SITALWeek #202

Stuff I thought about last week 7-21-19

Greetings – fast food is going from product to platform, and many incumbent restaurant chains could fail to transition; could Zillow and Opendoor ultimately own and rent homes as REITs with iBuying becoming a minority of their earnings? ARM Semiconductor’s response to open source challenger RISC-V falls short; Apple and Google’s app stores are likely too highly valued by investors; and, the race to zero for investment management fees picks up speed. Much more below...as always, reply back with thoughts or grab me on Twitter.

Announcement: This September, NZS Capital’s very own Brinton Johns is running a 100-mile race (all by himself!) in Steamboat Springs, Colorado. While we still aren’t sure what Brinton is running from, we know what he’s running for: Brinton has set a goal to raise $100,000 to help research a gene therapy cure for the rare neurological disease SLC6A1. One of our former colleagues, Amber Freed, has a son who was born with this condition, and she’s working tirelessly to help raise the funds researchers need to move forward. NZS Capital is kicking off the effort with a $10,000 donation. You can read more about the cause and join us in donating here.

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Stuff about Innovation and Technology

The IoT is bringing better beer and wine to your dinner table with connected sensors throughout the brewing process:

“Of course, there are other key environmental factors that vintners and brewers must monitor and control. In addition to temperature, these include things such as sugar and CO2 levels, humidity, and the environment outside the tank. In breweries and wineries across the world, new technologies are helping to monitor these elements to make sure that the fermentation process goes smoothly and that the end result is exactly what the vintner or brewer intended.”

The NY Times ran a welcome article this week on the 5G safety conspiracy, detailing the bogus “research” behind the false beliefs. Concern over 5G health effects is akin to worrying about accidentally falling off the Earth if you walk too far in one direction. Yet, the fear is widespread thanks to social media and YouTube brainwashing. Recently, the tin-hat-wearing 5G contingent kept Verizon from obtaining a permit in my hometown (Verizon is suing and is likely to win). My degree in astrophysics comes in handy every once in a while: the physics and biology of the interactions between ionizing EM waves and non-ionizing EM waves with living cells has been a matter of scientific fact for many, many decades now. Ionizing radiation from UV sun waves or other cosmic emissions would be of far greater concern than non-ionizing cellular radiation, and yet the species has happily evolved over millions of years to live with all sorts of EM waves. Human skin actually blocks non-ionizing radio emissions, and the higher the frequency (like 5G) the better the blocking. This is why your new Neuralink from Elon Musk will need to be hardwired into your brain. If you want to believe in a conspiracy theory, a much more credible one is that Russia and/or China are behind the anti-5G propaganda in an attempt to brainwash people through social networking to harm the competitiveness of Western countries! Let’s instead focus our energies on real problems facing the planet that 5G can actually help us solve through connected, AI-enabled IoT devices.

Domino’s Pizza is finding itself a victim of the “platformization” of the US food delivery market. From their earnings call this week:

“That group of aggregators has taken a fairly significant share of voice out there in terms of the advertising landscape around food delivery. So we expect that behavior to continue for some period of time. I think these players, while the economics of the business are still I think open to question for the long term, the near term activity certainly indicates that investors are very willing to lose a lot of money in the near term to try to drive trial and market share in those businesses. So we remain attentive and watchful of everything that's going on and certainly analyzing our own data to better understand what our customers behavior is over time, but I don't see any signs that that activity is going to slow down in the short term.”

This is a topic we love to explore: is your business a standalone product/service, or is it a platform? (See the final section of SITALWeek #196 for more details.) The economic transition to the Information Age heavily favors platform businesses (or businesses that can plug into platforms while maintaining their own economics). The quick-serve food industry is generally a collection of products/services, but several companies are aggressively building multi-sided marketplace platforms that will extract economics from both consumers and producers (restaurants). The delivery platforms' advantages are based on scale/density of delivery and logistics (like Uber’s driver network) combined with user aggregation through large customer bases. Delivery platforms will make money from consumers willing to pay more for food because of the choice and convenience as well as from restaurants. Restaurants pay a commission (which, in part, is subsidized by lower marketing dollars they would otherwise need to spend to capture customer attention) or an advertisement/coupon to win orders when it makes sense for them to do so. However, as one SITALWeek reader pointed out to me in a conversation this week, the two-sided network effects have remained weak in a number of countries for food delivery platforms (though stronger examples exist, e.g., Amsterdam-based Takeaway). Further, cloud kitchens or “dark” kitchens – facilities built from scratch to serve food delivery networks – seem like a potential flaming arrow of disruption bearing down on the entire quick-serve food industry for the markets that don’t already have an established takeout/delivery system at the individual restaurant level (this varies greatly by country). I talked about dark/cloud kitchens a bit in SITALWeek #194 referencing this FT article on the subject, and just this week Uber Eats announced a restaurant accelerator fund in the UK in partnership with Karma Kitchen. People in the US get delivery pizza because it’s convenient, consistent, and cheap. But now every variety of food could achieve these table stakes requirements through food delivery platforms. What could/should Domino’s have done? Perhaps leverage its large customer base and delivery technology to become a platform itself to deliver food for other restaurants? This type of self-disruption is such a hard pill to swallow for most companies that it’s highly unlikely they make the transition. Fast food in many ways feels like retail 20 years ago - the disruption is only beginning.

Speaking of the changes happening in the fast food delivery industry, this NYT reporter discusses the crazy life of a bike food courier in NYC:

“The riders are the street-level manifestation of an overturned industry, as restaurants are forced to become e-commerce businesses, outsourcing delivery to the apps who outsource it to a fleet of freelancers.”

There was a little hand wringing this week over Netflix’s Q2 2019 subscriber miss in the US. This has been well covered in many places, and I don’t have a lot to add except that traditionally cable companies like Comcast saw summer seasonality in subscribers, and surely we know traditional TV ratings drop in the summer. People are busy with vacations (and sometimes I hear kids even go out and play in the sun...or maybe they are just spending more time video gaming with friends and communicating through musical memes on TikTok). One other thing I find funny is how Netflix keeps trying their hardest to kill the rumor they will start an ad-supported tier: it’s not going to happen in the Western world, or perhaps the entire world, but many investors are so stuck to their prior convictions they don’t want to hear it! From the Netflix Q2 shareholder letter:

“We, like HBO, are advertising free. That remains a deep part of our brand proposition; when you read speculation that we are moving into selling advertising, be confident that this is false. We believe we will have a more valuable business in the long term by staying out of competing for ad revenue and instead entirely focusing on competing for viewer satisfaction.”

And, I can’t resist mentioning this cynical quote that rings true from Barry Diller (CNBC video clip) last week: 

“The only people who are willing to watch commercials are the people who can’t afford to buy the goods being sold. So, that’s an existential long term issue.” 

I hear that email newsletters are the new thing, and this week Substack, a platform to distribute, manage, and monetize subscription newsletters raised $15M in funding (Ben Thompson did a good interview with the founders, you can read it here if you are a subscriber to Stratechery). I think the untapped opportunity in email newsletters is around reading and discovery: we need an app that manages newsletter subscriptions, allows for annotating, link bookmarking, and discovery of new newsletters based on reading history. I have come across one tool called Stoop for reading email newsletters based on a few of you who already use it, but I’ve found it to be a little underwhelming so far (but with lots of potential!). And, have no fear, SITALWeek won’t be going up behind a paywall anytime soon; we love the feedback and engagement from all the readers. I always get back more than I give, so thank you!

I’ve updated my February post on Zillow and the trends in iBuying for the US real estate market with some additional comments on Redfin as well as some of my thoughts on why houses are shifting to institutional ownership. After I had posted the Zillow blog update, an article on this topic was brought to my attention on my Twitter feed: Fortune ran a feature called “America’s AI Landlord” in their July edition about the rise of institutional home buying on the back of data and technology. I cover this in the blog update, but one provocative question I’d pose after reading the article is: should Zillow and Opendoor vertically integrate one step further and own large portfolios of rental properties? Ultimately, is Zillow a REIT (definition of a REIT for those that aren’t familiar with it), and are its agent-based advertising and iBuyer (and ancillary) services becoming a minority of its earnings? Related to this topic, I’d point folks to read up on the positive trends in the mobile-home-parks sector. Consumers continue to be priced out of starter and lower-priced homes for three reasons: 1) stagnating wage growth, 2) high debt burdens from things like student loans, and 3) structurally-low rates that are making it easier for institutions to enter the market and buy lower-priced homes. Companies like Sun Communities (SUI), Equity Lifestyle Properties (ELS), and UMH Properties (UMH) are large players operating in and consolidating the mobile home park sector, which generally has more attractive characteristics than most people think. I am not an expert on this sector, so do your own diligence here – REIT stocks are yield instruments and, as such, are sensitive to moves in interest rates (low rates drive REIT multiples up as investors seek yield and vice versa).

As I continue to spend more time understanding the teen cultural phenomenon known as TikTok (covered in detail last week), I am surprised to see how many popular creators are using it to drive fans to Instagram, Snap, and YouTube. Taking a Bayesian approach here, this makes me a little less fearful on the incumbent social networks. YouTube also announced new tools for creator monetization recently, some of which are earning stars $400/minute. There are other signs that social media platforms are being used to point audiences back to YouTube, such as these stars that use Instagram to test material for YouTube. No wonder American kids most want to be YouTubers instead of astronauts these days!

The WaPo is building out a cookie-free advertising tool to prepare for a world where browser tracking may no longer be possible, or will be controlled by a small number of platforms like Google. I wonder how closely Bezos (who owns the Post) will be watching this deployment as it relates to Amazon’s growing advertising juggernaut?

Softbank’s ARM has been backed into a corner by the rising success of the open-source processor alternative RISC-V. This week ARM announced a “try before you buy” program that delays the significant upfront licensing cost, but it doesn’t address the reason engineers are embracing RISC-V: rising, heterogeneous workloads require deep customization for power management and other reasons, which is something the open-source community is better poised to address. A great example of this is a new processor called Morpheus, based on RISC-V, which can change its internal code every 50ms to make hacking at the chip level impossible. ARM faces a classic innovator’s dilemma similar to what happened with open-source software: the best tactic might be to move higher up the stack into services such as security and other IP. ARM is working on these developments, but it might be too late.

Spotify partnered with Disney to create a hub of kids songs on the platform. I mentioned to several folks last week that Spotify more aggressively pursuing a media/services bundle (like they have successfully done with Hulu) would cause my credence to rise on their future success. Disney+ is the bundle that I think is most intriguing, and while this “hub” doesn’t necessarily indicate a potential bundle, it’s an encouraging sign of what might happen in the future.

Tim Ferriss stopped his fan-supported podcast transition, falling back on his ad-supported version instead. I sense that the main reason was lack of participation. I think most of the shifting of podcasts behind paywalls will be a failed experiment. I also think podcast exclusives pursued by Spotify, Apple, and Luminary will be a bust, but I recognize that’s a minority viewpoint.

More than 50 police departments across the US have tied into Amazon’s Ring home video camera networks for crime prevention. Ring is not currently using facial recognition, but it could in the future. Orlando Police recently canceled their plan to use Amazon’s controversial Rekognition face recognition software. 

License plate readers are showing up in neighborhoods all over the country thanks to new software and open-source tools. Meanwhile the Florida DMV makes $77M a year selling their driver license database to markets. 

Tinder becomes the latest app attempting to bypass app store fees on the Google play store. This is a smaller component of Alphabet’s valuation; however, I tried to dissect the mirage of Apple’s “services” revenues back in February, and I believe investors are likely assigning an aggressive valuation. Ultimately, lower app-store fees could be offset by higher ad revenues for both Google and Apple, but I’d be wary of what the ultimate app store toll is going to be: 10% is more likely than 30%.

The rise of connected home gym equipment feels like a sustainable trend to me (I’ve been a happy Peloton owner). Unless you are into the social nature of gym culture, the ability to take the best class from the best instructor on demand on your own schedule without the trip to and from the gym is pretty compelling. The category has been expanding with Tonal, which does strength training, and Pivot, which just raised $17M in VC funding to help sell it’s sensor- and machine-learning-based workouts and classes.

Miscellaneous Stuff

The Farmer’s Fable: at NZS Capital we are big fans of understanding the mathematical concept of ergodicity. As I wrote in SITALWeek #197:

Ergodic systems have the same expected value as the average value: if you toss a coin a hundred times, you expect 50/50 heads and tails, which is the same as the expected probability of any given toss. Non-ergodic systems, in contrast, take into account the path through time, not just the probabilistic outcome. For example, you could potentially get 20 tails in a row (albeit at a low probability), and, if you were betting on those tosses, the multiplicative damage that might do to your wallet if you are doubling down on every bet is potentially catastrophic.

Enter The Farmer’s Fable (note: link is an interactive website that takes a second to load), a great story to help you understand what happens when you pool resources and collaborate in non-ergodic systems. The value of and interaction between arithmetic and mathematical compounding combined is the critical insight. And, I’d point out that this is a key part of non-zero-sum (NZS) outcomes in game theory: cooperating will always produce better results over the uncertain path through time.

The Mountain Goats performed one of my favorites, "This Year," with a little help on Colbert. This was 10 years in the making after a prior recording on Colbert’s show never aired. If you don’t know John Darnielle and the Mountain Goats, check them out. I recommend starting with the albums Tallahassee and The Sunset Tree; from there you’ll want to navigate your own path through their extensive list of albums.

The new trailer for Star Trek: Picard debuted at Comic Con, providing easy motivation to sign up for CBS All Access as DirecTV (AT&T) drops CBS for 6.6M customers. As direct streaming access grows, the big studios and networks have more leverage than ever over cable and satellite allowing them to have their cake and eat it too in the direct to consumer streaming transition.

Fossilized 130M year old Microraptor in China swallowed a lizard whole, giving more clues as to how dinosaurs took to flight out of the cretaceous period to evolve into modern birds. 

The city of Berkeley has banned natural gas in new buildings. We covered this topic back in May with the NYT article from the Rocky Mountain Institute. It’s intriguing, but still difficult for many places that have colder winters. Meanwhile “vast swaths” of the Arctic are engulfed in forest fires.

Stuff about Geopolitics, Economics, and the Finance Industry

Terry Guo may run as an independent after losing the pro-China party nomination. I believe Taiwan’s upcoming election is an important event for the growing tensions between the US and China (which I covered in more detail last week). We could see a Trump-like situation where outsiders influence the Taiwan election through social media. The ongoing political turmoil in Hong Kong may continue to serve as a warning to China because this activity would be much amplified in Taiwan if China moves closer to absorbing it politically.

Fidelity announced a new Federal tax-exempt muni fund with a 7 bps fee, undercutting Vanguard by 2 bps. This announcement follows recent comments from BlackRock and Schwab about the growing potential of the Bond index fund/ETF market, which BlackRock believes will double to $2T over the next five years.

The WSJ reported this week on earnings pressure at passive giants BlackRock and State Street. Three things seem fairly certain in the professional investing world today: 1) passive funds and ETFs are in a race to zero or even negative fees as full-service financial institutions use the stock and bond market exposures as loss leaders for the rest of their business; 2) large equity investment firms will find themselves pinned between the pressure to mimic passive strategies and lower fees and the inability to preserve or rebuild their ability to be true active investors; and, 3) this creates an increasing opportunity to be a real active equity investor for smaller firms with the right investment culture as the middle is hollowed out of the funds industry.

In reflecting more on the FTC’s wrist slapping $5B fine to Facebook last week: the largest and most obvious mistake by a big Internet platform with the most tangible negative consequences was Facebook’s dealings with Cambridge Analytica, and that had consequences that rounded to zero. If there is no agreement in DC around platform regulation, then there will be no meaningful regulation of big tech in the US. Around the edges, I think the fear of scrutiny keeps Internet giants from doing something that would create headline outrage. And, it seems like any adjacent move – like Facebook’s Libra – faces a huge uphill battle. For new readers, we covered our thoughts on tech platform regulation in this post: “Tech Regulation: Trying to Jam a Power Law Back Into a Bell Curve Won’t Work.” Meanwhile, Facebook board member Peter Thiel, perhaps emboldened by Facebook’s above-the-law stature in DC, suggested the government forcefully interrogate Google over treason accusations.

Tom Cruise’s bomber jacket drops the Taiwanese and Japanese flags in 2020’s Top Gun 2 trailer, no doubt because Tencent was one of the financial backers of the film. During the Cold War, we got plenty of ideological conflict with the Russians front and center in movies like Red Dawn; but in the East vs. West battle of current times, China is a big consumer and funder of US movies. Despite the Chinese censorship of our media, it’s nice to know Maverick’s representation of US individualism will still be seen all over China. I don’t think Russian citizens saw much of Wolverines in action in the 1980s.

-Brad

Disclaimers:

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

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