in revenues.
-A 20% topline compounder over ten years trading at 21x today will give you a 9% expected return and have $5.2B in sales in ten years. At 15x, it would yield 13% expected return.
-A 30% topline compounder over ten years trading at 39x today will give you a 9% expected return and have $10.6B in sales in ten years. At 24x, it would yield a 15% expected return.
-Just for fun, a 50% compounder over ten years trading at ~100x sales would give you an expected return of 11-12% and end with $38B in revenues and $13B in FCF.

What did I learn from this? It comes down to your expectations around the range of outcomes for a specific high-growth software business and what your expected rate of return is for the risk associated with that range of outcomes. The faster a company is growing, in general, the wider the range of outcomes and the higher sensitivity to the growth rates. So, is a 5-6% expected return worth an investment given the range of outcomes for the early-stage company and its ability to win or expand its TAM? It’s important to look at the revenue number in ten years and think about the TAM the company operates in, as well as adjacent TAMs. It is very difficult to find examples of software companies that compounded well above 20-30% once they achieved over $1B in revenues (but, it’s also still a relatively small sample size for cloud software companies of this size, and cloud is obviously different than legacy on prem). This comes down to your own hurdle rates and your portfolio construction process. At NZS Capital, we account for these variables in position sizing. If the range of outcomes is wide and the expected return is not as high as one would like to accommodate that range of outcomes, then it is an Optionality position if the asymmetry still warrants owning it. The last point I would make is that the rare SaaS company with real FCF today has the potential to create higher returns over time by redeploying that capital into M&A or stock buybacks and dividends. That scenario is hard to capture in an analysis like this, but it’s important to think about how the management team will allocate capital, whether it’s from FCF or dilution from acquisitions and stock options.
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*The equation for each ‘EV / 1-Year-Forward Revenues’ cell is:
[(Starting Revenue) x (1+Rev CAGR)^9 x (FCF Margin) x (FCF Terminal Multiple)] / [(1+Hurdle Rate)^9] / [(Starting Revenue x (1+CAGR)]

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #279

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, lassos, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: transparent business model coming to prescription drugs; Qualcomm bolsters Arm processor business while Intel finds a new CEO to help them respond to the threat of Arm; increasing risk of cloud concentration; robot sommeliers; what makes a good idea from Nick Cave; the velocity of information and how to fix the Internet; and lots more below...

Stuff about Innovation and Technology
2020 Year-End Letter
NZS Capital’s year-end letter is now available on our website. You can also find part of the market commentary at the end of this email.

Handy Beverage Butler
Samsung debuted a concept robot at the virtual CES this year called Bot Handy. The robot is intended to be a helper around the house anytime you need an extra hand, but I believe its most popular feature is acting as a bartender on wheels. Bot Handy can even pour a glass of wine, leaving me to ask only one question of Samsung: Where were you in March of last year when we needed this most!?

Non-Zero-Sum Prescription
The Mark Cuban Cost Plus Drug Company is a new venture from the prolific entrepreneur to make generic drugs with the following mission: “We will let everyone know what it costs to manufacture, distribute, and market our drugs to pharmacies. We add a flat 15% margin to get our wholesale prices. This makes sure we remain viable and profitable. There are no hidden costs, no middlemen, no rebates only available to insurance companies. Everybody gets the same low price for every drug we make.” We talk a lot about the increasing transparency ushered in by the Information Age and the corresponding need for businesses to focus on non-zero-sum (NZS) – win-win outcomes that maximize benefits for all constituents. The idea of bringing transparency plus lower cost to an established market fits right in with that view of the world. MCCPDC plans to have 100 drugs available by the end of 2021 and will build manufacturing capacity in Dallas.

Virtually Sliming the NFL
CBS Sports teamed up with Nickelodeon and the NFL to project live, augmented-reality graphics and videos onto gameplay for a separate kids version of the Saints vs. Bears. Touchdowns resulted in “virtual geysers of slime bursting from the field”. The rest of the on-field graphics for 1st down markers, etc. all got a Nickelodeon makeover. The game also featured broadcasters focusing on educating kids about the game as the NFL tries to grow their younger fan base.

Qualcomm Leveling Up Processor Power
Qualcomm plans to acquire Nuvia, the Arm processor startup helmed by a team of ex Apple and Google chip designers. In SITALWeek #258, we noted that Nuvia was “blowing the doors off performance-per-watt standards with their new Arm processor with a single core boasting twice the performance for a fraction of the power – only 3 watts”. Nuvia, as of early 2020, was being sued by Apple for conspiring to start a new business while employees were still working at Apple, and Nuvia countersued Apple. Qualcomm is no stranger to lawsuits with Apple, having dropped a high-profile battle in 2019. Nuvia was rumored to be focused on servers, but the announcement sounds like it’s not a data center focus. I’d be surprised though if Qualcomm doesn’t leverage this team to restart their previously failed Arm server efforts and go all in on processors for laptops and PCs. Microsoft, who blurbed the Qualcomm press release on the deal, is playing catchup regarding Arm implementation, for both the data center and portables, compared to Amazon, Google, and Apple. Qualcomm would be a natural partner if Microsoft doesn’t acquire its own chip business first.

Intel’s Step One Rehab Complete
Intel announced that company veteran Pat Gelsinger will return to take on the CEO role. In “Intel’s Paths Forward” in #277, my first recommendation for Intel was to hire an engineering- and product-minded CEO, and Pat is a great choice. Pat will breathe oxygen into the strong engineering culture at Intel and rally the troops, but the next steps ahead of him are daunting in the race to maintain share against the rise of Arm in PCs and Servers. Intel will wait until Pat’s February start to make any manufacturing decisions, but last week outgoing CEO Bob Swan floated the idea of licensing tech from a foundry (presumably TSMC or Samsung) for deployment at Intel fabs rather than fully outsourcing manufacturing. I think this could be a smart win-win if TSMC or Samsung is up for it. Either company could set up shop inside of Intel’s US-based leading-edge fabs and help establish new processes in return for a licensing fee rather than building new capacity. However, TSMC’s big increase in capex guidance leaves open the option that the latter may happen as well.

Chains Vying to Take Share of Takeout
Established restaurant chains are experimenting with virtual brands and virtual kitchens. Denny’s launched The Burger Den and the Melt Down, both of which will feature some popular items cooked up in Denny’s existing kitchens, but only available via delivery with 3rd-party partners such as DoorDash. Other companies experimenting with virtual brands include Brinker, Applebee’s, and Bloomin’ Brands. Meanwhile, Noodles & Company and Fat Brands are opening ghost kitchens this year. Fat Brands plans to use ghost kitchens to grow their recent Johnny Rockets acquisition. The ability to experiment with virtual brands and new menu items could drive a positive feedback loop benefiting existing locations and could favor the big chains taking share of the takeout market. These share gains come at the expense of local restaurants, who struggle to compete with well capitalized, national ghost-kitchen operations, as Portland Eater explains.

ISP AUPs and the Risk of Cloud Saboteurs
As rising global security risks coincide with a shift to more homogenous cloud infrastructure, we may see companies rethink how many of their eggs they put in each basket. Infrastructure analyst Lydia Leong at Gartner penned a helpful recap on anti-spam, ISPs, and ToS takedowns in light of AWS and others shutting down Parler. To be clear, if your company is doing illegal things, as defined by the governments of the countries you operate in, and/or you are in violation of your agreed-upon terms of service, then you have no right to operate on those platforms. The Gartner article made it clear that if you are in violation of your ISP’s acceptable use policy, then you might not have anywhere else to run (except perhaps Russia) due to the near universality of the agreements. Further, security vulnerabilities due to single points of failure are rising – a reality highlighted when BI reported that Amazon was implementing “‘blocked days’ in parts of the US, a designation that prevents employees from making any major updates or changes to services without the approval of the company's most senior leaders” in response to the events of January 6th. Amazon further “warned its data-center employees to be extra cautious about their safety after threats to attack the company”. As the ability to create hybrid cloud and multi-cloud implementations becomes easier, it seems likely that the world may move more toward heterogeneous workload locations, or at least maybe not as fast towards ‘one cloud to rule them all’, in order to reduce the impact of security breaches (perhaps the next iteration of Among Us could be designed around ferreting out the traitors at a cloud-services behemoth).

Walbank
Walmart is partnering with Ribbit Capital to start a fintech company to serve the 16% of US adults that are considered “underbanked” (without a bank account or limited bank account use).

Miscellaneous Stuff
Distinguishing Gems from Frass
Nick Cave discusses how a writer knows when they have written something worthwhile in Red Hand Files #130: “One day, you will write a line that feels wrong, but at the same time provides you with a jolt of dissonance, a quickening of the nervous system. You will shake your head and write on, only to find that you come back to it, shake your head again, and carry on writing — yet back you come, again and again. This is the idea to pay attention to, the difficult idea, the disturbing idea, shimmering softly among all the deficient, dead ideas, gently but persistently tugging at your sleeve...” He also warns against the easy ideas: “Beware, however, of the idea that comes too easily, as this is often a residual idea and only compelling because it reminds us of something we have already done”. At the risk of taking an incredibly beautiful answer from Cave and sullying it, I found his advice very similar to what it’s like when I find a compelling investment idea (sorry Nick!); but, perhaps the similarity just exists because both experiences are rooted in that elusive concept of Quality.

“Lasso Locomotion”
Invasive brown tree snakes brought to Guam from Australia have learned how to move vertically up tall metal poles by forming a lasso and shimmying upwards. The new form of motion for snakes was a fast adaptation to scientists trying to protect nesting birds by mounting their nesting boxes on poles.

Post Truth, WCW, and David Arquette
After finishing the movie, You Cannot Kill David Arquette, I wasn’t sure if it was a documentary, a mockumentary, or my favorite: a perplexing combination of the two. I discussed this latter genre in #207 in reference to the Amazing Jonathan and Bob Dylan ‘documentaries’. Writing about the Arquette movie, which details his attempted return to the world of professional wrestling, Variety drew further post-truth parallels with wrestling and the world at large today: “For decades, wrestling has said to its audience: ‘You love this because you pretend it’s all real! Yet the truth is that most of it is fake! And we let you know it’s fake! But by being so upfront about the fakery, we turn it into its own reality! So it’s not fake after all! It you believe in it enough!’”

Stuff about Geopolitics, Economics, and the Finance Industry
Fiction’s Viral Spread and the Role of “Utili-Publishers”
Truth travels slower than fiction. Tall tales can spread and evolve quickly and with ease. However, the truth requires time for reason and logic to balance the emotions evoked by an idea. The Copernican Revolution, which put the Sun at the center of Earth's solar system, and Darwin’s On the Origin of Species, which put natural selection and evolution at the center of biology, probably would not and should not have traveled through society at the speed of the Internet before ample evidence supporting the theories had been compiled. When fringe ideas prove right, they often become the heart of human innovation and progress – lightning bolts that ignite vast new areas of knowledge and research and bring increased understanding to the world, thus elevating our awareness and humanity. When fringe ideas are based on falsehoods, or come from a point of fear and/or hate, they have as much power to destroy as beautiful ideas have to create.

What seems to be at issue since the invention of today’s market-dominating online social networks (as well as the powerful cloud platforms that host the startup and smaller social networks), is the speed at which different types of information travel. Information not having to do with an immediate threat to safety or need for assistance should percolate slowly. Ideas need time for contemplative thought, reaction, argument, debate, and resolution. The truth is hard to find, and crafting it from the evidence is not a quick process. Our brains are wired to believe, and when the velocity of information is too fast, it hijacks those pathways and the truth becomes even more elusive.

But, we are presented with a problem because the Internet is today’s means of communication. The market-dominating social networks and cloud platforms are a new beast, an emergent hybrid of utility and publisher to which don't fit with the current laws. A combination of the phone company and the newspaper, both vitally important, but very different things. AWS is no longer just a compute utility, it is also a publisher deciding what can and cannot be said online. Apple and Google are both utilities and publishers, and even Internet services providers (i.e., the "phone" companies) could become publishers, deciding what can or cannot pass over their networks. Online social networks and cloud platforms enable people from all over the world to discuss the marketplace of ideas, including fringe ideas, instead of just a small group in one city or an isolated handful of academic experts. They open ideas to much more feedback, cooperation, and collaboration. If we cut idea formation off from the Internet, it’s like cutting people off from pen and paper or the telephone – it’s severing their basic means of communication.

The solution appears to lie in three places. First, over time, humans will get better at understanding and coping with the speed at which information is traveling, but we are in a race against the clock on that front. In the meantime, unvetted ideas need to be intentionally slowed down and isolated in the digital realm. Second, the same rules regarding protected speech that apply to utilities and publishers need to apply to Internet “utili-publishers”. As such, platforms should each adopt a formal policy for what they will and will not allow to be published on their sites (they have all refused to do this out of fear they lose the pretense of being only utilities, and not also publishers). We’ve been through decades of court battles over what is and is not protected speech and discrimination – we don’t need to reinvent the wheel. If someone has a problem with a theoretical platform policy (e.g., should anti-vax propaganda be protected speech?) that’s a question that can and should be resolved via the legal system without the government unilaterally dictating what is and isn’t protected speech. We've also been through centuries of court battles over what is and is not considered incitement. And third, the world needs to do a better job of supporting people displaced by the economic transition from analog to digital. A growing group of folks are increasingly weighed down by forty years of rising inequality and globalization from the Information Age that have left them far worse off than they should be. It is possible to achieve the best of all worlds where fringe ideas that are true and useful can be vetted and proven to help lift everyone up, while those ideas that are destructive wind up in the dustbin of history.

Capital Joins ANT March
Capital Group plans to enter the active ETF market in 2022. Capital joins Fidelity, T. Rowe, Natixis, BlackRock, Invesco, and others in the march to offer active non-transparent ETFs (ANTs) as the legacy mutual fund model continues to offer no better returns, often higher fees, and potential tax liabilities.

2020 Year-End Letter:
NZS Capital’s 2020 year-end letter is available here, and you can read a partial excerpt from it below:

The fourth quarter progressed through a backdrop of uncertainty and volatility toward potential light at the end of the tunnel with the approval of several promising vaccines. A small group of highly valued companies has been leading the market higher since the beginning of the global pandemic. The market dynamics are a striking echo to behavior during the dotcom bubble, with the important exception that, today, companies with ballooning valuations represent a much smaller part of the overall market.

You cannot invoke the term bubble without concurrently discussing time horizons and hurdle rates. The idea of a bubble in the present time implies that valuations will correct down over the short term. High starting points for valuations also imply that long-term returns will be lower. However, if your expectation of equity returns over the next decade is lower than historical figures, then even valuations on some stocks today are not high when measured against a 3-5% hurdle rate. Most of us, however, strive to do much better than single-digit returns on equities, and, therefore, many stocks today become uninvestable even on a five- to ten-year time horizon. Low interest rates are of course at play when any investor considers their hurdle rate for long-term returns. And, the lower rates drop, the more short-term valuations are sensitive to small changes in interest rates.

When we think about valuation and position sizing in the portfolio, especially in the context of an equity bubble, we focus primarily on whether the range of outcomes is widening or narrowing (a concept we covered in more detail in our Third Quarter 2020 Letter: “If you let a winner run even though the range of outcomes is still very wide, then you are explicitly making a large bet on a narrow prediction about the future, which means all you have done is increase the risk in the portfolio. And, in turn, you are starving resources for new Optionality positions.”). To never sell or trim a stock simply due to a high valuation, no matter how large the opportunity might appear, would be a misunderstanding of risk at the portfolio level – at some point that strategy becomes gambling rather than investing. As always, we remain vigilant about the range of outcomes and implied returns across our strategies. With the world still in the early stages of the global economic transition from analog to digital, many sectors are still presenting good investment opportunities for long-term growth.

The research process at NZS Capital is always guided by the unpredictability of the world around us. Our lens on the world, which does not rely on narrow predictions of the future, is ideally suited to the current state of the markets. We believe companies that maximize non-zero-sum outcomes for all of their constituents, including employees, customers, suppliers, society, and the environment, will also maximize long-term outcomes for investors. Our view of the world informs our portfolio construction process, which combines a relatively small number of Resilient companies with a long tail of Optionality companies. Resilient businesses have very few predictions underpinning their success and a narrow range of outcomes, while Optionality businesses have a wider range of outcomes and their success hinges upon a more specific view of the future playing out. This combination of long-duration growth with asymmetric upside is well suited to navigating the increasing pace of change throughout the global economy.
Continued here.

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Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #278

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, avocado armchairs, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Chips in short supply; the shift in deferred payments from credit card balances to buy now pay later providers; video game viewing is growing faster than video game playing; GPT-3’s abstract images; premium scripted content comes to audio; the extraordinary grind of autonomous driving; some bubble perspective; and lots more below...

Stuff about Innovation and Technology
Epic Mall Rat
Interactive world builder and gaming engine Epic Games is taking over a distressed shopping mall in Cary, North Carolina for their new headquarters. Some of the structures may be demolished as they create a campus that combines office and recreational space. There must be a joke somewhere in this news about Dawn of the Dead, zombie-mode video games, and Epic moving to a soon-to-be abandoned mall, but the punchline eludes me.

Video Game Spectating Outpacing Playing
SuperData reported 12% growth for the video game sector in 2020 across console, PC, and mobile to $140B. Growth accelerated from 6% before lockdowns in January and February to 14% for the remainder of 2020, but that’s only marginally above the 10% growth the industry has seen for the last decade. I would have guessed higher growth given how many people were locked up at home with no place to go. In total, 55% of US residents played video games during the initial COVID lockdown. SuperData’s forecast, which I wouldn’t put much weight on, calls for only 2% growth in 2021. Growth of video gaming revenue seems to be far slower than that of video game spectating, as suggested by YouTube Gaming’s recent report of 100% growth in hours viewed from 50B in 2018 to 100B in 2020.

Sleep Monitoring via Radar
Both Google and Amazon are working to bring wireless sleep monitors to your nightstand. Google is said to be working on a new Nest Hub containing its Soli radar, which could be used to monitor sleep, or lack thereof. Amazon is working on a small device that would sit on your nightstand and use millimeter-wave radar to track sleep, including potential sleep apnea. It’s suggested that the device is part of the Alexa family, but I also wonder if it has more to do with Amazon’s accelerating ambitions in healthcare following the shuttering of the rudderless Haven joint venture with JP Morgan and Berkshire. STAT News reported on the acceleration of Amazon Care’s intentions as Haven failed to launch.

Illustrating Language
When OpenAI’s GPT-3 language model came out, I found myself in the camp of folks like Melanie Mitchell who noted the language model’s inability to analogize and make abstractions. But, I’m not an expert by any means on AI learning and language models, so I deferred any judgement to experts. Last week OpenAI extended GPT-3 with image recognition, which allows you to ask it to conjure images of things such as “an avocado armchair” or “a baby daikon radish in a tutu walking a dog”. As MIT Technology Review reports, this extension of the model seems to give some level of abstraction, or perhaps a better illusion of abstraction, which may be comparable to the best visual interpretation of language that some of us humans could ever hope for.

BNPL Takes Share
“Buy Now, Pay Later” (BNPL) is on the rise in the US during the pandemic in a period where it seems younger people are using credit cards less than older generations. According to data from Experian, total credit card debt has fallen from a 2019 record of $829B to $756B over the past year. That drop seems to perhaps be connected to the $116B reduction in spending on food/beverage and apparel (less eating/going out) that I wrote about in the final section of last week’s newsletter. I would speculate that postponed vacations also play into reduced credit card debt. So, there are certainly a host of pandemic-linked factors potentially contributing to less card-based debt burden; but, if data from Australia (where BNPL is a popular option) are any indication, the trend of shifting deferred-payment purchases from credit cards to BNPL seems plausible. The Australia data show that the number of credit cards have declined from over 16.5M to under 15M since 2017; meanwhile, BNPL volume has increased from $100M to $700M (comparing units vs. AUD is not terribly useful, but it’s a striking contrast in directional change). It will be interesting to see how credit card share of deferred payment transactions changes as the economy opens back up.

Celebrity Storytelling
The WSJ reports on actors doing podcast storytelling: “A-list celebrities like Matthew McConaughey, Kristen Wiig, Rami Malek and Cynthia Erivo are turning to scripted fiction podcasts with the production qualities of TV and film—just without the pictures”. When you combine this trend with Netflix testing audio-only for videos in its Android app, there is an emerging trend of scripted, premium audio akin to old-time radio programming. I wonder if this ambient audio trend is temporary until the slew of connected glasses are released in the coming years, in which case every podcast may have added video elements. In the meantime, the balkanization of podcasting – with certain shows becoming exclusives and various platforms being acquired (like Wondery’s sale to Amazon) – is making things harder for consumers. Clearly, a better model needs to exist to monetize the rapidly growing listening category by shifting and growing the $40B+ in global radio ad dollars.

Semi Shortage Hits Autos
The FT reports on a global shortage in semiconductors for automakers as capacity is being hoovered up by demand for leading-edge datacenter and mobile chips and the associated demand for discrete, peripheral chips that go into the same PCs, servers, phones, etc. As a result, VW is apparently cutting Q1 production by 100,000 vehicles. Likewise, Nissan and Honda will also be reducing production. Chips have become less cyclical over the last two decades as the industry has rationalized; however, it is no stranger to booms and busts caused by double ordering in good times. That said, underlying demand drivers over the next several years – from AI, cloud, IoT, 5G etc. – remain healthy. Semi Engineering posted their 2021 CEO outlook with views on growth from various industry players.

Out with “Self-Driving” in with “Fully Autonomous”
Waymo’s CEO John Krafcik described (FT) the “extraordinary grind” of rolling out fully autonomous vehicles. Note that Waymo said in this blog post that they no longer call it “self-driving”: “It may seem like a small change, but it’s an important one, because precision in language matters and could save lives. We’re hopeful that consistency will help differentiate the fully autonomous technology Waymo is developing from driver-assist technologies (sometimes erroneously referred to as ‘self-driving’ technologies) that require oversight from licensed human drivers for safe operation.” If I were cynical, which I try desperately to avoid, I might suggest that it’s quite a good idea to do high profile press about the tough slog of autonomous when the funding environment for startups is as fast and loose as it is now. Waymo’s $3.2B fund raising was “the single largest capital raise for a pre-revenue company in the history of the universe” according to Krafcik.

Miscellaneous Stuff
AI Tackling Human-Animal Language Barriers
Michael Bronstein at Imperial College and the Cetacean Translation Initiative is working to use AI to understand animal communication, according to New Scientist. Bronstein is looking to build a “sperm whale chatbot that can feed learned patterns of codas back to the animals to see how they react”...I hope we don’t accidentally offend them. Other AI language initiatives around the world include trying to detect signs of stress or pain from animals such as chickens and sheep.

Stuff about Geopolitics, Economics, and the Finance Industry
Dry SPAC Powder
The FT reports that SPACs have around $300B of acquisition firepower based on $70B raised in 2020.

Who Knows What?
Back in SITALWeek #213, I wrote a brief follow up to The Great IPO Debate about the risk of apparently legal – but questionable – trading on potential insider knowledge ahead of direct listings. Private market investors, management teams, and employees obviously have greater information on a company before it goes public (e.g., more history with the company than what can be adequately disclosed in the S1), and they are not typically subject to a lockup period if it is a direct listing. If there is relevant information that private investors possess that public market investors do not, lockups can provide public investors more time to do research before insiders and the prior private investors can sell. The traditional IPO process, while not perfect by any means, does allow for some protections that help level the playing field for insiders vs. public investors, and SPACs allow theoretically sophisticated investors to complete extensive due diligence prior to merging with a private company. Asymmetric information advantage is something to keep in mind with any type of private to public transition because at the point a company goes from private to public, many prior, private investors become short-term holders, while the new public investors become long-term holders. If I had to rank the risks of the various ways of going public for public market investors, I would rank traditional IPOs as lower risk than SPACs, and SPAC as lower risk than direct listings. Caveat emptor.

Investing Insights from a Dotcom Veteran
During the dotcom bubble, Scott Schoelzel managed the Janus Twenty Fund, a concentrated mutual fund that in many ways represented the market dynamics of the late 90s. Bloomberg’s Trillions podcast spoke to my former colleague about the parallels between twenty years ago and today in the markets. Having started my career at Janus as an intern in 1998, I can say that Scott is one of the more uniquely qualified people to provide valuable perspective. We'll discuss our market outlook including views on valuations in our year-end letter next week.

✌

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #277

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, ancient food carts, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: The importance of seeking 2020's lost randomness; Intel’s paths forward; cash everywhere and the specter of inflation; AI-driven nuclear fusion; multiplatform gaming; lockdowns drive better sleep; negative-sum business model of food delivery; the limitless potential of reinforcement learning; and lots more below...

Stuff about Innovation and Technology
Biohybrid Smellicopter
University of Washington scientists have developed the smellicopter: “an autonomous drone that uses a live antenna from a moth to navigate toward smells”. The video shows the drone navigating with an antenna of a moth connecting two wires, enabling conversion of chemical signals (odors) to electrical ones. Following smells autonomously could allow it to find gas leaks or unexploded bombs.

20 Seconds of Fusion
The Korean Superconducting Tokamak Advanced Research (KSTAR) nuclear fusion device, aka an artificial sun, was able to sustain plasma temperatures of 100 million degrees for 20 seconds. That’s more than twice the eight-second record achieved in 2019. The research group has a goal of five minutes of operation by 2025. DeepMind’s Demis Hassabis also let slip that Google is working on AI to control plasma in nuclear fusion.

Amazon’s ‘Couture’ Clothing
Amazon’s new “Made for You” clothing uses images taken by your phone to create a body double. You can then customize clothing (for now it appears to only offer a t-shirt for a reasonable price of $25) and see how it will appear on you.

It’s Among Us
Popular bluffing game Among Us continues its meteoric rise from 295M monthly active users in October to nearly 500M in November. That’s enough to beat out top mobile game rivals Candy Crush and Pokémon Go. Among Us appears to be the most popular game ever as measured by the number of monthly players! And, game-maker InnerSloth only has four employees. As more games go multiplatform (allowing simultaneous play across mobile, PC, and console) we may see more fickle behavior and boom/bust cycles for games than in the past.

COVID Streaming Surge
The number of streaming subscriptions grew 50% in 2020 to just over 250M total in the US, with the household average going from 2.7 to 3.1 services according to data in the WSJ.

Better Living through Lockdown?
Smart-ring maker Oura discussed its 2020 data suggesting that social distancing might be good for our health. I might modify that to say physical health (and perhaps not so much mental health). The data from 45 million nights of sleep showed a significant drop in nighttime resting heart rates (RHR), which is typically a sign of better health and recovery, from 2019 to 2020. Oura also discovered that RHRs follow seasonal patterns – peaking in December and troughing in the summer, although the exact reasons for that remain under investigation. The lack of going out on weekends was a big contributor to lower RHRs in 2020, as alcohol, lack of sleep, and eating late can all increase RHRs. People are also going to bed earlier and waking up later (perhaps the effect of not having to commute in the morning as much). I can’t help but think about how much of this benefit is accruing to white collar workers who have fared much better during the pandemic – another example of widening inequality.

Instacatch-22
Americans spent $53B less on food and drink through November 2020 (compared to the same 11 month period of 2019) as grocery and liquor stores gained $80B in sales while restaurants/bars lost $133B according to US retail data tallied by Jason Goldberg of Publicis. Despite near-ideal tailwinds in 2020, the business of delivering some of those food/beverages continued to search for a model to support the value placed on it by investors. I have been tempted, like a good Bayesian, to update my paper from 2019, The Evolution of the Meal, but it’s not clear the tumult of 2020 changed my credences. It continues to appear that vertical integration and a mix of store pickup options are currently the only path to profitable digital food sales of any significant size. Beyond that, a profitable delivery model will also likely require subscriptions and routing to grow beyond a large niche market of affluent households. I continue to think most food delivery service providers find themselves in a Catch-22 (see #252): if they want to be profitable, they will need to begin to build and operate their own stores/restaurants; but, if they want to scale quickly, they will also need to maintain their existing store/restaurant customers, which are increasingly not best served by third-party delivery services. The WSJ reported on the predicament of Instacart, which had its first profitable month in 2020 since being founded in 2012. However, their grocery store customers complain they don’t make any money off the orders after the 10% commission. Most delivery businesses today are zero-sum or perhaps even negative-sum propositions (in which the end consumer benefits at the expense of the store/restaurant). If you further take into account the treatment of the contracted drivers, then it seems clearly negative sum. And, the delivery businesses are still being subsidized by investors making an increasingly narrow prediction that scale will improve economics over time without significant changes to the business model.

Intel’s Paths Forward
Intel was in the news as the company’s ongoing manufacturing struggles caused an activist investor to send a letter to the board. The letter seemed to simultaneously suggest that Intel consider exiting or selling its semiconductor fabs and also enter the business of designing different, custom chips for cloud giants, which would require access to leading-edge fabs and a host of design capabilities Intel doesn’t currently possess. Putting aside the poorly-informed suggestions in the letter, there are some good options for Intel to get back on track. First, replace the financial-minded CEO with a product person, preferably someone with really strong engineering chops. Second, Intel should keep and milk its cash cow x86 manufacturing capacity (focusing on leading-edge rather than bleeding-edge manufacturing). X86 chips might be losing share of compute workloads as Arm moves into PCs, but it will be a predictable fade that will allow Intel to generate FCF for several more years. Meanwhile, x86 servers will stay in high demand even as workloads grow on Arm, GPUs, and custom silicon – it’s a situation of “and” not “or” for x86. Third, Intel should outsource the leading-edge portion of its chips to TSMC or Samsung (this can be done in the world of chiplets, where components are made separately and then assembled into one 2.5D/3D multi-die package). Fourth, Intel should get together with Apple, Amazon, Google, Microsoft, and others to form a JV with either TSMC or Samsung. This should be a massive $100B+ effort to build a leading-edge chip supply chain on US soil for geopolitical reasons (and common sense). And fifth, Intel should put in a $50B+ rival offer to acquire Arm with the same JV fab consortium of Internet platforms and foundries. That last item is a long shot (and there are a lot of reasons why it’s an insane suggestion, but it sure would be fun to watch play out). Among other things, it would be a $50B acqui-hire of Simon Segars to be the CEO of Intel. Those pipe dreams of investing in their future aside, what will most likely happen is Intel will just buy some more stock back and end up as one of the more spectacular examples of roadkill in the brutal technological disruption cycles. Failure to adapt creates an existential crisis, which can happen for a number of complex reasons even in a tech industry as old as semis. If you’re interested in learning more about semi tech and where the sector is headed, check out Brinton and Jon on The Knowledge Project podcast and our whitepaper and podcast from earlier this year.

YouTube Phenom MrBeast
MrBeast (Jimmy Donaldson) spent the last several years figuring out what types of videos would produce the most views on YouTube and leveraging the site’s mysterious algorithm to go viral. “Make a clip too long, no one watches or wants to watch another. Make one too short, people won’t linger. Use a bad thumbnail photo or title and no one will click....His videos often blend three popular YouTube genres. There’s the outrageous challenge, such as staying inside a block of ice for a day or being the last one to leave a vat of ramen noodles. There’s the celebrity guest appearance...And there’s the reaction video...” According to Bloomberg, his videos cost on average $300,000 to produce, and MrBeast is said to generate tens of millions of dollars in advertising across his various streaming and social media accounts. The MrBeast YouTube channel has nearly 50M subscribers. Donaldson was in the news recently for launching a nationwide burger chain overnight (well, likely with months of planning) leveraging existing kitchens in 300 restaurants. The MrBeast Burger app was the 2nd most popular free iOS download on the launch day.

Miscellaneous Stuff
Ancient ‘Hot Dog’ Cart
Scientists unearthed a very well-preserved fast-food stand in Pompeii. The brightly painted stand – known as a thermopolium – sold various dishes, including duck, pig, goat, fish, and snails, out of earthenware bowls built into the counter along with wine and hot beverages. In addition to the striking paintings on the food stand, it is quite remarkable how little has changed in 2000 years, except perhaps that now you can get fast food delivered thanks to generous investors.

Is Minimizing Free Energy the Ultimate Reward?
David Silver is the principal reinforcement-learning research scientist at Google’s DeepMind for AlphaGo, AlphaZero, and MuZero, an AI engine that learns on its own as described in a recent Nature publication. This Wired interview contains several interesting comments from Silver, who believes that a machine will eventually be able to do anything a human can: “The brain is a computational process, I don't think there's any magic going on there”. Silver views reinforcement learning, i.e., reward-based learning, as the entirety of AI (and, by extension, how the human brain may work). According to Silver: “the reward-is-enough hypothesis...says that the essential process of intelligence could be as simple as a system seeking to maximize its reward, and that process of trying to achieve a goal and trying to maximize reward is enough to give rise to all the attributes of intelligence that we see in natural intelligence”. Recall in SITALWeek #271 we discussed Karl Friston’s principle of free energy (i.e., the brain is optimized to minimize prediction error). Friston believes that giving AI the directive to minimize surprise would make for a superior training model. Importantly, because minimizing free energy is an internal (rather than an external) reward system, it’s a good candidate to be the ultimate reward in the hypothesis Silver referenced. I haven’t seen mention of DeepMind focusing on free energy, but a 2018 Wired article notes that some of Friston’s students have gone on to work there. David Silver was also on Lex Fridman’s podcast back in April.

Seeking Randomness
Several years ago, engineer Max Hawkins wrote an algorithm to randomize his life. He had realized that his life was so predictable that it was entirely questionable as to whether he, as a conscious organism, was even necessary for his routine to be dutifully completed. So, Max let a randomizer take over. Instead of deciding where to eat, shop, socialize, exercise, or even live, the program would make the calls (like hailing an Uber for a destination unknown...or ordering a move to Mumbai) with no input or oversight from Max. Thanks to his years-long experiment, he discovered an astounding, enjoyable array of experiences he would have missed if the algorithm hadn’t forced him out of his comfort zone. The Debugger article from Medium goes on to suggest that the increasing dominance of algorithms from social media, streaming services, etc. are exerting control over our lives and digging deeper and deeper ruts – narrowing and reinforcing our routine rather than expanding our horizons (which, for globally-connected network platforms, seems rather disappointing). This article struck a chord with me because the invariant repetition dictated by 2020’s pandemic lockdown has served to dig those grooves so deep that we are now desperately lacking randomness – the ad hoc, unexpected, and crucial connections that make life interesting and create opportunities for creativity and growth. On the surface, the fact that we rebel against monotony might seem to contradict Friston’s theory of free energy minimization being the driving force for life – isn’t lack of surprise what the brain wants? Recall, however, that curiosity and a drive to explore are critical components of the free energy principle – if you don’t create a knowledge map of your environment, you leave yourself open to surprise. Apparently, when everything is the same, there’s no new data for our Bayesian-based neural prediction machines to chew on, creating an internal crisis. Our rate of learning even impacts our perception of the passage of time – without new experiences, time seems to move more quickly (see this Vox article on COVID’s impact on our sense of time). For many people right now, the grooves are so deep the record player isn’t even playing music anymore – a potentially dangerous situation. The Debugger article reminds us that once we get used to following orders (e.g., from questionable algorithms, ads, and/or the echo chamber of social media) the mind control can lead to unwanted behaviors with potentially devastating consequences. It’s good to remember that it was curiosity, randomness, and luck that got humans to where we are today instead of exclusively remaining part of the fossil record. If you find yourself still stuck in a 2020-era rut, it might be worth thinking about ways to introduce more positive randomness into your life.

Stuff about Geopolitics, Economics, and the Finance Industry
$3.4 Trillion
The seven largest tech companies added $3.4T in market cap in 2020. And, coincidentally, S&P 500 companies hold $3.4T in cash on their balance sheets (up from $1.3T in 2019) as US companies overall borrowed $2.5T in 2020. The FT also reports that, according to Leuthold, the number of zombie companies – those with debt payments higher than profits for three years in a row – has risen to an all-time high (e.g., an estimated 15% of US small-cap companies). Household cash levels also rose in 2020, in part thanks to the financial health provided by the previously mentioned $53B decline in spending on food/beverages as well as the $66B decline in spending on apparel (it seems that dressing up to go out to eat puts a big burden on our wallets!). Even colleges are getting in on the cash-raising action – selling a record amount of debt in 2020, according to the WSJ, as investors look to earn a little scratch on all that cash sitting around (a situation reminiscent of charitable foundations selling debt earlier this year). The specter of short-term inflation is slowly going from translucent ectoplasm to potentially visible ghoul as an economic post-vaccine rebound seems increasingly likely. The Economist reports that, in 800 years of data, typically inflation goes up after pandemics. It would seem crazy not to expect pockets of rising inflation short term. Long term, however, it still feels like a tug of war between cash in the system and deflationary/disinflationary trends that have been underway for 40 years – and potentially just beginning to accelerate in the AI Age. For more on that topic, see the end of SITALWeek #258: Can We Harness Technology’s Deflationary Pressure?

Amplified Vaccine Skepticism
The first 14 million doses of vaccines will start expiring in late January, and with the current paltry pace of injections, more than 4M doses may very well end up wasted. The NY Times reports on the myriad reasons the US has failed so far to effectively administer vaccines efficiently. And, the LA Times indicates vaccine skepticism is one of the reasons that 20-40% of frontline healthcare workers in LA County decided to delay or pass on being vaccinated. Facebook, YouTube, and (to a lesser extent) other Internet platforms not taking responsibility for the misinformation on their sites is now putting human lives at risk on a grander scale than ever before.

✌

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #276

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, the winter solstice, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Mainstreaming Arm in the data center; movie making on a holodeck; app stores; the balancing act of multi-sided marketplaces; Netflix speeds up and goes audio only; humidity helps fight viruses in winter; genetically engineering against swine viruses; and lots more below...

Stuff about Innovation and Technology
Tweets via Arm on AWS
Twitter is migrating algorithmic timeline feeds to Amazon’s Arm-based Graviton2 processor on AWS. It’s hard to overstate how big of a milestone it is to have a large-scale platform with complex real-time computing needs running on an Arm-based processor in the cloud. Implementation of the latest, 5nm semiconductor process node has finally opened the floodgates for low-power Arm chips – from the Graviton2 in servers to the M1 in Apple computers. Microsoft is rumored to be playing catchup with their own Arm-based silicon for servers and PCs (recall that two weeks ago I suggested Microsoft should consider acquiring a large Arm chip designer to catch up more quickly as shifting from x86 to Arm is increasingly existential). The switch to Arm in the data center and computers will put significant upward pressure on the supply chain as processor demand is increasingly handled by TSMC and Samsung more so than Intel. The previous chicken-and-egg hurdle of shifting the entire software stack is fading away quickly. This shift continues to underscore the strategic, global importance and extreme vulnerability of Taiwan, and it continues to argue for a JV between US chip companies, Internet platforms, and hardware makers for building $100Bs in US-based semi fab capacity. In related meta news, Amazon is now using Graviton2 to run Synopsys software to design its own chips.

StageCraft a Cinematic Paradigm Shift
Buried in the middle of a long and impressive look at the enormous amount of content coming to Disney+ over the next couple of years was a discussion of Industrial Light and Magic’s new StageCraft filming technology. Developed in conjunction with Jon Favreau (who, we’ve noted in the past, is a big fan of filming in virtual reality worlds like Unreal and Unity), the tech appears to have moved from VR to the real world with a holodeck-like giant, circular, high-def LED screen surrounding a sound stage. The projected world can be completely controlled much like a video game. There is a good video on the first version of StageCraft used in The Mandalorian Season 1, and if you go about 1 hour and 17 minutes into this analyst day video you can get a good peek at the latest version. The newest generation of StageCraft, recently used on The Mandalorian Season 2, merges all stages of production (including pre and post) – with big efficiency gains – and has been vastly improved since The Mandalorian’s first season. This advance seems likely to have a huge impact on film making in the post-COVID world, and appears vastly superior to green-screen filming, where actors must imagine the background rather than experience it. In addition to the current StageCraft facility, Disney is building three more – in LA, London, and Australia. And, yes, I want one.

Spotify now on Epic as Music Streaming Growth Slows
Epic Games announced the availability of Spotify in its app store last week. The move portends a bigger effort by Epic to compete with mainstream app stores in the future. While Epic is still locked in legal battles with Apple and Google, beginning late next year with the launch of Version 12, Google will make it easier for 3rd-party app stores like Epic to run on Android phones. Assuming standard terms apply, Spotify will keep 87.5% of revenues from the app on Epic compared to 70% on iOS and Android, which could incentivize Spotify to make the app cheaper for Epic signups. Epic’s app store has over 100M users. In other music streaming news, Billboard reports a leveling off of listening, perhaps due to people spending more time on social apps, playing video games, and listening to podcasts.

Shopify vs. Amazon: Merchant vs. Consumer Centric
Amazon’s Webstore, the long-time effort to provide an online marketplace for vendors, failed and shuttered in 2015. It’s likely that merchants feared giving Amazon access to transaction data (tending to view Amazon as an enemy) but I don’t know if it was those concerns or a lack of focus on Amazon’s part (or both) that ultimately killed the initiative. Similar concerns are preventing Amazon from selling its Just Walk Out checkout technology to other retailers. BI Premium reported last week that Bezos, in his return to overseeing daily operations at Amazon this year, has taken a renewed focus on the threat from Shopify. Shopify has been successful, in large part, by maniacally focusing on merchants. This approach is in direct contrast to Amazon, which I believe has been successful because of its maniacal focus on consumers, sometimes at the expense of merchants. As I wrote in SITALWeek #273, marketplaces have historically struggled if they prioritized merchants over consumers, and it therefore makes little sense for Shopify to launch a marketplace to compete with Amazon. Likewise, Amazon choosing to prioritize sellers in a (semi)independent webstore product would likely conflict with Amazon’s customer focus if the new marketplace had any sort of Amazon branding and/or connection to Prime and Amazon payments. This long interview with Shopify founder and CEO Tobi Lütke at The Observer Effect is well worth a read to understand how and why Shopify has been successful.

Amazon Care as Haven Fails
Amazon is also looking to take Amazon Care, it’s healthcare service for employees, and sell it to companies, bypassing insurance companies and brokers, according to BI Premium. The new effort follows the failure of Haven, the Amazon JV with Berkshire and JP Morgan, which is no longer focused on primary care. The BI article paints a picture of chaotic fits and starts and failure to execute in healthcare for Amazon. While it would be great to see technology completely upend the failed US healthcare system, that day might still be far in the future.

Netflix's Ambient TV
Netflix continues to experiment with its Android app by allowing for variable playback speeds of 0.5 to 1.5x (if you want to have some real fun, watch a Hollywood production at 0.5x). And, their latest move is to allow audio-only playback in the Android app. Creators aren’t thrilled with the changes, and it will be interesting to see if Netflix expands these consumer-friendly modifications to other streaming locations in a way that underscores its seemingly increasing role as ambient TV – video entertainment as background noise.

Overdraft Fees Eroding Entrenched Banks
Conor Witt at Armchair Quarterbacking highlights the rise in US bank service charges to $34B. Despite a 50% drop in fees in Q2 of this year, as savings balances rose and overdrafts were less common, a number of startups are going after those fees by offering much more consumer-friendly banking services.

Not Just Leading-Edge Semis in High Demand
Strong demand across the board for analog, sensing, power, and RF chips has led to a shortage of trailing-edge 200mm chip manufacturing capacity/machines.

Miscellaneous Stuff
CRISPR Bacon
Genus, a British animal genetics firm, used CRISPR gene editing to remove the CD163 gene from pigs. CD163 is a receptor on white blood cells that makes pigs susceptible to porcine reproductive and respiratory syndrome (PRRS). The pigs suffer greatly from the virus and it claims up to $600M annually in the US ($2.5B globally). The tech was published several years ago, but Genus now thinks the modified swine will soon be commercially available, possibly within five years. And, given that pigs are a primary vector for the human flu, work is underway to see if pigs could be made immune to that as well by removing genes for proteases that aid viral infection. Technology Review suggests that: “the pig hatchery shows that CRISPR might be able to give people inborn ‘genetic vaccines’ against the worst infectious diseases they might encounter”.

Engineering Behind COVID Vaccine Campaign
There are a lot of complexities in the road to making billions of vaccine doses. Beyond the obvious cold storage, logistics, and jabbing challenges, there’s the special Valor glass from Corning, and a potential shortage of cholesterol (which is combined with fatty acids to encapsulate the mRNA for delivery). IEEE Spectrum walks through the various challenges and how it will all be possible.

Fight Viruses by Boosting Winter Humidity
It turns out colds/flus don’t proliferate more in winter just because people are packed together indoors and get less sunlight than in warmer months. Coronaviruses are also more stable in lower temperature and lower humidity (as well as in very hot/humid air – it’s the in between that poses a problem for viral stability). National Geographic reports: “Lower humidity evaporates droplets to a smaller size, making it easier for the virus to bump into other chemicals in the droplet and inactivate–but only up to a point. If the droplets get too small, the naturally occurring salts in the fluids we exhale crystallize and trap the virus, preserving it for awakening when the drop gets dissolved in a new host’s airway”. Further, cold air and low humidity negatively impact the immune system and mucociliary clearance – the body’s mechanism for trapping viruses and moving them back out through the nose and mouth. An immunologist interviewed for the article suggests using a humidifier indoors and wearing a scarf over your mask outdoors to boost humidity and help limit viral infection.

Stuff about Geopolitics, Economics, and the Finance Industry
CCP Censored Zoom Calls of Americans Outside of China
A Zoom executive was charged by federal prosecutors for disrupting video calls and terminating accounts of Americans convening “video calls about the 1989 massacre of pro-democracy activists in Tiananmen Square”. The FBI alleges the Zoom employee “worked as Zoom’s primary liaison with Chinese law enforcement and intelligence services, sharing user information and terminating video calls at the Chinese government’s request”. As explained by Foreign Policy: “The presence of CCP cells in Western companies operating branches in China is unremarkable. The party’s constitution requires companies with three or more members to form a cell. Cells are much less prevalent in foreign firms than in domestic firms. In the majority of cases, cell meetings are tedious box-ticking affairs, although they’ve increasingly become a tool of direct influence inside private business under President Xi Jinping. Foreign firms have raised concerns about party cells influencing business decisions under the new regime, but their presence is well known.”

❄️
Happy winter solstice to everyone! We will see you all in two weeks in 2021. In the meantime I will be playing the anthem of 2020, This Year, by The Mountain Goats.🤘✌

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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. 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, LLC has no control. In no event will NZS Capital, LLC 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 #275

Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, magicians and comedians, 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 sign up form; if you have any issues or questions please email sitalweek@nzscapital.com)

In today’s post: Abstracting banks; the real cost of IPOs; TSMC buys land in the desert; lower rates driving higher asset prices; ergodicity goes mainstream; raising money in the face of the unknown; the similarities between investing, magic, and stand-up comedy; and lots more below...

Stuff about Innovation and Technology
Gamers and Fans Flock to YouTube
100B hours of video game content was viewed on YouTube this year, up 100% from two years ago. More than 80,000 gamers have over 100,000 channel subscribers each, and over 1,000 have more than 5M subscribers each. Leading the viewing was Minecraft at 201B views followed by Roblox at 75B views. In total, 10% of the 100B hours was watched live.

Empowering Gamers to Generate Content
Manticore’s Core platform is a “ground-breaking user-generated content (UGC) platform for creating and playing: to democratize and open gaming to a whole new wave of creators, from all horizons” that will pay out 50% of revenues to all users generating gaming content – and cover the entire stack of needs for developers. Essentially, this takes the UGC model of YouTube and applies it to a gaming platform. It’s exciting to see so much value created in the gaming industry both outside of and built from core platforms – those non-zero-sum value propositions tend to accelerate growth for industries.

The Abstraction of Banking
The idea of a bank is to lend money out in relation to the deposits it has. This provides liquidity in the economy and allows people to bet on the future by borrowing today. Since the financial crisis over a decade ago, banks are doing a lot less lending. Speaking at a Goldman Sachs conference last week, JP Morgan Chase CEO Jamie Dimon lamented the change: “The banking system as a size relative to the global economy gets smaller and smaller and smaller and smaller. And remember, the market sets capital requirements, not just the bank and not the regulator. So you've had 80% of the mortgage go outside of banking. Tremendous amount of private credit is going outside of banking. And you can go down one after another, things that are leaving banking because they get more favorable treatment outside. And the regulator (inaudible) out what they want because eventually they're going to regulate the banking system out of business.” Dimon went on to discuss how the government also replaced banks as agents to intermediate in times of market crises: “you saw it in March and you may see it again, is the ability of banks to intermediate because they hit a whole bunch of walls...And of course, who -- if the banks can't intermediate, who intermediates? The Fed. Is that what they want? If they are the permanent -- step in when something goes wrong to come intermediate, and that's what happened in March with the repo market.”

So, what does the next decade look like for financial services? Or, more bluntly, what is the point of a bank? The idea of holding assets and lending money is being abstracted. Stripe’s new Treasury product white labels banking as a service. Google Pay is becoming a banking marketplace. Affirm is aiming to displace credit cards for point-of-sale lending. Modern mobile-first banks, like Chime, are making banking friendlier and easier for a younger generation. The list goes on and on, and function after function of big banks are disappearing. What could happen is an extreme power law where a small number of traditional banks act as a system of record for holding assets, while many innovative companies proliferate in the fintech space. Or, as was suggested on Net Interest, Dimon’s comments may simply be calling on regulators to catch up and regulate the disruptors more. In the meantime, I still seem to write a lot of paper checks, and yesterday I saw a line to get into a local Wells Fargo branch. Meanwhile what’s Dimon’s reaction at the same GS conference to watching all the fintech innovation from the sidelines? "We could have done that, too, and we didn't.”

Across the Pond, Amazon’s Still a Little Fish
Here’s an insightful look at Amazon’s failure to execute across Europe as ecommerce remains, in many instances, a regional market. Although the numbers could be skewed by growth in AWS, Amazon has less to show for its international investments compared to the other Internet giants (in Q3 2020, Amazon’s international revenue was 38% of the total, down from 39% in the prior year; by comparison, Facebook garnered 53% of its revenue outside the US, Netflix’s subscribers outside of the US and Canada represent 62% of their total subscribers, and Google generates 54% of its revenues outside the US; sources: most recent quarterly filings for each company). The same can be said of leading ecommerce platforms around the world who have not expanded from their home territories. Ecommerce's end state may simply be more regional than search, social, and streaming.

TSMC to Set Up Shop across from In-N-Out
TSMC has purchased 1000+ acres in North Phoenix for $89M (conveniently near an In-N-Out Burger) for what could be the beginning of a huge semiconductor supply chain expansion on US soil. So far, TSMC’s US expansion plans are too little, too late to make much of a dent in the global tensions between the US and China. I would still love to see a major $100B+ JV between the big US chip designers and TSMC to roll out several leading-edge facilities. Apple, perhaps, has the most to gain from funding such an endeavor, as they increasingly generate much of their value from chip design (it’s always been a story of success via vertical integration, but, as of late, the chips seem to outshine the other areas of the business in my opinion), and Apple has the most to lose if something catastrophic happens to TSMC. The CHIPS for America Act in the US is now joined by a new effort in the EU to increase investment in domestic chip innovation and supply.

Music Royalty’s Hard Knocks
Musician David Crosby highlights the zero- (and often negative-) sum, economics of the music royalty business with his remarks on the reported $300M+ sale made by Bob Dylan for Dylan’s entire publishing catalog to date: “I am selling mine also ...I can’t work ...and streaming stole my record money ...I have a family and a mortgage and I have to take care of them so it’s my only option ..I’m sure the others feel the same”. The entertainment industry is complicated, and a lot of artists choose to take more money up front while sacrificing future paydays (as Chapelle recently complained about), but it still feels odd when I listen to a song knowing the people who created it aren’t earning much, if anything.

Musk’s Musings and EV Licensing
I thought this BI interview with Elon Musk was more insightful than the typical interview (where Elon metaphorically punches the journalist in the face). It’s behind the BI paywall, but it’s worth a read if you have access. Musk was more open about licensing various parts of Tesla’s tech stack to other auto companies. He also discussed how he often sleeps in conference rooms at factories, and how he remains focused on “[increasing] the scope and scale of consciousness so that we can try to figure out how to answer these questions, and what questions to ask” (a reference to the philosophy of The Hitchhiker's Guide to the Galaxy). AI is discussed quite a bit, and Musk thinks no one is coming close to what Google’s DeepMind is achieving in the field. He also commented: “I'm trying to use technology to maximize the probability that the future is good. And, at a foundational level, that means ensuring we have a future, which is why sustainable energy is so important for the future of Earth.” And, “Science is great for science. Science is discovering things about the universe that already existed, and engineering is about creating things that never existed. I think to create something new that, as far as we know, never existed in the universe before. That's great.”

Miscellaneous Stuff
Dolly Parton: More Real than Real
RuPaul interviews Dolly Parton for Marie Claire. Parton, who normally wakes up around 3am after an average four hours of sleep, said: “Well, I’m energized by just what I do. It’s like, work begets work, energy begets energy. I just really stay alive because I just live on creative and spiritual energy. I’m like the little Energizer Bunny. I’m just recharged by the excitement of being able to still be active and to still be able to create stuff and to be still in demand.” Parton, who earlier this year donated $1M that contributed to the creation of the Moderna COVID vaccine, also dropped a new Christmas album last week that includes duets with Miley Cyrus, Willie Nelson, and more.

Stuff about Geopolitics, Economics, and the Finance Industry
Low Rates Fuel High Asset Prices
The average investment-grade corporate bond now has an inflation-adjusted yield of zero. Meanwhile, I recently spotted an original Mike Tyson’s Punchout Nintendo cartridge for $90,000 on Rally Rd.

Ergodicity Finally Headlining
It’s thrilling to see ergodicity economics hit the mainstream in this well done Bloomberg article. The path through time matters, but all traditional economic and finance theory ignores this crucial factor. Here are the dozen times we’ve discussed elements of ergodicity in SITALWeek if you’re interested in further reading on the topic.

Pandemic Advantages Homeowners
Homeowners in the US have gained $1T in equity due to home price increases during the pandemic. This highlights the pandemic-accelerated bifurcation of the haves and the have nots. Rising home prices could also be a significant bolster to consumer spending in the coming years if homeowners tap the equity with cash-out refis or HELOCs.

Overcoming Fragility in Face of the Unknown
In November of 2011, Netflix raised a desperate round of $400M at a split-adjusted price of around $10 per share. After bottoming a little lower around one year later, the stock has since risen 50x. The shares sold in the offering would be worth around $20B today. In April of this year, Airbnb raised $1B in debt financing at an implied price equivalent to around ~$30 – around 1/5th of where the stock traded in its IPO debut last week (discussed by the company’s CEO, who struggled to respond to the IPO pop, here). It’s interesting to reflect on these two offerings, whose only connection is dilutive fund raising in a time of uncertainty for each business. It’s hard to fault either company for the capital raises given the circumstances, but were they due to a lack of confidence in the future, or a failure to have enough resilient buffer on their balance sheets? Even the strongest managers, with clear visions for their companies, cannot confidently face off against the unknown while beholden to fear. On the flip side, overconfidence in narrow predictions can be just as damaging. As we often note, balancing resilience and optionality, while cultivating a culture of innovation and adaptation, is the best insurance against unforeseen change.

Real “Cost” of IPO Pops? Modest Dilution
With the IPO pops of DoorDash and Airbnb in the news last week, I thought it would be worth revisiting the actual cost of IPO pops in typical IPO deals. DoorDash’s IPO raised $3.4B at a price of $102, selling ~33M shares. DoorDash had ~321M shares outstanding prior to the IPO including granted-but-not-yet-vested options and restricted stock units. DoorDash closed day one around $189. If they had raised the same $3.4B at $189, they would have only needed to sell ~18M shares. The extra 15M shares sold thus represent 4.7% dilution to the owners of the 321M shares before the IPO took place. Airbnb’s IPO raised $3.5B at a price of $68, selling ~51M shares. Airbnb had ~650M shares outstanding prior to the IPO including granted-but-not-yet-vested options, restricted stock units, and warrants. Airbnb closed day one at $145. If they had raised the same $3.5B at $145, they would have only needed to sell ~24M shares. The extra 27M shares sold represent an extra 4.2% dilution to the pre-IPO owners. No employees or prior owners sold on the DoorDash IPO, and only the three founders sold around 1.5M shares total on the Airbnb IPO (leaving over $100M on the table). So, that ~4-5% dilution was the only actual cost of the IPO pop to non-selling prior owners, not an 80-100+% move in the stock (which also, by the way, assumes that there is information value rooted in the day-one closing prices, which I’d argue there isn’t). And, given these are both consumer brands, that dilution should be offset partially by the branding halo of the massive volume of press both deal pops generated (indeed, retail investor buyers were likely a major factor in these IPO pops). Effectively, if someone complains about the IPO pop, they are claiming to be upset that their stock went up 100% instead of 105%. I wrote more about the pros and cons of the IPO market in this essay last year. One of the biggest issues for IPOs remains the supply side of the equation. For both DoorDash and Airbnb, less than 10% of the shares are publicly traded until lockup agreements expire. The demand, especially in the current market, is outstripping the supply of shares by a large factor. This supply issue appears to be something both Roblox and Affirm want to address as they postpone their IPOs, according to the WSJ. Allowing more employees and private investors to sell earlier in a public company debut comes with benefits as well as some concerns (as long-time company insiders may have an asymmetric information advantage over new public investors) but, clearly, a middle ground can and should be achieved. The most important piece of information to determine the price of the next trade in a stock is the price of the last trade in the stock in a liquid market. IPOs do not have that information available, therefore there is no good way to reach consensus at a single point in time as to what an asset with a wide range of outcomes is worth when it transitions from the private to the publicly traded world.

What Investors can Learn from Magicians and Comedians
There was an interesting question posed on Twitter: which five people would you pick to invest in your fund and become your mentors? My immediate thought was to think about the key weaknesses most of us investors have, regardless of experience. The first weakness is cognitive bias – the ways in which our brain is engineered to trick us. And, the second one is failure to see the obvious – we get so wrapped up in the stories or the details, that we miss making the most obvious connections. I’ve often said the two most similar crafts to investing are professional magicians and stand-up comedians. These are the professions that understand the most about how the brain works against you in real day-to-day life. So, my list of mentors was a magician, a comic, and three scientists, two of whom are experts at complex systems and the third is an expert on knowing your brain’s weaknesses and strengths. In 2014, I wrote a shareholder update letter (you can find it in full on page 49 under “Outlook” in this SEC document) about investing, comics, and magicians that concluded:
This comparison of the three seemingly unrelated fields largely comes back to the idea of presence – the hardest thing we do every day is to simply be in the moment, 100% focused with vigilance and attention. This is an obsession that all great investors, standups, and magicians are constantly perfecting. If a standup isn’t paying attention all the time, they will miss their next great joke opportunity – and if they fail to follow cues from the audience, they will lose the reaction. If a magician fails to pull off a trick leveraging the brain’s built-in biases, the illusion is revealed and the mystery is lost. The standup and the magician lose their audiences if they lose focus, much like the investor loses long-term performance if they fail to connect dots, avoid cognitive bias, and pay attention. Technology investing is a dynamic environment with a rising pace of change – this creates an even higher burden for presence and the ability to connect unrelated dots. Using these methods, we are able to focus on finding the signal in the noise of data points.

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Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. Often I try to make jokes, and they aren’t very funny – sorry. 

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