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

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In today’s post: a big cloud infrastructure cycle is coming as big tech finds itself in good graces again; stifled fintech innovation in the West hampers crisis reaction; how thinking in terms of complex systems helps us prepare for, and react to, tail events; the problem with asset management’s use of attribution analysis; cities are facing a cash crunch; who might buy Arm Holdings? and, more below...

Stuff about Innovation and Technology
Melt-Blown Fabric Bottleneck
A key component of N95 masks is melt-blown fabric. The machines to make the material cost around $4M each. It’s like making precision, nanometer-scale cotton candy. The price of melt-blown fabric in China has gone from $6,000/ton to $60,000/ton since the outbreak began, according to NPR, and one Chinese maker of masks has seen his fortune rise over $1B, according to the FT. 

eNASCAR a Hit
Fox Sports aired a NASCAR esports racing competition last weekend, pulling in over 900,000 viewers according to Nielsen. Real-world race car drivers competed in the virtual race, and NASCAR was reportedly “blown away” by the popularity. Fox will continue to air virtual esports versions of canceled races in the coming weeks. 

Quarantine by E-Fence
Taiwan is using cell phone GPS to virtually contain people. If your phone leaves your residence or is powered down, you will be checked on by authorities within 15 minutes. They also call randomly twice a day to make sure you are near your phone.

Surge in Patreon Creators and Patrons
Patreon has seen a 36% jump in patrons supporting creators in March compared to levels in February.

Puzzles Up, Apparel Down
Ecommerce marketplace software platform ChannelAdvisor has been posting weekly trend data based on transactions from sellers using their platform. Jigsaw puzzles and computers are up big, along with other items to keep people busy at home, while discretionary items like clothing are down. Some of the early surge in demand for things like K-Cups has softened in recent days as people are stocked up. 

Non-Gamers Flock to Twitch 
In addition to the live concerts (discussed last week) taking place on Twitch, electronic music artists are turning to the self-broadcasting platform (historically mostly used by gamers) to connect with fans. Live broadcasts, rehearsals, and studio sessions are opportunities to grow fan bases and accept donations to keep the music alive. This long article on DJ Mag is filled with examples and challenges. Non-gaming content on Twitch has quadrupled over the last three years. Last weekend set a new Twitch record of 47M hours viewed on both Saturday and Sunday; and, this weekend, Twitch Stream Aid hosted over 70 live musical performances.

Contactless Payments Encouraged
The European Banking Authority is encouraging payment firms to increase use of contactless payment cards and smartphone transactions. The coronavirus crisis could massively accelerate digital payments in the West, perhaps allowing us to catch up with China, which is years ahead. And, with no viable alternatives on the horizon, market share could all accrue to the card networks near term and create significant network effects for Apple Pay and Google Pay. This Economist article points out that Visa makes $7/card per year in revenues (call it $20-30/person if people have 3-4 types of various cards in their wallet). That number is deceivingly low as it doesn’t account for the bank fees that tax transactions (which are 5-10x larger), often usury-like interest payments, or the lost innovation due to the monopoly control of the industry. My prediction for a crazy deal during this crisis: Amazon could buy JP Morgan Chase and make a big splash in payments and banking by creating a new closed loop.

Legacy Banking Slows Economic Recovery Disbursement 
The US Government appears ill-equipped to distribute fiscal stimulus to consumers and loans to companies. Slow loan approval processes and an inability to efficiently print and send checks could delay the much needed injection of money to thaw the frozen economy. Debit cards are one possible solution to get cash to consumers fast. Meanwhile, online lenders are offering to help speed the process of getting loans to small businesses, but they are likely to meet with regulatory roadblocks. If US fintech innovation hadn’t been crushed for decades by the regulatory capture of the current banking and card monopolies, stimulus money could have perhaps found its way into wallets much sooner.

5G Delays as Engineers Fail to Collaborate Virtually
The 5G rollout will be delayed as the standards board 3GPP punts and suspends work during the pandemic. Many deployments were already underway globally (especially in China); but, with a pushout for phone availability (Apple is rumored to delay the 5G iPhone launch) and the recession, 5G was likely to be delayed regardless of standards setting. In particular, this standards setting delay will mostly impact the incremental use cases of 5G like IoT. The delay is a good example of how we all need to rapidly adapt to working virtually: “Part of the problem here is that 3GPP meetings tend to be large, conference-style affairs, held all over the world, sometimes including hundreds of delegates from all continents. The whole process relies on consensus being reached at every stage. Online meetings and conference calls, which working groups have already organized for the coming months are, traditionally, less likely to lead to compromises and swift conclusions.”

Big Tech Lends a Big Hand  
Over the last couple of weeks, I’ve been trying to keep track of all the good things big tech companies are doing to help their own employees as well as frontline workers and others impacted by COVID-19. But, there have been so many examples I couldn’t effectively keep track – Google just donated $800M in cash and free advertising! In SITALWeek #236 a couple of weeks ago, I talked about big tech getting back in good graces with the government: “I can’t help but reflect on how quickly the anti-tech-platform rhetoric has slipped from the political vernacular. With the lefter-leaning presidential candidates dropping out, a seeming lack of public support for anti-tech regulation, and the distraction of the coronavirus, it seems like the extreme threat of breaking up the big tech platforms (or imposing heavy taxes) may be dropping in probability.” Last week, even the EU’s Internal Market Commissioner praised big tech, (proving that we’ve jumped to a bizarre branch of the multiverse!). Indeed, it seems times have changed, and, if anything, we are relying more and more on Microsoft, Google, Amazon, and Facebook to work from home, stay in touch, and entertain ourselves as we adjust to this new way of life. While it’s easy to be cynical, I think big tech genuinely wants to help. However, closer ties between big tech and government runs the risk of rising regulatory capture that snuffs out innovation – an idea I discussed in detail in “How I Learned to Stop Worrying and Love the Monopoly”.

Helm to Engineering: We Need More Cloud Power!
Microsoft saw a 775% increase in Azure cloud usage in areas impacted by stay-at-home orders and, as anticipated in SITALWeek #236, will be prioritizing some customers and limiting some access to services for others in order to avoid downtime. Microsoft is “expediting the addition of significant new capacity that will be available in the weeks ahead”. It’s an acute problem for Microsoft specifically because they have large apps on Azure that their direct customers rely on, including Office 365 and Xbox Live. As I discussed a couple of weeks ago, we are likely at the beginning of a long wave of computing and networking infrastructure buildout around the world, which will be followed by a complete shift to the cloud for all workloads and apps. This demand will likely also increase multicloud models whereby customers spread workloads/risk over multiple, redundant locations and providers, which will also spur demand for hardware and connectivity. 

Wearables Become Disease Sentinels
Oura is back in the news again – they are partnering with UCSF to determine if their connected, biometric rings can detect COVID-19 early. In the study, 2000 frontline health workers will wear the rings. Another trial at the Scripps Research Translational Institute is looking for a much larger group of people, with various fitness trackers, to participate in a longer-term study to identify viral hotspots. With all the health data that Apple and Google have from apps and sensors, it’s not clear to me why they haven’t created anonymized maps of potential viral flare-ups already – maybe something they will launch before next fall’s outbreak?

Could SoftBank Amputate Arm?
SoftBank is looking to sell $41B in assets, including $14B of its stake in Alibaba, to shore up confidence and, in perhaps the ultimate gamble, buy back its own stock. The company’s Sprint stake is not immediately liquid following the T-Mobile deal; and, many of its private assets have suffered valuation declines, as have key public holdings like Uber. WeWork saw its bonds trade at 43 cents on the dollar this week, and SoftBank allowed satellite startup OneWeb to go out of business. Could all of this point to Arm Holdings as a source of cash for SoftBank? Arm has seen its revenue growth slow dramatically with the overall deceleration of the smartphone market; meanwhile, it has also taken up R&D spending and is facing a threat from open-source competitor RISC-V (I wrote more about Arm and RISC-V in this post from back in Feb 2019). I don’t have more than a guess as to what Arm could be worth today, but it’s far less than the $30B price tag paid by SoftBank in 2017 – perhaps now worth half that? Despite the disruptions, there is still a lot to like about Arm – it’s a fantastic company with terrific engineering talent and is critically important to companies like Apple, Samsung, Google, Amazon etc. The world runs on Arm-based chips today as much as it runs on any other technology. And, as noted in SITALWeek #236, Arm has started to gain significant traction in the server market with Amazon’s Graviton2 chip. Complicating matters for any potential acquirer, however, is the fact that Arm China is controlled by China, thanks to a bizarre deal struck back in 2018. If Arm is one of the assets SoftBank sells, the buyer likely needs to be a neutral 3rd party, such as IP and chip design software provider Cadence, or a consortium of Arm’s largest customers. I would love to see Apple, Google, etc. get together and buy the asset and transfer it into a non-profit, open-source foundation with a commitment to fund R&D for years to come.

Those Who Can’t Do, Watch
Following up on last week’s musings on the demise of movie theaters, Amazon has now launched an “In Theater Purchase” hub on Prime Video for people to buy current releases for $19.99. Meanwhile, streaming video apps saw a surge of signups – Disney+ new users tripled in one weekend as quarantines went into place around the world.  Overall, TV viewing for the prior week was up 20% according to WarnerMedia, which also saw a 40% increase in HBO Now app usage. Even TNT and TBS saw increased viewers. The WSJ reports that overall streaming is up 12% and ad slots are up mid teens, but advertisers are increasingly canceling their ads due to the frozen economy. Google is now limiting YouTube bandwidth globally for a month, and I think that forebears a significant risk the Internet is going to crash soon. After all, Google has all the data – remember, they sent their global workforce home before anyone else made that call! Podcasts, however, are on the losing end of media consumption. According to analytics firm Podtrac, the audience for podcasts has dropped around 10% over the last two weeks, likely from less commute and gym time.  

Uncertainty and Quarantines Slow Home Buying
The homebuying market has slowed around 30% in the US in the last couple weeks, and is likely to slow further. Redfin reported a 27% drop in requests to see homes and noted closings taking place by passing documents through cracked car windows! Zillow has seen around a 30% drop in site traffic and leads to realtors, according to analyst Mike DelPrete. When the market picks back up, housing is a good example of a market that will likely see an accelerated digital transformation as a result of the crisis. Zillow is well positioned to enable this transformation, as co-founder and CEO Rich Barton explained this week (PDF of call slides) in an investor update: “Lloyd and I were raised at Microsoft in the '80s and '90s. Part of the Microsoft lore is that Bill's dad told him he always should have enough money in the bank to be able to run the company for at least 1 year with 0 revenue. This is how I have managed every company I founded and led, and this is how I have advised every company I have invested in or sat on the Board of.”

Miscellaneous Stuff
Tired of Netflix?
If you need a break from all the contemporary video streaming apps, I highly recommend checking out the Criterion app. As they say, it’s “A Movie Lover’s Dream”. The app houses 1,000 movies, plus a rotating selection of art house titles, and is available on all your favorite platforms. 🍿📽

Fading French Wine Consumption
Wine consumption in France has been on a steady decline for decades, falling by around 15L per person every decade to 40L (less than one glass/day, on average, across the population). Exports to the US and China are so far picking up the slack. 🍷

Crowler Production Up with Demand for Portable Brews
Ball Corp, the only maker of 32 oz crowler cans (the aluminum version of glass growlers), is ramping up production to satisfy demand by breweries that are doing more carry-out business during the lockdown.

Dylan’s JFK Elegy
Bob Dylan released an elegy to JFK this week. Murder Most Foul, Dylan’s first original song in eight years, is also his longest ever at nearly 17 minutes. The enigma hasn’t been unraveled yet, but the song also feels like an elegy to many elements of the 60s and 70s, and perhaps much more.

Stuff about Geopolitics, Economics, and the Finance Industry
Where’s Warren?
Investors have been waiting in anticipation for Warren Buffett to emerge from hiding and declare that the world is still going to continue, and that there are great values for long-term investors. Maybe some are even hopeful that Berkshire will rescue some companies or buy some big American brands...Well, instead we get this new animated handwashing PSA narrated by Buffett on YouTube.🧼👐🤷‍♂️

Local Gov’t Cash Crunch
State and local governments are going to face a large, crisis-caused cash crunch, thanks to delayed tax revenues from postponed filing deadlines, lower sales tax collection with decreased consumption/gas, and increased pension liabilities (as underfunded status rises with the market drop). It will be interesting (and probably painful) to see how it all plays out. My local town reported last week that it has four months of payroll and interest payments liquid without dipping into emergency reserves. This could hamper the much needed digital transformation of government without Federal and state action to save local governments.

The Problem with Attribution-Based Incentives
Across the investment industry many of today’s $100B+ asset managers are facing the same existential problem: too many assets, constraints, and liquidity problems, which can lead to undifferentiated performance; yet, they still charge for “active” management even as products increasingly act like the passive indices. As the competition from passive index funds rose, many large shops focused more on the index benchmarks as their bogeys; in consequence, asset managers now often use attribution to measure performance of analysts/PMs. Attribution measures the performance of a stock in a fund relative to its benchmark weight. If compensation is linked to attribution, then incentive shifts (consciously or subconsciously) from optimizing a portfolio for client outcome to sizing positions in closer adherence to the benchmark to protect individual compensation. This misalignment in incentivization can be sub-optimal for long-term portfolio outperformance. Many institutional and retail investors understand this rising problem, and they are seeking investment opportunities elsewhere – index funds, boutique or other shops that prioritize active management, private equity, etc. At NZS Capital, we know attribution is a flawed system that can disadvantage the client. NZS’ investment team owns our firm, and we only do well when our clients do well. Our process puts a healthy burden on debate and rooting out sources of bias in portfolio construction: it’s never about “me” or “my” idea, it’s always about what is best for the portfolio and the client. Brinton and I are thrilled to have Joe Furmanski and Jon Bathgate join our investment team at NZS Capital because we know they are team players and world-class stock pickers. At NZS Capital, we only win as a team if our clients achieve their objectives – 100% alignment. 

Complexity Mindset
The muted early reaction to coronavirus was a failure to understand complex systems, as this Atlantic article explains – a failure to understand multiplicative dynamics and 2nd and 3rd order impacts. “In many complex systems, efficiency, redundancy, and resiliency pull in different directions: More efficient systems, which are cheaper, eliminate redundancies, which provide resilience but cost more.” Critical analysis is of course much more easily accomplished in hindsight – humans are terrible at precisely and accurately predicting the future in a complex world. However, when thinking about the future, a good start is to accept that we do indeed exist within a complex system, with myriad interconnections and a strong disposition to “fat tail” events. Who thought to mass produce skinny nasal swabs ahead of the pandemic? No one. But, adaptable companies, who can quickly and efficiently evolve their businesses to meet the changing needs of the world will emerge stronger from the crisis. Thinking in terms of complex adaptive systems is the heart of our portfolio construction process at NZS Capital, so it’s second nature to us to look for companies who exhibit adaptability. And, because the exact nature of crisis events will undoubtedly affect different sectors and businesses to varying degrees, we will continue to use resilient companies in our portfolio as batteries to power investments in a wide range of disruptive and innovative companies transforming the world for the better. 

The events of the last few weeks have frequently reminded me of the importance of understanding ergodicity and the failures of asystemic thinking. How many people in their 10-year DCFs had 2020 revenues down 60%? As investors, we want to believe that a spreadsheet can give us comfort; but, the concept of margin of safety has very little to do with forecasting business prospects and building complex models (see Non-Ergodic Systems Bury the DCF for more explanation). As we wrote in Redefining Margin of Safety last fall, investors should focus on “the ability of a company to adapt – which, in turn, is dependent upon management Quality and nature of growth...Hallmarks of gentle sloping ‘S-curve’ businesses that we look for are negative feedback loops, tight-knit customer relations, and positive NZS. Slow, long-duration growth allows for timely innovation, decelerating the game clock so managers can make smart decisions and maintain their lead through adaptation.” When extreme events happen, such as what we are experiencing now, stock price movements are volatile, but that volatility does not represent risk. Risk is represented by the degree to which a company can or cannot adapt to changing circumstances. We took no comfort in DCFs before the crisis, and we take no comfort in them now. A great place to start today when looking at the market is asking: Which management teams will emerge from this crisis stronger and with more future Optionality in their business?

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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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