10foot Scuttlebutt: April 2018 edition

10foot Scuttlebutt: April 2018 edition

Here is my scuttlebutt post for April 2018, with a few things I’ve seen or thought recently.

Find the moat (at Afterpay)

Rumour has it Afterpay is pretty aggressive when it comes to tackling criticism of its not-credit (actually retail tech) product. That is just a rumour – and no I haven’t heard from them. But to me this rumour raises an interesting question.

Surely Afterpay’s product is legal and compliant with regulation? It so obviously must be (otherwise the company has breached the law 1.5 million times and counting), that I wonder why Afterpay cares about the critics.

As legendary entrepreneur Curtis James Jackson III would say when faced with this situation:
“If negroes hate then let them hate, watch the money pile up.”

Inverting that compliance, Afterpay has a massive competitive advantage by not having to provide credit checks on customers before providing them with retail tech services. The company itself has acknowledged it has no direct competitors.

So, where does the edge come from?  Surely it can’t come from the fact that the company doesn’t have to comply with the same regulations as other companies do. What I mean is, surely Afterpay’s edge isn’t dependent on a free pass from the same regulator that is:

1. Vulnerable to political pressure
2. Vulnerable to media pressure
3. Actively reining in payday lending and other aspects of the credit industry
4. Part of the Royal Commission into fin services

 

In response to my earlier post I had some great responses on Twitter. One person pointed out that Afterpay likely has or will have pricing power with merchants in time, which is something I hadn’t considered.

The regulation aspect however also heightens the risk in my opinion. If Afterpay is forced to provide credit checks, then there will be a degree of ‘deleverage’. It won’t just be harder and costlier to attract customers, it will make the product harder for customers to use and it will also eliminate Afterpay’s primary competitive advantage and make its product stand out much less (though it will retain a strong brand).

It usually takes a media article to get a politician or a regulator to act. So, is Afterpay just one bad media article away from greater regulation and a less attractive business? I’m not sure, but that’s an interesting question given the likely consequences of more regulation and Afterpay’s rumoured sensitivity to criticism.

Poor people spending irresponsibly is a pretty hot topic, you would think that the regulatory risks are higher than otherwise.

I would like to like Afterpay. It’s got a fantastic product. If you think that the product becomes ubiquitous, as I do, then the company is a tricky short idea. On the other hand, if you think the valuation is optimistic and the risks are higher than the market realises, as I also do, it’s hard to like.  For now, it’s firmly in my too hard basket.

The Tesla Bubble

I don’t short stocks (yet), but I think Tesla is an absolute slam dunk short idea on paper. I know I’m like 3 years late arriving at that conclusion, but I had an argument with a Tesla bull over Easter, which brought my thoughts to the fore.

The biggest Tesla red flag to my mind is the perceptual black hole that exists around Mr Musk. Everything you say to a Tesla bull is replied to with some variant of “yeah but this is Elon Musk and he is special.”

“Tesla is an asset-intensive cash burning (PoS) business that is entirely dependent on loose lending markets to survive.”

• Yeah but Elon Musk is a tech genius from paypal who can land rocketships on Earth

 

“Tesla has woeful build quality problems and astonishing debt for a company that’s not generating any cash.”

• Yeah but Elon Musk is automating everything and he works 25 hours a day plus AI, visionary, future, machine learning, buzzwords”

 

“I don’t think Tesla has ever met a single one of its production forecasts in the last 3 years and it is still falling short.”

• Yeah but this is Elon Musk, it’s not his fault that his vision is too ambitious for what can be achieved in the short term. He thinks in terms of forever.

 

I mean, seriously. Every discussion with a Tesla bull involves some version of reframing the issue to make the problem sound OK because Elon Musk.

If you cannot see that you are living inside a perceptual bubble when you hold a stock, you have gone waayyyyyy off the reservation. There’s that old Warren Buffett quote:

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Tesla might be a winner, and I do hope that Elon Musk saves the world, but I really doubt it (on both counts).

I also think it’s a darn shame that Tesla doesn’t use SPVs because, mark my words,  Elon Musk is The Smartest Guy In The Room.

Edit: I forgot to include this video in which Hitler discovers that he owns Tesla bonds. I laughed so hard I nearly fell off my chair.

The L1 Capital Full Court Press

L1 Capital is running a full court press on their upcoming IPO:

It’s an interesting one. I saw in the prospectus that they have around 200%-300% annual turnover, suggesting a lot of trading activity?  Peter Lynch did about the same turnover if I recall correctly, but that would be something to look into were I a buyer.

A quick note on Blue Sky and Vinomofo

I commented briefly in February that I was looking into Blue Sky, particularly the Vinomofo fund. (I’d never looked at BLA, but I had a couple of suggestions, including from a financial adviser and another guy that’s short BLA.)

I’m embarrassed to say I couldn’t make a lot of headway, and I particularly struggled to understand the structure of all the funds. Still, I spent $40 on the damn Vinomofo report, so I figure I might post its cash flow and income statements here for others to judge for themselves. Quoting BLA,  Glaucus states that BLA invested $25 million for a 22.7% stake in Vinomofo in Feb 2016. That works out to about $110 million for the full company at the time. I am not sure what the valuation is now, but applying that $110m valuation to the 2017 annual results, Vino is priced at:

• 2.5x sales
• 7.1x gross profit
• Has negative net assets of $7.5m (no book value)
• Made a loss of $4.7m after tax
• Burned $6.7m cash

I attach the statements here for those who are curious,  Balance Sheet/ Cash Flow/ Comprehensive Income:

 

A lot of cynical comments have come out about BLA since the Glaucus report, and I look forward to seeing BLA’s rebuttal.

Trimantium GrowthOps survives its IPO

Trimantium GrowthOps finally made it to the ASX, after a difficult offer process that was extended 3(?) times and a (I suspect) Chinese bidder that pulled out at the last moment.

After the first round was extended and still closed undersubscribed, Growthops found a mystery bidder that subscribed for all of the shares remaining in the prospectus – but the buyer didn’t send the cash.  The offer was extended for a time to allow the group to send the cash….but they still didn’t send it and Growthops had to go back to the drawing board again. This has happened in our market several times previously, such as with G8 Education, and it is a dead giveaway of a Chinese bidder, in my opinion (TGO declined to comment).

Mumbrella has covered the story the whole way through.

https://mumbrella.com.au/delayed-trimantium-growthops-ipo-closes-company-planning-commence-trading-20-march-504437

I still reckon it’s a mediocre business and that the transaction generated a lot of wealth for vendor Trimantium Capital with fairly little risk on their part. TGO shares are now trading at $1.32 after failing multiple times over a period of months to raise enough bidders at $1. But hey what do I know?

A trust deficit? 

The new chief of ASIC James Shipton made his debut speech recently. In it he says that finance is the least trusted profession in Australia and there is a major trust deficit that needs work to rectify. He’s spot on with that, but I also think he’s dead wrong in a way.

I would politely suggest that he’s confusing cause and effect – we don’t have a trust deficit, we have a ‘thieving motherfuckers in jail’ deficit. People don’t trust anybody in finance because financial misbehaviour is not often caught or adequately punished.

I have not once met an investor who thinks that ASIC is a good regulator. ASIC has an OK strike rate but they are incredibly slow to move – look at their Twitter feed, most of the jail sentences announced date from 2013, 2014.

If I had to put my two cents from the outside looking in, I would suggest that ASIC mostly thinks of themselves as an oversight committee rather than specifically a crime fighting organisation. They spend a lot of time doing really useful stuff to improve investor awareness, but there have been some blatant bazookas fired off under their nose that they have totally missed – despite several warnings – and totally failed to act upon afterwards (looking at you, Storm Financial).

Alternatively, just look at Jenny Hutson. It took ASIC nearly 3 years to charge her for her alleged activities at G8 Education. ASIC today announced she was charged with a variety of misdeeds.

I have been thinking about this since Shipton’s speech – and I frankly have no idea what I’m talking about – but if I had to make suggestions to ASIC to improve its operations, they would be this:

• Create a structure that incentivises catching bad dudes. Current financial regulations are imperfect, but reasonably adequate. Most people do an OK job of complying with the law most of the time and could be left unsupervised with relatively minor adverse effects. A major problem appears to be that bad people are seemingly not caught in a timely manner and/or not punished adequately. ASIC also has virtually zero success acting preventively.
• For listed companies, hire investment analysts (not lawyers) to oversee them. Lawyers are concerned with compliance with the law, but stock analysts are trained to spot risk and avoid loss, which is a different thing. Especially for listed companies, investment analysts know the industry intimately, especially via scuttlebutt and rumour.  I think this would greatly increase the degree to which ASIC is ‘in touch with the market’ and I suspect would accelerate awareness of problems and reduce the reaction time.
• Pay staff more. Current ASIC pay rates are woeful (I looked into this awhile ago) especially if you have to live in Sydney where ASIC is based. More poignantly, when you’re competing for legal and financial skills, you’re competing for staff with investment banks, law firms, and fund managers which pay a lot better. Money shouldn’t be the primary goal at a regulator – you want to self-select for people that enjoy monitoring compliance or stopping wrongdoing – but you also need to pay enough to attract a reasonable standard of staff and put them personally in a safe financial position where they can upskill and give 110% every day (because financial security = better personal health and wellbeing).
• Develop better market overwatch and sources of intelligence. Often everybody in the market knows that a company is questionable but there’s no real way for ASIC to do anything about it. (analysts would help here, especially those that come from informationally advantaged funds).
• Bring ASX’s listing compliance function inside ASIC. This will remove the inherent conflict from ASX (which gets paid by having lots of companies listed) and will also increase the degree to which ASIC is in touch with the market.

 

I’ve already commented on ASIC’s absolute rort of a document system. Just look at Blue Sky – as mentioned above it costs $40 to see Vinomofo’s annual report, just to check if BLA is marking that asset aggressively. BLA and BAF own stakes in dozens of different entities, so if you want to follow that through it could cost you an absolute fortune (like in the thousands of dollars).

This creates a two tier market where a large number of people are informationally disadvantaged, even though the information is ‘public’.

They say the two biggest regulatory problems in finance are a) bad financial incentives in organisations and b) lack of enforcement to punish people for wrongdoing. ASIC knows that well but…the beast is slow to change.

I have no position in any company mentioned, listed or unlisted. I do not and have never worked for ASIC. This is a disclosure and not a recommendation.