Stuff I thought about last week 1-20-19
Greetings - couple quick announcements this week for email subscribers: I am posting the newsletters on the SITALWeek blog on evolusophy.com typically within a few days of when the email goes out. I’ll occasionally link back to past weeklies to provide context, and the archive will make it easier to go back in time and see how often I change my mind, say something hypocritical, or most likely how I am just frequently wrong! I’ve also added a short section at the end that contains the top 5 links that I think are worth reading from the weekly. As always, reach out on with any thoughts or comments. -Brad
[Please read important disclaimers at the bottom of this email]
Stuff about Innovation and Technology
Tying together a couple of topics from the last couple of SITALWeeks - this past week I spent a lot of time thinking about the idea of the broadening definition of fiduciary duty in light of several recent developments. When I wrote the section last week on failing utility Pacific Gas & Electric connected to this topic I had scheduled SITALWeek to email out several hours in advance, and I was unaware that as the note was going out PG&E’s CEO would resign and the company would announce plans to go bankrupt. What is less surprising, but no less astounding, was the letter from hedge fund BlueMountain Capital which drives right to the heart of the debate on fiduciary duty: "It may appear easier for Board members to file for Chapter 11 - shifting the burden of dealing with the myriad issues that will face the Board and placing it squarely on the shoulders of the Bankruptcy Court and the companies' advisors - but it will destroy value for the Company and in particular its shareholders - the only groups to which you owe a duty." That last line is quite chilling and represents this idea of a legacy, 20th century minded investor, in this case BlueMountain Capital, failing to see that society now defines a Pareto Efficient outcome of a capitalist transaction as one that takes into account a broader set of constituents. It’s no longer only about making sure equity holders maximize their earnings per share - outcomes today must be optimal for customers, suppliers, employees, the environment, society as a whole, etc. Focusing just on a “duty” to shareholders is a recipe for bankruptcy as PG&E, and I suspect an increasing amount of other companies, will find out in the next decade. PG&E seems to be going bankrupt because they failed to spend adequate money on their electrical grid to maintain it in a safe way that also accounted for climate change risks. Instead they maximized earnings and dividends for equity holders. Now their employees, customers, and the environment suffer along with and in many cases much worse than their equity holders. Yet, an investor like BlueMountain Capital seems to think focusing on equity holders is the way out of a problem caused seemingly by focusing on equity holders too much - the irony appears to be lost...
Thus I was thrilled to see comments form Satya Nadella transcribed by Ben Thomson in his Stratechery newsletter (subscription required) - here are 3 quotes from Satya speaking to industry analysts that are relevant to this topic:
"so that’s why I’m not one of those guys who celebrates some market cap measure because I think all of that is – I mean that’s just not stable, at least not with our business model – because our business model fundamentally is about creating more surplus outside us. We will only be long term successful if people are making more money around us."
"simply put for a multinational company we have to accept that unless you are really added an economic service in every country you are operating in, truly, that is measured by employment, measured by taxes you pay, measured by essentially all of the prosperity around your activity that gets created locally, if that is not true, I just don’t see how the world just kind of says “let’s just go back to this thing”. I mean basically, look, globalization was fantastic except that it hollowed out the middle in many parts, not just in the United States, but all over the world and given that, I think everybody is going to be looking to say, “Ok how do I get back?” and the equation between innovation and democracy or whatever form of government they have and economic prosperity that’s broadspread because that’s the only way to stay in power and so given that we as a business community better be sure we are in harmony with those goals."
"It means structuring simply a business model that allows you to create for every dollar that you make multiple orders of dollars beyond that in our channel broadly speaking. What are the local startups? What are the localized feeds? Who are the local SI’s? What’s the total employment digital skills inside of the companies?"
This was music to my ears and it’s a perfect illustration of the concept of NZS or non-zero-sumness we discussed in our Complexity Investing paper. When Satya Nadella states Microsoft’s “business model fundamentally is about creating more surplus outside us” this epitomizes the idea of a shifting definition of “duty” and a rising importance of positive sum, win-win or NZS outcomes. In the Information Age boards and managements need to broaden their definition of fiduciary duty and set their game theory outcomes to maximize results for more than just equity holders. And, investors need to start focusing on and pushing for this broader definition as well. That’s why a legacy investor like BlueMountain Capital (particularly disappointing to me given their affiliation with the Santa Fe Institute - a place that provided much of the foundation for our Complexity Investing framework!) is creating further negative sum outcomes instead of broader positive sum outcomes. I’m no saint and I don’t really embody many of these NZS concepts myself, so I am a willing hypocrite here (as philosopher-magician Penn Jillette once said on the side of a Starbucks cup “I have no problem with hypocrisy. It just doubles my chances of agreeing with you"), however, it seems like this is an increasingly important concept to internalize for investors.
Related to this Blackrock’s annual letter from CEO Larry Fink to CEOs of companies Blackrock invests in calls out the unprecedented $24T wealth shift that will happen between boomers and millennials highlighting "Companies that fulfill their purpose and responsibilities to stakeholders reap rewards over the long-term. Companies that ignore them stumble and fail. This dynamic is becoming increasingly apparent as the public holds companies to more exacting standards. And it will continue to accelerate as millennials - who today represent 35 percent of the workforce - express new expectations of the companies they work for, buy from, and invest in.”
Interview with former Google head of China Kai-Fu Lee who now focuses on AI venture capital in China underscores that China’s data advantage puts them soon well ahead of the US. Early examples include real time analysis of student’s concentration or confusion to custom tailor learning programs.
“Well, Silicon Valley has been the single epicenter of the world technology innovation when it comes to computers, internet, mobile and AI. But in the recent five years, we are seeing that Chinese AI is getting to be almost as good as Silicon Valley AI. And I think Silicon Valley is not quite aware of it yet.
China's advantage is in the amount of data it collects. The more data, the better the AI. Just like the more you know, the smarter you are. China has four times more people than the United States who are doing nearly everything online.”
Tencent’s WeChat product is going through a major evolution and change as the China Internet landscape faces new competitors while facing mounting government pressure. This comes at a time it appears things have slowed heavily and hushed layoffs might be occurring for the big Chinese Internet companies. Meanwhile Tencent challenger Bytedance comes in at the low end of their expectations for 2018. It’s always hard to know what’s priced into stocks and the Chinese Internet share prices have suffered of late, but clearly it’s not all rosy near term.
Consumers spent just over $100B on apps in 2018 and that’s expected to grow about 20% in 2019. From the full report which is available to download in pdf here we see that gaming still commands almost 3/4 of spend, but is still losing out to faster growing subscription and ecommerce apps. Despite hunches to the contrary time spent in social apps keeps growing - there have been a couple recent surveys and stories (here and here) that taken together might lead to the conclusion that despite logic to the contrary, it’s possible Facebook is through the worst and has settled into its core user base which is likely at least 90% of what it was before various scandals began impacting the company in 2016 (and it has added many new users since then globally across all its platforms). That would certainly explain the company’s comfortable, tone-deaf response to ongoing controversies. As long time readers know I consider my point of view as temporary, taking in new evidence in a Bayesian way and adjusting prior credences - I am not ready to flip one way or the other on FB yet, but these data points are worth logging as contradicting my otherwise negative bias.
Rising nationalist focus on data in India might make these markets complete zero’s for Amazon, Walmart and Alibaba - it’s hard to ignore the weight of this quote from the CEO of Reliance:
“He said, much like Mahatma Gandhi led a movement against political colonization of India, “we have to collectively launch a new movement against data colonization. For India to succeed in this data-driven revolution, we will have to migrate the control and ownership of Indian data back to India – in other words, Indian wealth back to every Indian.””
“The Most Powerful Person in Silicon Valley” - Fast Company ran a long and detailed story on Masa, Softbank, and the Vision Fund - focusing on the “flock of birds flying in formation” strategy which still leaves me generally perplexed. The story about Softbank’s yet to be fully realized or explained purchase of ARM gets weirder and weirder over time as well:
“The day unfolded like a scene from a James Bond movie: Segars landed at a small airstrip near the village of Marmaris, Turkey, where two security men picked him up and whisked him to an empty restaurant overlooking the marina. (Son had arranged to have it cleared of other customers.) “It was surreal,” Segars says.”
Meanwhile Softbank’s ARM fights to stay relevant in the explosion of IoT devices in the face of open source semiconductor challengers. This comes as their core market and revenue driver in smartphones is facing a tough, slow period. Worth remembering that the Vision Fund is highly levered and Masa’s survival of the dotcom bubble bursting involved some skill, but also a lot of luck.
Comcast is rumored to be selling its Hulu stake to DIS (giving DIS 90% control) and appears to be focused on their own streaming platform for NBC Universal. This appears to be yet another example of a subscale media platform that consumers will likely ignore. Meanwhile every month that goes by Netflix drives several months ahead of these challengers (crazy “ratings” metrics in this link) having reached escape velocity years ago. DIS+FOX and Hulu is one of the only platforms strong enough to be an independent option along with Netflix for consumers in the US, and perhaps globally over the next few years.
Microsoft has recently announced what it hopes are transformational partnerships with Walgreens and Kroger. With the cloud wars over and only 3 IT platforms to migrate toward, retailers will increasingly choose Microsoft over Amazon’s AWS and Google’s cloud. As Amazon and Google enter more businesses and see their voice platforms become more powerful over time, more industries likely migrate to the Microsoft Cloud along with retailers.
The power of selling on Amazon: “Amazon today announced that more than 50,000 small and medium-sized businesses exceeded $500,000 in sales in Amazon’s stores worldwide, and nearly 200,000 surpassed $100,000 in sales in our stores. The number of small and medium-sized businesses eclipsing $1 million in sales in Amazon’s stores worldwide grew by 20 percent in 2018.”
Some musings on semiconductors: I like the equipment suppliers that enable chips to get made - companies like ASM Lithography and Lam Research, but it’s worth noting these suppliers are heavily tied to the leading edge which is quite slow right now thanks largely to the slowdown in smartphones and cryptocurrency mining. Meanwhile the coming wave of 5G and AI investment should get the leading edge going again in a year or two once the current inventory correction works through. In the meantime the IoT explosion of chips and sensors might point to more interesting companies to focus on in that sector for now instead of the equipment makers. It was good to see TSM (the world’s largest maker of leading edge chips for semiconductor companies) report weak numbers but see their stock do ok - we’ve seen that a few times lately in semis which is typically a good psychological indicator for a group of stocks.
This is a topic I mentioned a few weeks ago, but I am still thinking about it - with the likely loss of Huawei and ZTE as global telecom equipment competitors, Nokia and Ericsson appear to be in very good positioning just as we enter a multi year expansion of available spectrum and upgrades to 5G. This is a long left for dead industry by investors that has gone through a massive rationalization.
I don’t understand sports ratings well enough to get this, but having one player move teams causing a significant drop in ratings for the NBA seems to call into question the staying power of the sport? I am probably totally misunderstanding it.
As competition cools off in office productivity tools Google is raising the price on its G Suite that competed with Microsoft Office 365. Another sign of stabilizing monopolies or duopolies at the big cloud players. Recall also that Microsoft is getting closer and closer to Android as their go to mobile enabler.
“A paper published Monday by United Nations University’s Institute for Water, Environment, and Health in the journal Science of the Total Environment found that desalination plants globally produce enough brine—a salty, chemical-laden byproduct—in a year to cover all of Florida in nearly a foot of it.”
Thrift stores are “riding the wave” of Netflix’s new show about tidying up your life!
For those interested in the screen time debate for kids and my stance as an anti-anti-screen time proponent - this is a provocative interview to read suggesting kids should start on social media a much younger age.
Stuff about Geopolitics, Economics, and the Finance Industry
Activist hedge fund Jana Partners who has seen assets drop from $11B to $3.5B according to this WSJ story is closing 2 of its funds as tough times continue for this asset class.
Top 5 to Read this Week
Nothing in this newsletter should be construed as investment advice. I may own long or short positions in stocks discussed in this newsletter. This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I may change my opinions without updating them in the newsletter. Lastly, often I try to make jokes, and they aren’t very funny - sorry.
I was the portfolio manager of the Janus Henderson Global Technology products (ticker: JAGTX) from May 2011 to November 2018. Prior to that I held various roles as an analyst and portfolio manager at Janus Henderson Investors for most of the period starting as a summer intern in 1998 up until the end of 2018. I graduated from Williams College in 2000 with BAs in Economics and Astrophysics. A complete resume can be found at: www.linkedin.com/in/bradsling
Investment framework co-authored with Brinton Johns “Complexity Investing” can be found here: http://www.evolusophy.com/complexityinvesting/
If you have any articles of interest, comments or questions please send them by responding to this email. I will generally try to read and respond to your comments or questions, but may not always be able to in a timely manner, for which I apologize in advance.