Stuff I thought about last week 1-27-19
Greetings - no announcements this week - as always reply back with any comments or questions.
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Stuff about Innovation and Technology
Facebook’s “friendly fraud” - 8 years ago I learned an unpleasant lesson losing money in social game maker Zynga. I did a lot of work to understand my mistake so that I could learn and not repeat it. My mistake boiled down to the idea of a “misplaced” network effect. Zynga had developed fairly strong network effects across its games at the time (remember Farmville?), however, Facebook was in control of that network effect - Zynga was borrowing it, so to speak, from FB. FB decided to de-emphasize gaming back then, to put it nicely, and Zynga fell apart and has not recovered to realize its full potential since. One reason I felt comfortable owning Zynga (through a private investment made in the company before the IPO) with this hybrid network effect model was because it appeared to me that gaming was a core area of focus for FB’s revenue growth. Why then was there such a sudden change of heart by Zuckerberg to de-emphasize social gaming? Well, maybe today we have the answer - FB appears, based on these documents, to have been engaged in blatant fraud to take money from kids without them getting their parent’s permission around the time leading up to their decision to move away from social games on the platform! FB internally referred to this as “friendly fraud,” and this article reveals what appears to be more evidence in a growing and disturbing pattern of a completely broken moral compass at the company. It’s important to note this reporting comes from records unsealed in a class action lawsuit that I believe is ongoing, and certainly this may not tell a complete story. But, if this is accurate, anyone still at the company with knowledge of this situation should be removed by the board. Unfortunately that might include someone who has complete voting control, and does not answer to the board, so shareholders will have no say - be careful who you sign that vote over to when you buy stocks with controlling holders. It might not be someone you want to hand your wallet over to. But, no worries, Zuckerberg says FB is cool in his WSJ editorial this week as he explained the facts about how FB works to us. Regardless of what turns out to be true or causal here, there is a very important takeaway when running a business or investing in one: who owns the network effect? For example, if you sell your app on iOS, would your business survive an Apple policy change? If you sell your mutual funds through advisors, would you survive those platforms deciding to shut down active management options or in source various choices for their investors? In the Information Age, a direct connection to customers is easier and more vital than ever as distributors of all types of goods and services either shrivel or change their own business models.
This week YouTube made a major change to its algorithm to begin excluding “borderline content” from its recommended lists. YouTube is a private company and not a free speech platform, so this is completely fine for them to do. But, we have to remember these platforms greatly control our brains and wire us to change our thinking without us noticing it - it’s true of any newsfeed even including something as innocent as the print version of the NYT - they are hacking your brain for various different reasons and motivations. So, it’s a little tough for me to swallow this line which makes it sound like YouTube is pro-free speech, which it’s simply not based on its policies: “We think this change strikes a balance between maintaining a platform for free speech and living up to our responsibility to users.” To be clear, I have no problem with YouTube planting a flag in the ground and saying the Earth is indeed not flat and it won’t recommend videos that say otherwise. But, the shape of the earth is pretty straightforward while most of the definition of “borderline” might not be. This new algorithm will greatly shape the minds of children and adults who spend a lot of time on the platform. It’s worth noting that some of the most “borderline” pieces of content throughout the written history of our species include such truths as Sun being the center of the solar system and, yes, that the earth is in fact round which - that novel idea was borderline content until about 2300 years ago!
More evidence is stacking up against Hauwei’s market share prospects in the West going forward as Vodafone looks to suspend purchases of Hauwei’s core equipment (good for Cisco and Juniper maybe?) and the NYT reports on Huawei’s long path toward gaining that share in Europe that it’s currently poised to potentially lose. But, this obviously remains a complex situation and Huawei could earn back trust by opening its code and chip designs up to carriers, governments, or 3rd parties for auditing - but at what cost?
And, speaking of developments in telecom equipment we had conflicting reports this week of just how big the upcoming 5G and spectrum building cycle is going to be. On the skeptical hand, the CEO of Ericsson said: “We actually see 5G as a very cost-competitive technology, because it is anchored in the 4G grid, so it's really the first mobile technology which benefits on the previous generation. So the rollout of 5G will be very incremental, so you take the 4G network, you add 5G, where you need capacity, and, ultimately, you are going to have a 5G network built, basically relatively inexpensively...so it's not this dramatic investment, kind of, bump, that's going to come, for the operator, but it will benefit the operator with a strong 4G network.” Hmmm, that’s in odd contrast to Xilinx, which makes programmable logic chips key to cellular equipment and has mentioned Ericsson as a customer in the past - on this week’s Xilinx earnings report where the company significantly raised guidance the CEO said “I would also point out that 5G is going to be, I've said this in previous calls, 5G is going to be a larger deployment overall compared to the past generations.” Later in the week Ericsson ended up posting a good quarter and outlook driven by 5G, so I think we can conclude the cycle is starting and there are signs it’s going to be bigger than expected. This is also generally good for a company like Taiwan Semi (TSM) as they look to fill the void of slower chip sales into smart phones and crypto applications. 5G is also going to be a significant stimulant to overall chips sales for the IoT, etc. In fact several semiconductor companies reported better than feared earnings and outlooks this week. I continue to believe investors are playing a short game while ignoring a decade’s long growth cycle of greater magnitude than the industry has ever seen before. We’ll hear from Nokia last this coming week.
I've noted a few times the increasing reliance and integration of Microsoft apps on Android. I recently noticed the Excel app for Android has over 500M downloads and is highly rated. Office and PowerPoint rank similarly while OneNote and Outlook have over 100M downloads. Hard to argue Microsoft “lost mobile” with a straight face any more. They don't have the control of the platform, but they are effectively leveraging it to strengthen their own network effects as they continue to shake off challengers like G Suite, Slack, etc. After playing around with the mobile Excel app I found it way more functional and useful than the G Suite sheets app. I can't help but think that Google's recent price hike on G Suite and lack of recent investment in the apps is part of an acknowledgement that not only has Microsoft won and that ship sailed, but that Google is better off if Microsoft's huge user base (second only to Google for non social user bases globally) embraces Android over iOS (because Microsoft is able to do much deeper customizations on Google's OS).
Google is asking the Supreme Court to take the case of 20th century dinosaur carcass Oracle suing Google claiming software interfaces are copyrightable. Google is right to fight this battle on behalf of the entire technology industry - and this affects companies outside of technology now given how many industries rely on software built into their products. Google is rumored to have an entire new OS, completely leaving Android behind, and one of the reasons might be in case they lose this case.
Disney’s ESPN+ streaming service picked up 568,000 new subscribers in one weekend and drove one of the largest ratings to date for a UFC fight since 2013.
Amazon continues to turn its internal services into external products - they have done this with cloud, AI, advertising, etc. and have been working to become a 3rd viable end to end shipping platform in the US. The latest effort has them forgoing the “padding” charges that UPS and FedEx put on residential deliveries. At the very least I wouldn’t bet against this - these charges would reduce the typical ground delivery costs by about 40% of $4 per package! This would perversely be a huge benefit to retailers competing with Amazon.
This week Walmart, a key Google ally dropped out of the most important parts of Google’s efforts to stem Amazon’s e-commerce train. This decisions is puzzling to me, and I have yet to see any great insight out there on what’s behind the move. Google is a retailer’s best friend if they are worried about Amazon, unless for some reason you’re concerned Google is going to pivot into a national retailer with their own inventory, logistics, and marketplace, perhaps via an acquisition? Maybe Walmart is big enough to go it alone, but without further information to go on, I think this is yet another irrational and naive decision in what’s been years of mistakes and missteps at the soon to be former top retailer in the US.
The power and scale of Netflix’s data continues to impress. The TV show “You” averaged around 600k viewers on Lifetime’s cable network and Lifetime did not pick up a 2nd season. Based on data Netflix had on shows by the creator of “You” they signed up to make a 2nd season even before the 1st made its Netflix streaming debut. Subsequently Netflix announced at least 40M households had watched at least most of one episode - that’s a little bit of a tricky statement to dissect, but it seems reasonable Netflix gave the show an audience anywhere from a few times to 10x or more it was garnering on Lifetime. Lifetime meanwhile lacked the data skills to have any clue this was possible.
Is Alzheimer's largely bacterial (with some other susceptibility components), and can it be easily treated and inoculated against - and, is that bacteria simply gum disease that makes it way into the brain!? Nothing like a huge paradigm shift on a perplexing problem to make you marvel at the scientific process and bias involved in human discovery of disease pathologies. Of course, my first reaction was: this is going to be a sustainable long term bump for the dental hygiene industry - let’s go research all the stocks leveraged to that!
“Patriot” which has aired 2 seasons on Amazon Prime Video has become one of my favorite TV shows of all time, and this scene of rock-paper-scissors is one I think about often if for no other reason than the discipline that went into the filming of this 3 minutes of video. I tend to not like anti-hero TV shows like “Breaking Bad,” but this one seems to defy that new genre and set off in a new direction of its own.
After 25 years of studying innovation, Clayten Christensen informs us that he’s largely learned nothing relevant in the 21st century about innovation. We had a longer and more detailed analysis of why we feel Christensen not only falls short in his discussions of innovation, but his industrial age advice is actually dangerous to CEOs in the information age (see chapter 4).
Stuff about Geopolitics, Economics, and the Finance Industry
With discussions rising about wealth taxes on the very wealthy in the US, I wonder if anyone has looked at the impact on charitable donations from something like that? I’d gather many folks in the net worth brackets under discussion are donating more than the 2-3% tax under discussion and getting a tax savings for it. Given many wealthy households hold their net worth in unproductive assets, I’d expect more than a few would shift from donating to paying the tax instead. Although I haven’t seen the data, I assume most charities convert donations to a higher % of utility than the government converts taxes, i.e., for every dollar of donation to a worthy cause, we might gain pennies on that dollar through the inefficient redistribution of a wealth tax. One other question I had is what is the impact on personal debt for the wealthy from a net worth tax? The motivation to leverage otherwise unproductive assets might increase risk seeking investing.
I give Bono a lot of credit for his self awareness here regarding the perception of socially responsible investing as he works with TPG to measure more scientifically the impact of SRI. (and, thanks to a reader for submitting this article to me!)
“I understand the cynicism,” Bono said. “There is banana skin all over the floor, I think. I am very conscious of it. We have had green-washing or purpose-washing with all manner of halos being offered up as fig leaves for companies who do bad things but then give money away and make up for it. I get that,” he said.
With the slowdown in the Chinese economy perhaps only growing a 1.67% last year, the lowest birth year since Mao’s great famine, and stumbling trade talks, it feels like the US is holding the better and better hand. I looked up the person negotiating with China and was slightly discouraged to read about his negotiating tactics which in the past included folding an offer by the Japanese into a paper airplane and sending it back to them across the table.
Investors continue to add to cash which is one of the more bullish indicators I’ve always watched for a market recovery - that urge to be greedy when others are fearful is just too hard for most investors.
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.