Infinite Nuance

Ubisoft: Peak Uncertainty

Thu, 22 Jan 2026 08:53:02 GMT

I purchased shares in Ubisoft today for the first time ever, at 4.70. This may come as a surprise because I have been telling everybody the company is dogshit for at least three years. That view is changing and I believe the company is at peak uncertainty, with direction of fundamentals now moving in the opposite direction of the stock price.

Originally, it was clear that Yves Guillemot was flailing and unsure how to get the company to the next level. However, the company also has very strong core franchises that are growing well, and obvious opportunities to improve e.g. productivity.

If the cost structure improved and the franchises kept growing, it was probably a $30 stock. However, if Guillemot didn’t get his shit together, it was a $10 stock. I spent 2023 and 2024 buying put-call spreads and selling each leg for 30-50% gains. I did this like five times. This was the original thesis I articulated in 2024:

Meanwhile, Guillemot kept selling the furniture to heat the house with Tencent trying to edge him out. It became clear to me that Guillemot was going to run the company into the ground and I told everyone it was uninvestable (it was). The stock is down 75% since then.

You can see a full history of my comments here:

ubisoft (from:10footinvestor) – Search / X

I’m not going to resummarise three years of work because frankly I have other, more important things I am focused on right now (see Fireside – here).

But I want to write this down because I focus on management quality turnarounds and this is the exact type of situation I look for – where qualitatives are moving in the right direction masked by near-term quantitative noise. Here is the pitch.

Bear case:

skilled but unmotivated CEO with a terrible leadership style, more concerned with his position and his legacy than the financial success of his company
historically mismanaged and currently extremely low-morale company
tonne of debt, distribution sucks (paying rent to Steam; no distribution it controls)
lowest productivity of any game company in the industry
just cancelled a bunch of titles (near term earnings hit)
talent departing
incrementally selling the crown jewels to tencent
poor product judgement and mis-investment (e.g. rabbids, NFTs)
CEO jumps in wrong direction / acts out of desperation

Why I think now is the time to do the work and the company is at peak uncertainty:

Finally got serious about focus, layoffs, and productivity. Once this all washes out it probably works out to a ~20% headcount decline in last 2-3 years. Full impact of this is still coming through.
Change in studio structure similar to what CD Projekt (another management turnaround I’ve invested in) resulting in better creativity, better delivery at scale, and much better link between creativity and implementation
Company has suffered enough (see: stock price) to finally motivate and catalyse the man to act
The core franchises are exceptionally strong, with more focus this may be enough to give you leverage / room to move on distribution
Got the CoD distribution rights from Microsoft. Ubisoft got this because it’s a badly mismanaged company who will never be a threat – but – they do know how to sell shooters and this is earnings accretive
unnecessary product development killed & unlikely to recur (cancellations today)
debt and FCF constraints greatly limit the direction the CEO can take; I believe this + Tencent will channel focus in right direction

That’s the high-level TLDR. Falling stock price changes Guillemot’s leverage and the equation quite drastically and you can see Tencent successfully chiselling out concessions. I think this will be enough to cause Guillemot to act and the leverage of Tencent will channel that energy in the right direction.

The downside here is very obvious. I have started with a very small position; I think the play here is very similar to Metro Bank or CD Projekt. There is a path, the path has milestones which indicate uncertainty reducing (reduced debt, lower cost structure, improved rev per headcount, free cash flow generation, + a bunch of stuff on the product and distro side). You watch the path and buy the stock, or sell it. All will become obvious in time.

YMMV.

I own shares in Ubisoft and CD Projekt. This is a disclosure and not a recommendation. I do not work as an investment adviser / equity analyst. Do your own work.

Case Study: Simply Wall St Dashboard Feed

Tue, 26 Nov 2024 22:42:21 GMT

This is a short overview of the “Dashboard Feed” project I led in my role as Content Product Lead at Simply Wall St, a fintech startup with circa 30 employees (at the time). This project was ultimately highly successful – far more than I’d anticipated at the time – so I want to look at:

Why we built the dashboard feed
How we determined what to build & tested this with users
How I positioned the team to deliver
The end result

TLDR: We built a dashboard feed that increased activation and retention significantly, and as 2024, the feed remains the largest single predictor of paid user retention.

(As with other case studies, I will omit commercially sensitive information. Thoughts and feedback welcome).

Simply Wall St’s primary acquisition tool for a long time was algorithmic/automated news articles distributed through a variety of channels. They contained insights that you simply couldn’t get on the platform and for a long time there was a slightly discordant experience where if someone enjoyed the analysis in an article, they would then click through to the platform and not find any of those insights.

Additionally, users would be dropped into a complex app (see below screenshot) with minimal guidance/direction. The result of this was that out of several million visitors, only around 5% became active users of the platform (measured by visiting once in a 14-day period) and a tiny fraction of that converted to paid. At the time, customer retention was also low and while the business enjoyed SaaS-like economics, it had retention closer to a newsletter product than a long-customer-lifetime B2B SaaS.

“News” – coming back to get new information – has always been a huge part of the SWS ethos and the CEO, Al, had determined that the way to improve both retention (of existing paid & free users) and activation (of new free users) would be a dashboard for users to track updates about their portfolio. It was an elegant solution as it would simultaneously solve several problems:

Give existing users a reason to come back to the platform (“maybe there is some news on XYZ stock I hold”)
Give new customers a clearer “hook” to engage with (“I can see the history of events at XYZ stock”)
Allow us to share article/news insights in a more natural way
Expand the existing Portfolio feature as currently it just showed dollar values

Quan Do (designer) and Mauro Ferrante (PM) led the dashboard product team designing the dashboard page itself. The current version of the dashboard looks like this, but the early one was very similar:

(Mock portfolio)

It became obvious in about five minutes that simply putting links to articles into the dashboard feed would not be ideal, as these were optimised for volume and also for attention-grabbing headlines like “Here’s why analysts are upgrading XYZ stock”. This meant that customers were getting many duplicate articles, and also the headlines “forced” people to click through to the article and read it (taking you to another website) rather than getting the information in the dashboard itself.

The headlines were also optimised for intrigue rather than communicating clear information. We considered making the articles native, which was not technically difficult – simply exporting already-stored text into another place on the site – but the articles would still have all the same issues of not communicating clear information, and it was far too much effort to recreate them in an ideal format. Likewise changing all of the headlines was not really appealing. (It would have meant creating and maintaining two types of articles, one for internal users and one for external readers/prospective customers – months or years of work which could not be spent improving the articles or improving other aspects of the experience).

However, the core analysis of the articles (code sorting companies into categories/outcomes) was very easy to recreate and could be done in days. We decided to create bespoke updates tailored for easy consumption in the dashboard format.

What do customers want?

So what should we update people on? What do customers care about? There are several answers to this, (and it is a lot more difficult than you would expect) but there is one overarching principle you must keep in mind:

Principle #1: People only care about whether the stock goes up or down and why.

Yeah they might look at the balance sheet, or new products, or revenue growth, or what Jim Cramer says, or [blah blah blah] but at the end of the day, everything boils down to “is this investment going to go up or down”, or, in limited cases, “will it keep paying dividends”.

For a subset of more sophisticated and enlightened customers, they might take a more longer-term view of “well I don’t mind if it goes up or down in the short term as long as it goes up more in the long term.” Everything we needs to relate back to that.

Principle #2: People don’t know all of the things.

Simply Wall St sells tools to investors. The amount of time people have for research is finite, and the number of things that could become relevant is almost infinite. As a result we cannot simply “build things that people want” because there are many more things that could be built that they don’t know about. A diagram:

Consequently, there is a big push-pull dynamic between:

Most data is irrelevant most of the time, but it becomes acutely relevant at certain times, and
There is more involved in investing than any typical user could possibly know or keep track of
People are learning how to invest, so you must help decide what to draw their attention to

For example, if a company director retires, this happens all the time – directors are usually old – and doesn’t really have any predictive information. If, however, five directors leave within a short period, well that’s a yellow flag and something any investor should look at before deciding whether to buy or hold the company’s stock.

So, there is judgement in what to show people and what to build. Building things and then relying on metrics/engagement also doesn’t work because there is a) too much data to do this, and b) you would deceive yourself. Probably what you would conclude is that “people aren’t interested in directors changing” when the reality is closer to “99% of the time it is not interesting but 1% of the time it is extremely interesting”. Understanding this helps you make a more informed decision about what exactly to notify people about.

Deciding what to build

Keeping these two principles in mind, this is how we decided what should go into the dashboard feed first. We used a combination of Jobs To Be Done (“JTBD” – more on this below), data available, reader interest, and judgement. In diagram form again:

While choosing JTBD is relatively straightforward, it’s also limited by the data we had from our provider. For example, at the time, data was provided on a lagged basis, so real-time updates were out. Similarly, we might have some interesting data (for example – auditor going concern flags) but it was only available in a handful of markets which may or may not have overlapped markets where we generated revenue.

So, once we’ve selected JTBD, and then narrowed them down to the jobs we can serve with data, they need to actually occur for companies that people care about OR be sufficiently interesting that they are worth creating because they are highly impactful. There’s no point having the world’s greatest update, but it only covers 10 companies in Malaysia where we have like 10,000 free users and 0 paid.

A note on “highly impactful” (which is a judgement call). Auditor going concern is a great example, as it’s a subset of our debt analysis that only covers maybe 100 companies a year. The vast majority of these are mining explorers or biotech speculators, but every once in a while it will cover highly indebted large caps like Ford or Tesla and is sufficiently important – “this company you have invested in might not exist next year” to notify people about.

A note on JTBD as this is important to understand:

Jobs to be done: Adam Hejl and Steve Jocum ran a JTBD research project where they interviewed >100 customers of all levels of experience and surveyed around 13,000 users to collect all of the possible “jobs” that someone could have when investing. There ended up being something like >400 jobs which clustered into five main categories. I won’t share these as it’s highly proprietary, but there was a category called “Monitoring” which revolved around users keeping track of companies they already owned, and this was the category we weighed most heavily for the Dashboard.

(Humblebrag: Using reciprocity principles, I wrote the text convincing users to complete the survey, which improved conversion by about 50%.)

After these steps we had the following information:

Important jobs for users, that
Could be served with data, and
Covered companies that people cared about,
At least somewhat frequently (>=2x a year)

While it’s not possible to know all events that will happen in the future, we did some sanity checks based on recent history to confirm that after we’d built the updates, >90% of all users and almost 100% of paid users would have at least 1 update for each of the companies in their portfolio currently. (There were a variety of limitations to this analysis, so the actual numbers were likely significantly lower, but we also knew we could improve this over time).

The last remaining step was the judgement step of determining what was actually relevant for moving the stock price.

Judgement – what updates are worth your precious time?

Simple example: When a company reports results, its earnings either go up, down, or are flat. Up and down are much more important than flat, but is flat still sufficiently interesting to notify somebody about? (It is, but we would test this).

To give a more complicated example: One director leaving is not interesting. Unless that director is the CEO, when it is very interesting. What about if it’s only a single director, but he was the chair of the audit committee? Two directors is probably not interesting. How about three? Four and more definitely is. Do people care if the board diversity changed (e.g. by adding a woman)? What about if a CFO leaves, but it’s the second CFO in a year? Maybe we should draw attention to frequent turnover. There are hundreds of possibles like this for most of the main jobs and it takes time to work through them.

In the end we settled on the following main updates to address user monitoring jobs:

Company reported earnings
Key personnel change
Key persons buy/sell shares
Meaningful analyst estimate change
Change in estimated valuation
Change in risk

Each of these had a range of variants, for example sometimes executives notify of an intent to sell stock before they sell. Sometimes companies report quarterly earnings but not half year, or only report annually.

…………….More to come later on:

having decided on what updates to build, how we created mockups and tested with users
deciding how to deliver (e.g. building in phases/ iterated delivery)
managing timeframes
measuring impact
training the team to deliver
people management & quality control throughout this process

Case Study: iApply Loan Application Flow

Wed, 23 Oct 2024 00:42:38 GMT

This is an overview of the iApply loan application flow project I ran in my role as Product Manager at Leveraged.

The purpose of this project was to increase revenue, reduce the time lag between marketing spend and revenue generation, and grow the business by losing fewer customers in the funnel. We would do this by eliminating paper-based applications, reduce processing time drastically below 30 days, and increasing the number of first-time approvals. This would also help us remain competitive with other market participants moving towards same-day loan approval by 2026. Leveraged loan approvals at the time took more than a month, which was slow by industry standards. The estimated impact of this project was several million dollars in revenue which, if achieved, would create a noticeable inflection in growth.

This project was ultimately unsuccessful as the bank made redundant a large chunk of its technical staff, so I want to look at:

The process I followed
How I diagnosed the issues, evaluated that they were commercially valuable, and got buy-in
How I circumvented issues that had derailed the project previously, and
The end result

Thoughts and feedback welcome.

Background:

Leveraged, the margin lending subsidiary of Bendigo & Adelaide Bank (ASX:BEN), has an outdated loan application flow that had not been meaningfully updated for somewhere around 8-10 years. It was complicated, slow, and had high drop-off rates. Several projects to revamp it had previously failed & the reaction to another attempt to improve was somewhere between “lukewarm” and “actively hostile”. When I reviewed the (sparse) previous project documentation I found that it had not progressed past the “collect issues” stage with a couple of kanban-style boards and email trails. There had been no clear vision of what the future state looked like, which made the issues with the form difficult to integrate into a solution. I prioritised starting with the vision, but more on that later.

In terms of the form itself, there were multiple branching paths and lots of complex if-then scenarios that were not well signalled and made it difficult for a customer to complete. The overwhelming majority of customers who started an application did not submit, and of the handful of customers that did submit, over 99% of applications were incomplete and required additional follow-ups from the Operations team.

The organisation was still using “paper” applications with high-net-worth clients as this allowed a sales representative to work with a client to get the application filled out correctly. There had also evolved a practice of complex handovers (which I won’t go into as it’s commercially sensitive), but basically issues with the form had caused a number of unnatural side effects within the business as it attempted to work around these issues.

Tracking / Data collection:

The organisation did not actively track loan submission/funnel information, so it did not recognise that the submission rate had been steadily declining for the past 3 years and had halved since 2019 – previously it had been around the average for other loan flows across the bank. Parts of the information existed in several different systems, including paper records, and not all systems used the same application number (for example the loan application number in the application software was different to the loan number in the operations/credit review stage) so it was difficult to follow a loan from application to approval.

With some effort I measured the average processing time as around ~30 business days. I introduced the concept of “revenue-days” because the primary tracking was done in Operations which mostly concerned about throughput (“actions per business-day”), whereas interest is earned (or not earned) on every calendar day. For the purpose of improving the application we wanted to improve both revenue and throughput, and the processing time based on a typical trailing three-month period was around 42 revenue-days.

Being deliberately vague with numbers here but ballpark half of your customers will draw down within 90 days after taking a loan and the majority will draw down within 180 days. A small percentage “never” draw down (at least not during any commercially relevant window). When combined with the time to approve a loan, this means you are waiting something like 130 days to generate first revenue from half of your customers.

Lead time to revenue:

When you factor in that the application itself is complicated (requires documentation etc) and may take several days or weeks to be ready to submit, and then add on the lead time from advertising conversion, you’re looking at 9 months or more from advertising spend to generate $1 in revenue. This slows the velocity of the entire business and makes it hard to replenish lost/retired loans. Even without any improvement to growth, simply speeding up processing time of new loans pretty obviously had a value in the millions. (For the purpose of this project I calculated a year-1 payback figure, which I won’t share as it’s commercially sensitive, but what this showed is the ROI with very conservative assumptions was enormous, conceivably easily a 20-50x return on spend simply by reducing processing time, and much more if it increased loan submissions).

I also did a sanity check of the credit process and found it was robust. Around xx% of loans would be rejected for credit reasons which was around the standard for the bank, and notes on the rejected applications I reviewed showed they were clearly not creditworthy. Funny story: I had to jump through several hoops including seeking explicit permission from the Head of NSW to review the case notes, and I think this was positively received as it was literally the first time in history anyone had ever asked. I was checking that loans weren’t being rejected for being incomplete, but the credit and operations teams were both really good & had a solid working relationship where they would move a loan back into operations to rectify any outstanding questions with the customer rather than risk rejecting the loan and force the customer to reapply.

The vision:

The appetite for change was not large enough to redesign the entire system or change vendor. It was however large enough to “just make it work” which is the initial language I used in discussion with stakeholders. As I held workshops and informal discussions I highlighted the unnatural behaviours that the organisation was doing (“this seems really difficult”) and observed reactions, and then asked people “what does ‘make it work'” mean for you?

We settled on three principles which were “make it easy to complete, make it fast, and make it crystal clear so that the customer doesn’t have to guess.” I subsequently started every meeting by reminding everyone of those principles & used them when broadcasting through the org and they resonated well.

The process:

Now we needed to look at the causes of drop-offs and processing difficulties. There was no tracking within the form whatsoever, but you could at least see the last question that a customer answered, and operations manually tracked issues within every submitted application. Issues occurred primarily in three key places:

Identity verification
Statement of position
Supporting documentation

100% of received applications had issues with at least one, and usually 2-3 of these, and they were a big driver of customer drop-off.

ID verification:

The online identify verification was unclear and had no error messaging, but it required the customer to correctly enter their legal name and information on several separate pages. For example you would enter your name e.g. “Jack” on the first page, but then on the fourth page you would enter your ID number 12345 which would check your Drivers License or Passport where your name might be “Jackson”. There were a lot of little issues like this where it was not clear that you needed to enter your correct legal name on the first page because that’s what would be used to check your ID on page 4.

Likewise the ID verification checked both the electoral roll and your chosen form of ID, but it didn’t explain to the customer that it was checking both. So if you’d moved house and updated your ID but not your electoral roll, it would reject ID verification but not tell you why – you wouldn’t even know it checked the electoral roll – and then you’d need to manually ID in a branch. This was obviously frustrating and it cost us customers as well as tying the team up verifying ID.

Statement of Position:

The statement of position was unclear in what it was asking for. For a loan application you need to provide absolutely everything; employment income, investment income, all expenses, all liabilities (credit card, HELP loan, BNPL, home loan), all assets (investment property, shares, etc). Failing to list any one of those would require the team to follow up and query it with you.

Additionally, the layout of the form was really unclear and not intuitive – much more like a spreadsheet than actual software. For example, if you’d listed on an earlier page that you earned dividends from investments, the statement of position would not recognise that, and you would have to enter that manually (whereas in reality it could be partly prefilled based on information you’d already provided).

This section came at the end of a form that was already 30 pages long and by this stage the customer was tired/bored – and this was the hardest section of the form by far. Again, it was a big driver of drop-off and consumed hundreds of man-hours of follow-ups from the operations team.

Leveraged employed a person full-time simply to call customers who dropped off during applications and coax them through to the end. Darren was absolutely brilliant, and as you’d expect a fount of insight; he’d spent 4 years on this and knew all the pain points inside and out. I spent a lot of time with him (and got his number when I left so I can hire him some day) but spending $100k on someone simply to help customers complete the application is another example of the unnatural contortions that had emerged in the business.

In terms of the form, there was no sensible grouping or automation to make it easier. For example if you had an investment property, you would have to make at least four entries manually:

Rental income
Expenses (insurance, maintenance etc)
Asset details (property value, location)
Liability details (list your mortgage, interest rate, mortgage provider, etc)

So if you had 3 investment properties you’d have to make 12 entries, plus all of the other entries for income, expenses, credit card etc etc. Most people couldn’t be bothered and literally nobody ever filled this out correctly. Ken Jackman the Sales manager had made a big push to improve this with his team, and when I was there, they had the first-ever “clean” application (no follow-up queries, straight through to approval) in something like 8 years.

Supporting documentation:

Lastly, the supporting documentation page was unclear. It was basically a single button where you had to upload all of your 20+ documents, but there were no prompts and no minimum requirements – you could simply click “next” and move on to the next page.

How this should have worked was something more like a box for each section based on information you had previously provided. For example, if you’d selected that you had investment properties, include a box to upload mortgage statements.

Solving:

At a high level the solutions were:

Make the ID verification clearer. Show the provided name on the page, make it clear it was being checked against both electoral roll and your chosen ID records. Also provide clearer error messaging to the extent possible (being a bit vague here as there are several possible vectors for fraud if you include too much info in the error messages).
Statement of position prefill based on information provided. E.g. if you indicate you have an investment property, prefill/pop out questions for you to enter mortgage value, home value, rental income and so on. Remove all possible instances of the customer adding entries to a spreadsheet.
Documentation requirements based on information provided. E.g. if you’d selected options ABCD during the application and listed assets/liabilities WXYZ, ask specifically for the exact documentation e.g. “latest mortgage statement for property 1, property 2, property 3” rather than making the customer guess.

To get buy-in for these, I put all of the recommendations in a list and circulated it with the relevant teams in credit, operations, sales, customer service, and product. The list went through 3-4 rounds with these stakeholders, initially starting very high level and evolving into the exact specific change that would be made. Everyone had extensive opportunity to comment. In parallel I worked with the technology product owner to ensure these reflected the way that the changes would work within the iApply software itself (a drag-and-drop form builder) and could easily be turned into actionable initiatives.

Results

Unfortunately, after I left the organisation, Bendigo Bank conducted a layoff of several of its technology teams and this form was outsourced to [Firm] who wanted [$$$$$$$] per day to work on it with its offshore devs, which necessitated going through a complex funding process for approving the spend, and the project died.

The same issues still exist and are waiting for somebody to pick it up. Markets are not efficient, sometimes there is a million dollar note left lying on the ground.

The End of Henry Morgan

Sun, 04 Dec 2022 06:11:29 GMT

Five years ago, I published a series of reports on a group of “pirate” companies after identifying concerns in public filings. Those companies, Henry Morgan (ASX:HML), John Bridgeman (NSX:JBL) and Benjamin Hornigold (ASX:BHD) have each since met their end.

Two were delisted by their exchange operator, and the third (BHD) had management voted out by shareholders and replaced, leading to the recovery of some value and the resumption of trade.

One of the funds, Henry Morgan, was liquidated by court order this year. To this day I still get asked about the story and, given that I removed my original reports on threat of litigation, let this be the abridged version.

Please note: The below is my memory of events and conversations. Others like Sulieman Ravell, Jon Dixon, Michael Glennon, Gary Miller, and Tony Bennett made their own contributions. However, you will have to ask them for their version.

How it started:

In 2016, several investment vehicles were founded and listed on the ASX. The plan was to trade managed futures and currencies, equities, and other listed instruments. The businesses operated in a fund/fund manager structure, where fund management company John Bridgeman provided fee-based investment management services to HML and BHD.

Management and performance fees for HML and BHD were 2 & 23 and 3 & 27 respectively. The Sydney Morning Herald had the following coverage of the IPOs:

“Pirates are very mobile and very flexible in decision-making,” McAuliffe said. “And have a very democratic system: if the leader is unpopular, he is voted out and goes back to join the rest of the sailors.

“And the whole focus is on profit.”

Benjamin Hornigold is intended to be a “high conviction” investment vehicle, focusing on “five to 10 key trading ideas”, he said, while Henry Morgan is focused on as many as 20-25 key ideas, carrying with it less risk.

You could be forgiven for thinking he is obsessed with pirates – and you’d be wrong.

“My fixation is actually military strategy,” he said, having studied the military campaigns of Julius Caesar, Napoleon and General George Patton, crediting this interest for his approach to investment markets.

Continuing the theme, these companies fitted out a pirate-style office with expensive furniture and a hidden door.

How I knew:

People always ask me how I “knew” something was up. This was the tell – the precise moment where the lightbulb went on and it clicked for me. This company wasn’t even allowed to invest in unlisted assets – it was specifically prohibited by the prospectus (this was later reversed by shareholder vote).

The valuation of these assets had been marked up based on financial models of their value, resulting in significant performance fees (based on the rise in NTA) payable to the fund manager, John Bridgeman. As a result, much of the easily valued cash flowed out of the vehicles. The NTA was an increasingly larger share of illiquid assets with valuations dependent on assumptions. The mark-ups on the valuations were based at least in part on implied growth so rapid (800% in a year) that probably only one or two companies in the history of the universe have achieved it. More on this later.

The information above is seemingly equivocal. Lots of companies have unlisted investments and some of them go up a lot. But in conjunction with the context around the proposed strategy, i.e. “Fund management vehicle launches a managed futures fund that invests in a prohibited asset class – unlisted equities – where valuations go up a lot in a very short period of time, resulting in the payment of huge fees to the funds management company”, this is where I became highly doubtful and started doing the work.

The rest of the story:

The Level 3 finding kicked off a long process of forensic work – late nights and several thousand hours of research. I couldn’t understand why the assets were valued the way they were. Many of the companies had only been recently incorporated and/or did not appear to have extensive operations (staff on LinkedIn, number of locations, etc).

I owe thanks to a number of people who anonymously contributed to the research.

One investor sent me the work he and his firm had done to date and offered to lend me an analyst to work on it. He had no position in the stock, just thought it was a market integrity concern, and I’ve never forgotten this.
A different person arranged for me to receive the entire ASIC documentation of all of the pirate companies.
#3 helped me test a number of theories around the Brisbane-based businesses and alerted me when my location information was made available through an image that I published.
A fourth walked me through the “who’s who” of prop trading operations, things to watch for in terms of principal/agent risk (e.g. around segregation of funds) and so on.

The ASIC reports cracked the door wide open as they allowed me to peer into the financials of the unlisted assets. Separately, a Sydney-based adviser, Sulieman Ravell, had been looking into the companies as well. More on Sulieman later.

Why did this take so much time? There was an enormous amount of material to review, including companies with complex (and constantly changing) cross-relationships. Some entities, such as Ashdale, had a history back to the GFC and had previously been the subject of investor lawsuits. I reviewed the content of the lawsuits I could find.

One lawsuit was particularly eye-opening, dealing with unlisted assets in an unrelated case (but with some of the same entities, including Ashdale) going back to 2010. However, as the case was settled, I was not able to investigate further or evaluate the claims made.

In any event, here is a “simple” version of the unlisted entities:

This is a point-in-time working chart from 2017. It may contain estimates or information that is incorrect.

During the course of the research, I published several reports about the pirate companies and described my concerns.

Fast forward three months to June 2017, and Henry Morgan was suspended by the ASX. Two months later in August, the company released a corrective disclosure that suggested many of my concerns around valuation were accurate. Previously, HML had told the market that its largest unlisted investment had $96m in revenue.

ASIC instructed the company to issue a correction. Annualised revenue at the time was $10m, not $96m, and even this $10m was a proforma figure, based on “entities that the Company controlled or anticipated controlling”. The correction speaks for itself:

Source: Corrective Disclosure to ASX 15 August 2017

The above company was at one point valued on paper at $165 million or more – 25m shares at $6.14 per share. Its primary investments appeared to be prop trading operations and retail forex currency exchanges.

Anyway, after much back and forth between the various exchange operators regarding a number of issues, all three pirate companies were suspended. John Bridgeman and Henry Morgan stayed suspended until they were delisted.

Litigation

Later, in 2018, the pirate companies sued my hosting provider to discover my identity. The AFR covered this here. Looking back, the main thing I would have done differently is to be more discreet. At that time, I still believed the market was well regulated and the regulator would act in a timely way. (Yes, have your little laugh). What’s funny about this story is that, according to the 2022 liquidator’s report, Henry Morgan was likely already insolvent by the time it filed the case against my hosting provider, but I’ll get to that.

Reader, I paid real money for this lesson so that you don’t have to:

*Never* put yourself in a position where you can be sued by a company. The company has more money, more time, and it takes trivial effort to make your life difficult. It is an asymmetric action – for the company it is a job; for you it will consume your entire life.

Trust me.

The Takeovers Panel

In late 2018, one of the other pirate entities made a takeover offer for Benjamin Hornigold. I was ecstatic. I was familiar with the Takeovers Panel from its work on the ADM/Graincorp bid and knew the bidder had made a titanic mistake. I recommended that advisers with clients in BHD apply to the Takeovers Panel to block the proposed bid.

NB: The Takeovers Panel is Australia's finest institution

In my opinion, the Takeovers Panel is Australia's finest institution and should be a model to governments everywhere (and I thought so long before this story played out). It has an ultra-clear mission, operates under extreme urgency (a typical turnaround time of a submission and review is ~24 hours; the typical application is resolved within weeks), and employs leading specialists in the legal profession who sign their name to every decision.

I was unable to assist with the Henry Morgan Application, but later signed a nondisclosure agreement and assisted with the Panel Applications for Benjamin Hornigold.

Again, I won’t go into all of the details as these applications took an enormous amount of work in a very short period of time. The Takeovers Panel declared the circumstances of the bid unacceptable, and some funds were recovered for BHD. Here is a short summary of the decision:

The Panel declared the circumstances unacceptable because (among other things) shareholders had not been given sufficient information to assess the bids, John Bridgeman, Benjamin Hornigold and Henry Morgan failed to adequately advise shareholders in relation to the bids, and certain transactions between John Bridgeman, Benjamin Hornigold and another entity operated as a lock-up device in relation to the bid for Benjamin Hornigold.

The process and decisions can be found here in the “2019” tab: The Takeovers Panel

Credit here goes to the financial advisers who really put in the hard yards, hired (out of their own pocket) the expertise of Corrs Chambers Westgarth, and drove the outcome. I assisted with making the argument/preparing rebuttals and collecting supporting evidence and received a small fee. The Corrs team was outstanding, and their junior lawyers in particular deserve recognition. I vividly remember working 9-5 in my day job, working on my part of the Panel app from 5.30pm until midnight, and then turning it over to the junior lawyers to have a first draft ready for 7am, followed by another round of review ready for submission at 9am.

When people talk about overwork in professional services, these are the scenarios they’re referring to, and the Applications could not have succeeded without these young professionals doing double (triple!) shifts.

The ousting:

After the successful applications, fast-forward again and Sulieman Ravell, Gary Miller, Jon Dixon, and Tony Bennett organised shareholders to vote out existing directors at BHD. After an enormous, concerted effort contacting the shareholder base, Sulieman Ravell, Gary Miller, and Michael Glennon (of Glennon Capital) became new directors of BHD. Then began the difficult work of untangling the mess and figuring out where value could be salvaged. I have no insight into this beyond what is in the public filings, so I would direct readers to the ASX filings for ASX:BHD from 13 June 2019 onwards.

The liquidation:

Following a circuitous series of events that are interesting but would take far too long to cover here, Jon Dixon and others later became plaintiffs in an application to wind up Henry Morgan. The application was approved, but the remarkable part of this process is the judge’s findings. The judge was scathing of Stuart McAuliffe (the investment manager and founder of the pirate companies), finding him an unsatisfactory and evasive witness:

Apologies for the walls of text, but these are worth reading in their entirety:

Unconvincing:

And another:

This is a good one:

Source: MF Lady Pty Ltd (Trustee) v Henry Morgan Limited [2022] FCA 978 (fedcourt.gov.au)

Afterwards, Henry Morgan was liquidated. There has been little to recover so far. The liquidator came to the same view on many of the concerns raised in my original reports in 2017.

Liquidated

There were several highlights from the liquidator’s report, including:

that HML may have been insolvent from June 2018 if not earlier (~15 months after I published my first report),
there was a lack of governance and compliance
the value of investments may have been significantly overstated
HML deployed the majority of funds for the purpose of investing in & paying fees to companies connected with Stuart McAuliffe
The final report is confidential (and I have not seen it), but the liquidator appears to be recommending further action to ASIC

I know of at least two people that wrote to ASIC advising them that Henry Morgan was insolvent at the time of the 2018 annual report.

The liquidator’s view of the reasons for failure is also illuminating:

Below are some other interesting highlights from the liquidator’s report.

Difficulties in obtaining books and records:

Unlisted assets increased from $167.02 to $26,667 per share in the space of five months.

When the business became insolvent:

Recommending further action to ASIC:

An inglorious end, to say the least.

In time, I met a decent number of investors in the funds. Their stories ranged from “deeply unfortunate” to “heartbreaking” and aren’t mine to share. I cannot stress this enough: do not invest money you cannot afford to lose, or that you might need in the near term. Equities are a risk asset.

In the end, Stuart McAuliffe and his CFO, Sam Elderfield, were charged with criminal offences by the Department of Public Prosecutions. ASIC release 23-050MR tells the tale. That case is ongoing as at March 2023.

Lessons learned:

I feel like a story like this should end on an uplifting note or with some kind of life lessons delivered. Alas, there is no uplifting note, and the lessons are the same as they ever were.

Always ask why the opportunity exists
- And why is it coming to you, random person on the internet, in the world’s most competitive marketplace?
Governance is really important
- A company can spend shareholder money as it pleases if oversight is ineffective
- As an investor, it’s very difficult to stop a company from doing what it wants, or what it is incentivised to do
Good journalists are a national treasure
The Takeovers Panel is Australia’s finest institution
Don’t let greed drive your emotions
Don’t invest money you can’t afford to lose
Always ask whether it is too good to be true
- If it sounds too good to be true, maybe it is?

Lastly, and this is a really important suggestion I find myself giving more and more in recent years:

Consider whether you are competent to own shares, except the level of competence is what you would require if “own shares” was replaced with “perform heart surgery”.

Which is a really complicated way of saying that 97% of people should just buy an index fund, and no, you are not the 3%. Investing is hard, the marketplace is competitive, there are few free lunches, and your default assumption should be that you don’t have an edge.

Final note:

And that’s all she wrote folks. Nearly six years later, the flaming wreck of one of the most disappointing sagas I’ve seen in my fifteen years investing. The one plus; I got pretty good at looking at risky companies like Trimantium Growthops, Updater, and Halo Technologies.

Stay safe out there.

Further Reading:

Directors Intentions following Board change – ASX 13 June 2019
The pyrrhic victory of the pirate mutineers – AFR, Jun 2020
ASIC’s gripes with skyrocketing pirate fund unearthed – AFR, July 2020
‘Shadow director’ probe in pirate fund business – AFR, Dec 2020
Henry Morgan – Pirate investor Stuart McAuliffe faces mutiny – AFR, Dec 2018

I have no, and have never had any, financial position in any company mentioned. I have no ongoing financial relationship with any company or individual mentioned. This is a disclosure and not a recommendation.

Halo Technologies IPO (ASX:HAL): Some Thoughts On Risk

Wed, 16 Mar 2022 21:10:40 GMT

I recently reviewed the Halo Technologies IPO (ASX:HAL) prospectuses for its planned listing on the ASX in April 2022. There are several key issues that I’m concerned may deliver suboptimal outcomes for investors.

The Setup

Halo Technologies provides “online global equities research and trade execution software solution that brings sophisticated institutional-grade analytical frameworks and market insights to everyday investors. HALO’s investment software solution offering can be divided into two integrated elements – HALO Global and HALO Trading.” Broadly, there’s an investment research arm, and a stockbroking arm, although there are also asset management businesses and financial software products like Macrovue in the mix. More on these later.

Halo and its parent, AAIG (more on this later too) have spent the last few years rolling up financial technology businesses to build this integrated technology platform. The underlying theme of the prospectus is very simple. Investors commit money to grow the Halo business. The management team takes below-market salaries ($150k) and invests the money in overseas acquisitions and organic growth via marketing and so on. In return, if management grows EBITDA from ~$2m to ~$14m in the next two years, they receive very significant stock awards.

If only it were that easy. In no particular order:

The concerns:

The incentive structure appears poor
The bulk of Halo’s revenue comes from Halo parent AAIG’s own clients
Halo has not demonstrated a talent for acquisitive growth
Halo is potentially overpriced
Halo management does not have a recent track record of operating profitable businesses
There is the potential for significant governance risk

So, there is a bit to unpack.

1. The incentive structure is poor

If they can grow EBITDA from $2.25m to $14.25m by 31 Dec 2023, Halo management will receive the equivalent of ~12.87% of the shares outstanding at IPO. IPO investors are providing all of the funding for management to acquire businesses and in addition to already owning ~50% of the business, management will receive another big chunk under the performance structure.

EBITDA is a low hurdle. Without per-share or cashflow guardrails, EBITDA hurdles can be met through a variety of creative levers like long-dated contracts booked upfront, and dilutive scrip acquisitions. My guess, given the incentives, is that the EBITDA hurdle will probably be met, but there’s no guarantee this creates value for IPO investors.

There’s an argument that the performance rights fairly compensate management for a low up-front salary & keeps cash free for growth. In this specific case, I strongly disagree with this. Shareholders are providing ~$40m in capital (~20x the company’s current balance sheet equity) in return for ~14% ownership of the business (fully diluted). They are funding all of the growth, taking all of the risk, and receiving only a fraction of the benefits.

Hilariously, the performance incentives of 18.75m performance rights are, at the $1.20 IPO price, more than the company will actually add in EBITDA! If successful, you’re paying management more than $1 for every dollar in operating profit they add over the next 18 months.

Better yet, that payment reduces the value of shareholders’ own shares through dilution rather than coming from the organisation’s earned cash (where management are the majority shareholders). This is a great deal for management and a shitty deal for investors, in my opinion.

2. The bulk of Halo’s revenue comes from AAIG’s own clients

In my view, Halo hasn’t yet shown that there is significant demand in the wider market for its product. The bulk of its revenue appears to come from related parties APSEC/ASR Wealth advisors and Australian Stock Report. These parties refer subscribers (B2B & B2C) in return for a commission. APSEC is co-owned by Halo parent AAIG and Halo Managing Director, Matthew Roberts (who owns >50% of Halo and >50% of APSEC). AAIG owns the Australian Stock Report.

This is fine, but it’s unclear whether this business can grow outside of its existing client base. Cross-selling to an existing customer is one thing, growing rapidly in a highly competitive market is entirely another. Customer churn is 12-15% a year which is OK for this kind of business.

3. Halo has not demonstrated a talent for acquisitive growth

Halo intends to “expand through a combination of acquisitive and organic growth, including in offshore markets”. On the acquisition front, the two investments it has made so far (Macrovue and Domacom) are simply not very good.

The rumour a few years ago was that Macrovue “failed”. It’s hard to say if this is true, but the gain on bargain purchase recorded by Halo lends the idea some credence. Additionally, the 2018 AAIG report highlights that “HALO acquired Macrovue towards the end of FY19 on deeply discounted terms following a period of negotiation…”. Two years later, Macrovue only has 180k in revenue. It’s an interesting product but it’s clearly not a successful business – not even a meaningfully growing one.

Domacom (ASX:DCL) is another interesting investment. Halo Technologies invested in Domacom – a recapitalisation transaction, of all things – for $3m worth in September 2019. My personal take is that Domacom was a basket case then and it’s still a basket case now. It spent most of the past year in suspension because it ran out of money (again).

Maybe investing in businesses on the cusp of failure is a genius business strategy. It’s not impossible to do very well out of it. Still, more than two years in, the results have not been spectacular.

Halo also owns a handful of other businesses like Push Notifications Pty Ltd, which it acquired in November 2020. Fifteen months on, that company doesn’t appear to be a meaningful contributor to revenue either. I assume it was acquired for the eponymous “push notification” technology, but given that most of Halo’s revenue still comes from related party clients, I’m not sure this acquisition has moved the needle on the business.

An interesting related observation – push notifications are bread & butter for any technology business. Did Halo feel the need to actually acquire that technology?

4. Halo appears overpriced

At IPO, Halo will have a fully diluted market capitalisation of $176m at the minimum level of offer, and historical pro-forma trailing EBITDA of $1.9m. Using the forward FY22 EBITDA performance target of $2.5m as a guide, Halo will list at 70.4x EBITDA.

The Independent Expert’s Report (IER) uses 20x EBITDA as a “fair” multiple for this type of business (I disagree because the comparison companies are Factset & Morningstar, but whatever). The IER concludes that reaching the performance hurdle ($14.25m EBITDA) will add $188m in incremental market cap to Halo.

In my view this is rubbish. The IER estimates that Halo will have a market capitalisation of $382.3m (post-dilution) if the performance hurdles are met. Ironically, this puts Halo on a multiple of 26.8x EBITDA, well above the IER’s own estimate of a fair multiple.

This doesn’t take into account the risk of further dilution for acquisitions. My guess is it’s more likely the EBITDA multiple shrinks and the growth to $14.5m EBITDA doesn’t create much incremental value.

For context, the comparison list. I would suggest CMC & IG Group on 6x + a premium for growth potential would be a fairer multiple:

5. Halo Technologies’ management team does not have a track record of operating a financially sustainable business

Every year from 2017-2021, Halo’s parent AAIG delivered atrocious results. Here’s a snapshot:

2017: Lost $4.7m on $7.4m revenue. Issued $7.7m in new shares.
2018: Lost $6.5m on $7.4m revenue. Issued $11.3m in new shares.
2019: Lost $9.8m on $9.6m revenue. Issued $8.5m in new shares.
2020: Lost $9.1m on $16.8m revenue. Issued $11.8m in new shares.
2021: Lost $6m on $18m revenue. Issued $8.8m in new shares.

I mean – Jesus Christ! Over the company’s lifetime it’s raised $62.5m in contributed equity and recorded $49.3m in losses. Now, there’s nothing wrong with running an unprofitable business. One of the joys of capitalism is that it lets you fail and start again. Plus, Halo Technologies is profitable, so maybe there has been a lesson learned here.

But – remember, the spending at Halo hasn’t really started yet. The company wants to raise $40m so it can separate itself from AAIG and scale up marketing and acquisition. I gotta tell you, looking at this, I am not McLovin it. Considering the AAIG directors in those years were Matthew Roberts, George Paxton, and Ivan Oshry – who are also directors of Halo – prospective investors ought to ask about the likelihood of financial success for Halo.

6. There is the potential for significant governance risk

Halo management will hold 50.1% of the Halo vehicle post IPO. The two groups that provided the bulk of the funding, AAIG and public market investors (assuming IPO succeeds), will own roughly the other half. As far as I can tell given limited disclosure, most or all of the initial funding for Halo came from AAIG.

Matthew Roberts, George Paxton, and Ivan Oshry were directors of AAIG and (I assume) Halo during all of those years. This makes me really, really curious about the commercial decisions that led to the directors of both parties deciding “the correct post-IPO split up of value here is 29% for AAIG who provided most of the initial funding and staff, ~14% for the public shareholders, and 50% for the Directors personally”.

It’s also very, very weird to me to see that directors of Company A earned 71% personal shareholdings in a company incubated by Company A, while being employed by Company A. Like, seriously? The Halo supplementary prospectus states:

“In February 2018, HALO Technologies was incorporated with the initial shareholders being Matthew Roberts (51%), AAIG (29%), George Paxton (10%) and Nicolas Bryon (10%). The shares were issued for nil cash consideration in recognition of the fact that the founders applied considerable time and effort to the establishment of the business and operations of HALO Technologies and did not receiving a salary from HALO Technologies…’

Man if I am reading this right, that’s such a great job to have. Run a company, start another company and make yourself the 71% shareholders, and use your first company’s funds & staff to fund your new venture in return for a minor stake. All while your first venture is disgustingly unprofitable and continually raising capital!

The above creation of Halo Technologies reflects significant governance risk, in my view. IPO investors must trust that they will receive 100% of the benefits (proportionately) from the funds that they invest. If management were to create future subsidiaries using investor funds with themselves as significant personal shareholders at no cost….uhhh that would not be good.

Hiring contractors as key management personnel?

Lastly, one factoid that stood out as interesting from the Halo prospectus was the use of “consultancy agreements” to fill all of the key executive positions. All of the key management personnel – CEO, CFO, Managing Director, are all independent contractors.

This is not unheard of but it is definitely not the norm. I would be very interested to know whether AAIG used a similar independent contractor structure and if that had any relationship to the incubation of Halo & management’s 71% personal holding in that business.

The bottom line

In my personal opinion, this doesn’t look like a great deal for IPO shareholders. It looks expensive and risky. Management has a very friendly set of incentives and the creation of Halo & management’s personal shareholdings raises interesting questions. Halo’s acquisitions so far do not appear to be spectacular. Plus, the previous company that directors ran was consistently heavily lossmaking and relied on ongoing capital raises to survive. Halo Technologies reminds me of Trimantium Growthops (ASX:TGO), a terrible IPO from years ago that had a similar combination of business risk with significant benefits for insiders.

Food for thought.

This post is written for entertainment value and reflects the author’s personal opinion. Please do your own research and consult a qualified financial advisor before making any investment decision. I have no financial relationship with or shareholding in, Halo Technologies or related companies AAIG, ASR, APSEC etc. Furthermore, I have no relationship whatsoever with any company directors or personnel. I will not participate in the IPO or purchase shares on market afterwards. This is a disclosure and not a recommendation.

Remote Work: Not As Simple As It Seems

Wed, 05 Jan 2022 23:56:13 GMT

I have read many misinformed and poorly conceived views on the remote work / working from home (“WFH”) debate. I tweeted about it a few times and that made me feel better for about five minutes but didn’t really solve my problem.

Framing the debate as “is working in-office better than remote work?” is hopelessly foolish. The primary determinant of success and failure is not (Jesus wept) what percentage of your staff work in the office! I can’t believe that needs to be said, but it apparently does.

Successful companies need to attract and apply people & other resources to problems and get good commercial outcomes. Transitioning to fully remote (for example) will at best be an input into that equation (e.g. affecting the ability to hire talent), and not the decisive one.

What I want to do first is talk about the two broad types of work and how these fit into the debate. Second, I want to explain why I think the in-office vs remote debate is pointless and ultimately has no meaning.

First, some qualifiers:

I worked fully remote and asynchronous for five years for an online business from 2013-2018. For three of those years I lived in Fiji with intermittent internet. Afterwards, I became an employee at a small software company, and later led a team there. During the COVID period, I led that team in a transition from in-office to fully remote and new ways of working. I am not an expert, but I have experienced both sides of the debate (WFH and in-office) from both an employee and a management perspective.

Second, some exceptions:

Roles that need to be in-person (plumbers, supermarket shelf packers, surgeons etc) are not able to be remote. Yes, they might be automated in the future, but it’s already clear there are no universal answers to the “WFH/In-Office” debate. I can’t believe that needs to be said either, but we shall continue undaunted.

could things really be more complicated than what I read on the internet?

Understanding Remote Work vs In-Office

The first thing to understand is that there are two types of work. “Do Tasks” (e.g. pull lever 100 times a day) vs “Seek Outcomes” (improve ROI on a marketing budget by X%). Understanding this difference is critical to understanding whether work is ideally fitted to be remote or in-office.

Do Tasks
- These are discrete and well-defined units of work with specific outputs. Writing an article, attributing investment performance, responding to emails, reading reports, etc. If you look at the world sideways, there are a lot more Tasks than you think.

Seek Outcomes / Solve Problems
- Outcomes are more open-ended and the goal is to get a result, not to produce a specific piece of output. So if the objective is to acquire 100 customers, how do you do that? Well you could cold-call, advertise on Google, make a Youtube channel, set up a billboard, distribute flyers, etc.
- When Seeking Outcomes, you are more likely to run into cross-disciplinary challenges (e.g. distributing flyers might require marketing and design disciplines). Remember this point, we will return to it later.

Many roles combine elements of both. An investment analyst does tasks (“listen to a conference call”, “update this model”) and seeks outcomes (“find good investments”, “evaluate a situation on the balance of probabilities considering known & unknown information”). Depending on experience and seniority, analysts might lean more towards doing tasks (updating models) or seeking outcomes (finding good stocks to buy).

Most roles lean predominantly one way or another.

Task-focused roles: Remote

Task-focused roles with clear expectations and measurable outputs are more likely suitable for remote work. This frees up productivity and requires clear expectations which reduces friction. If your daily target is respond to 100 emails and you can do that in three hours while maintaining quality, why wouldn’t you? Why commute and spend nine hours at a desk when you could work intensely and asynchronously for three for the same outcome?

People are capable of considerably more when incentivised in the right way. While roles typically lean one way, often the tasks are attached to the outcomes so it’s not easy to achieve a clear split. The potential gains here make reviewing this worthwhile, but that process is outside the scope of this discussion.

Outcome-focused roles: In-Office

Outcome/Problem -focused roles are more likely suitable for in-office work, especially if they need multidisciplinary skills. Here it’s important to have a well-aligned and tight-knit team that knows each other well, understands their strengths and weaknesses. Teammates will watch each other working and iterate based on new learnings and inputs disseminating throughout the organisation.

I only have software examples to draw on, which is a bit limiting. For example this might be highlighting misconceptions that users are forming about the product based on market/user research. The solutions might be better messaging & positioning, requiring a combination of design, marketing, product & engineering.

I firmly believe that both types of role can be used effectively both in-office or remote. In practice, decisions depend the type of work being done, the culture of the company, the pace of iteration, and a whole host of other variables. If you go fully remote, you need to grow new organisational muscles to maintain org culture, coherence and alignment and reduce silo-ing, but so what? Doing that is not any harder than any other challenge an organisation will run into.

Shared resources vs cross-functional teams vs siloed teams

These nuances are further complicated by whether you are a shared resource, part of a crossfunctional team, or if you are part of a “siloed” team.

Shared resources are centralised services like analytics and design or studio work. Projects might not require a full-time designer for example and so these teams perform ad-hoc projects and requests as they come up. Requests are a lot closer to task work (and thus might be tempting to have remote) but the work can be highly technical and require significant collaboration.
Crossfunctional teams are more-or-less self contained teams of professionals that can drive part of a business forward with minimal dependencies. There might be an engineer, product manager, marketing, and SEO expert in order to create and iterate rapidly with a self-contained feedback loop. Best practice in the technology industry is for these teams to work very closely together. The crucial ingredient here is not physical proximity but mental proximity, i.e. a very high level of collaboration & alignment of the team.
Siloed teams are where teams are aligned by function (all the marketing people on one team, engineers on another team, all the analysts on a third, etc). Everyone is essentially a shared service of everyone else. I have an opinion on this structure, but I have limited experience with it so I will avoid commenting.

So we can again see that depending on the team & org structure, the nature of the work, and the level of collaboration required, there’s no obvious answer to “is remote work better than in-office”.

Why the in-office vs remote work debate is ultimately meaningless

The core, existential question of most companies is “how do we sell products people want” (and be ~financially sustainable). The bottom line is always the same. Companies exist to make things people want. The right question is never “should our staff be remote or in office?”.

The better question is something like: “Based on the constraints & opportunities we face, what is the best incremental decision to take in light of new information [COVID & subsequent surge of remote work] that will optimise our ability to deliver things people want?”

To be fair, it is a lot easier to just ask “why can’t people work from home” but if I thought that question would get you a useful answer I wouldn’t have written this post.

Every organisation and team within an organisation needs a “north star” metric or goal. Whether this is customers acquired or 5-star ratings in the app store or number of levers pulled or whatever, goals keep the organisation focused. You can then make “ways of working” decisions to optimise your ability to deliver those goals. Without a clear reference point for decisions, your thought process will be woolly and ill-defined. Exactly like most of the media coverage on remote work.

The attractiveness of remote work could never depend contextually on the circumstances…could it?

Closing Thoughts:

Don’t make organisational decisions based on tripe you read on the internet (this post included). Take a detailed look at the environment & how the company operates:

What is the goal
What is the current state of affairs
Considering opportunities & obstacles, what is the desired future state
How will you get there, accounting for all of the constraints specific to your role and organisation?

To reiterate:

The battle lines are not drawn around what percentage of your staff works in an office. The dividing line between success and failure is always the organisation’s ability to apply resources to commercial problems. Remote work is at best an input into this process.

Do you want my personal opinion? Remote work is great. If you get a chance, do it, especially if it comes with autonomy over your time. There is nothing better than getting up early, doing a day’s work in 4-5 hours and then going to the beach. Doing all the household chores during the week is a recipe for great evenings and weekends.

By comparison, when leading a team or trying to push a business forward, you need to be “closely aligned” with your team. Whether that’s in person or not is immaterial. In-office, remote, or hybrid working are just tools that can be used to achieve desirable outcomes.

Yes, it is interesting that my view as a manager is different than my view as an employee.

And yes, it’s more complicated than what people write on the internet.

Metro Bank: Peak Uncertainty

Sun, 12 Dec 2021 06:54:38 GMT

Metro Bank (LON:MTRO) was the first new bank to open in the UK in over 100 years. It is one of the few neobanks that (almost) made it to scale, with $20bn in assets funded predominantly by customer deposits. As I wrote in Xinja’s Pivot, starting a new bank is like “pushing a very large ball of shit up an extremely long hill” which is why, fourteen years on, Metro still hasn’t become consistently profitable.

Metro has made it almost to the top of the hill, but it’s stalled out in the final stretch. Now, it urgently needs to generate additional forward momentum. Without progress the ball will start to roll backwards, with catastrophic consequences (for shareholders).

In 2018, Metro announced that risk weightings were incorrect for part of its lending portfolio. Correcting this caused the bank’s risk weighted assets to increase by £900m and it was forced to raise capital. Shortly afterwards, it failed to launch a bond offering and business customers pulled ~ £200m in deposits. The flamboyant founding chairman stepped down and shortly afterwards, the CEO also left the business. The PRA and the FCA both began investigating the risk weightings mistake. Metro itself began a costly audit of this part of the loan book that has cost circa ~£100m to date.

As to the impact of all this, well…

The stock is down 98% in the last three years. It has a market capitalisation of ~£160m and trades at 0.2x book value while the rest of the industry is on 0.6x. There is significant intangible value in the branch network and brand. Even so, the equity is clearly impaired.

A new CEO with experience in banking turnarounds, Daniel Frumkin, was appointed. He has been affiliated with private equity firm Carlyle portfolio companies before, and Carlyle made a takeover bid at an undisclosed price for Metro in early November. The talks fell through for undisclosed reasons (my guess is they couldn’t agree on price).

Scale

The problem is that Metro is essentially sub-scale. It has a high fixed cost base (cost to income ratio in 2020 was 143%) and doesn’t have enough funding to hugely expand the branch network. Raising money is hard because the equity is close to worthless, and the business is unprofitable. One solution is to grow the loan book, but that’s not easy because it is capital constrained and losses eat into its capital every year.

Metro could cut staff and close branches. But, there are leases, and the business is deposit funded at an extremely low cost (~30bps and falling) which would have to be replaced. Closing branches and firing staff also hurts the Metro culture and the community bank, people-to-people approach the company is famous for. Metro’s been ranked as the best consumer bank in the UK for >6 years running and has traded off first and second in SME lending over the same period.

It is an extremely tight spot to be in. The sole cure is operational excellence.

Strategy

Perhaps the most fascinating part of this whole saga is that a new leadership team came in, looked at the bank and decided that actually, yep, the existing strategy and culture are great and they work and we’re going to adopt it pen and paper clips.

Given rapid historical growth in core lending from 2014-2019, Metro had neglected to add a lot of ancillary products like insurance and personal/auto loans to its stable. Consequently, it wasn’t getting a proper level of revenue per customer or employee, or a proper return on the balance sheet, and was thus unprofitable.

Management determined that the path forward (see FY19 AR, Transcript FY19) was to optimise the balance sheet, compete on loans rather than deposits and create new products. Essentially; to grow the way out of purgatory rather than cutting costs to survive. Notably there were no layoffs as part of this change.

The new CEO has done all of the right things, and a few that are downright genius.

Closed the main company headquarters & downsized
Bought several discounted branch properties during the Covid crash for close to the IRU asset on the balance sheet, removing years of rent expense with minimal capital impact
Bought Ratesetter, closed the p2p lending and used the brand recognition to put high yield personal loans through the branch network (MTRO is already greatly exceeding Ratesetter’s monthly volumes pre acquisition)
Added new high-yield lending products (personal loans, overdraft/credit cards, specialty mortgages)
Adding new fee-generating products (insurance & pet insurance through partnership with a specialist insurer)
Sold a lower yielding part of the mortgage book at a modest profit and now sitting on $3bn in liquidity which provides optionality

Metro is also progressing an AIRB application that will give it some latitude in measuring its risk. I assume the intention behind this & the drive into specialist mortgages is to take some pressure off on the capital requirements front. I find it remarkable, the idea that the PRA will approve an AIRB approach when the subtext is presumably “we are capital constrained, let us measure our own capital requirements so we can hold less capital” but if that is the plan it is very, very clever.

Progress So Far

The proof is in the pudding. Yields on risk weighted assets have risen from 6% to ~7.9% in ~18 months. Cost of funding is down significantly and 6% of the portfolio is now in high-yield personal loans.

“Run the bank” cost growth has been contained to 2% on a like-for-like basis and management is transitioning the portfolio towards higher risk & higher yield lending. Lending yield has risen 90bps over the past 18 months and will probably rise a little further.

It’s a fine tightrope to walk because incremental lending growth requires capital, which Metro doesn’t have a lot of. The company has said repeatedly that it will dip into its capital buffer later this year and intends to operate there for a time. Consensus (judging by analyst commentary on calls) appears to be that the PRA will not let a bank operate within the buffer and Metro will need to raise capital. However, Metro has operated inside its buffer before for a short period last year, and management appears confident it will be able to do so again. CEO Frumkin’s view is that the excessive amounts of liquidity on the balance sheet may give the company the tiniest bit of extra leeway with the PRA.

Whatever the case may be, this is a critical coin toss with an unknowable outcome. It could go either way, and a need for capital could easily lead to an emergency sale of the company.

Looking beyond that, management is working to generate additional fee income. Branch activity is still 20% below pre-covid levels and several types of fee income (like forex) fell during Covid. These should recover over time and the introduction of insurance products to the customer base for the first time should have a significant positive impact.

These are the last year’s worth of numbers for Metro:

£367m in revenue, £421m in run the bank costs, £115m in “change the bank” costs, £15m in credit losses, ~£50m a year in remediation expenses, and a total loss of ~£200m.

The Path Forwards

There are a bunch of moving parts here. It’s difficult to model because the next two years are critical yet so much depends on the timing of expenses and new initiatives. Here is a quick overview:

Change the bank spend is frontloaded and mostly complete; this will decrease over the next ~12 months (management will stop reporting it separately from next year) and should drop essentially to zero.
Future investment should typically be via opex as there will be minimal branch opening in foreseeable future
Remediation expenses should start to decline this half although there is some uncertainty. My expectation is that these will drop to zero after 18 months.

Once those expenses drop off the radar (and we know Metro can fund them because of its excess liquidity), the revenue hole is somewhere around £100m. If Metro can get to £460m in revenue, it should be essentially break-even and capital neutral. If it can generate £500m in revenue it should be decently profitable (although ROE will remain low). The first event could cause the stock to re-rate, and will likely make it much more attractive to bidders who don’t need to take on the fixer-upper work and costs. There are a few levers that can be pulled to get there:

Recovery of fee income to pre-covid levels, (adjusting for new customers added in FY20-21 (~£15-20m))
Fee income from insurance products introduced to 2.4m customer base (unknown, perhaps £5-10m although conceivably much larger)
Revenue improvement from new loans written as older, higher weighted loans roll off (hard to say, maybe £5m this year and potential for £20-40m by 2023 depending on balance sheet reshuffling)
NIMs improvement from repricing deposit base and shifting lending mix to higher yield credit (hard to say, maybe 5bps this year [£10m] and 10-20bps over the next couple [another ~£10-20m]
Deploy say £2.5bn of excess liquidity (management prefers to keep this un-deployed given macro uncertainty, but for illustration the £3bn disposed mortgage portfolio generated ~£60m p.a.. Deployment of this partly depends on how much of TFS was repaid vs deposit growth & growth in TFSME, so I’d say potential for ~20-50m per annum uplift. )
Post-remediation, sell remediated portfolio of assets (which has a 100% risk weighting despite good credit quality) to free up capital. There are other assets on the B/S that are “hugely capitally-inefficient” that could also be sold and that capital redeployed.
Add new customers (via marketing, being added to aggregator channels for the first time, instant-quote API rollout, and two more stores [~3% increase in footprint] – unknown, but footprint would suggest ~£5m ish). Metro is closing in on same-day credit decisions which is still very unusual in the banking world.
Full-year impact from already implemented initiatives (hard to say; definitely >0, but I’ve assigned no value to this)
Reduction in rent expense from purchased buildings (probably fairly trivial in the scheme of things – maybe £0.5m but I have assigned no value to this)

Note: I’ve deliberately not shared the root assumptions here because they are almost certainly specifically wrong. For example NIMs improvement – does cost of deposits fall to 28bps? 27? Does the personal credit part of the book grow to 10%? 12%? 80% of new loans are specialty mortgages, how many of those are 90% LTV, how many are professional BTL, how many are to the self-employed, how long does that continue and how large a part of the book does that come to? What’s the weighted average yield uplift – 50 bps? 55? What’s the incremental cost of risk on those? etc. The correct question to ask here (in my view) is: “Is it plausible that Metro can get X uplift in Y domain through a combination of actions A,B,C.” Is it reasonable to assume that MTRO can get a £20m uplift to interest income through NIMs repricing and mix shift?

So, through a combination of new products and initiatives within the existing book, Metro is attempting to chart a path towards profitability. Launching new products will require incremental costs, certainly. But they should be very profitable income streams because all that’s required is a few staff to run them, and those products will be distributed across a very large existing base. There should be minimal additional costs to the mix shifting & new loans.

My guess at the maths says that Metro has a £100m gap that needs to be filled – call it £110m after growth opex – to breakeven, and another £33m after that to be what I call “comfortably profitable”, or Healthy Profit on the charts below.

Outlook

That doesn’t get it to a 15% ROE or anything flash – more like a 3% ROE – but it could be around £40-60m in annual profit before tax. For context, management is targeting a 8.5% return on tangible equity by 2024. I don’t think the precise RoTE calculation has ever been disclosed but making some guesses based on the balance sheet gets us roughly to the same ballpark, if not a little higher.

“New investment spend is key to the delivery of the strategy and you’ll see that we are forecasting
between now and 2024, between £250 million and £300 million of change opex in the plan. This will
be front end loaded. The first two years will probably account for just over 50% of that spend and
every year will be lower than the last. It’s just the way you need to think about how that change opex
is going to come through the plan.”
Transcript 2019 (page 8)

In the above model, Metro is still unprofitable by the end of its transformation. However, no credit is given to unknowns like customer growth at existing branches, and further new product initiatives (e.g. auto loans) whereas we know in reality that Metro is still growing customers at a good clip and is proactive in creating new products.

In many of these examples the upside could potentially be a lot larger. You should be able to make more than £5m in insurance fee income from 2.4m customers. When deploying liquidity, management may be able to get higher yields, as the disposed mortgages were among the lowest yielding in the book. So here is an optimistic scenario:

Again I’ve avoided specific time frames because all of this will straddle financial years, but these changes should happen in the next eighteen months or so and have a full year impact in the year after that. I see the company breaking even on an underlying run rate in 2023, which roughly lines up with management’s forecast of actual breakeven in FY 2024.

The bottom line:

What you can clearly see from the models is that Metro Bank is at peak uncertainty. There is a lack of clarity around the timing, size, and profitability of all of the new initiatives, as well as the deployment of capital, capital adequacy, and finalisation of remediation and balance sheet restructuring. None of these things lend themselves well to being modelled which is why the above charts are basically conceptual in nature.

All of this explains why the bank trades at such a depressed valuation. ~£160m is completely the wrong price for an established bank with an outstanding brand & reputation, 77 branches, £20bn in assets and £1.2bn in book value, but there are very good reasons for the discount. I haven’t even bothered talking about the risks of moving into higher yielding credit & generating rapid growth in new credit products.

It must be said; I don’t think Metro Bank is can be owned by the average investor here. The upside is fairly limited (say 3x in the next few years), the risk of loss is severe, and you will have an opportunity to wait and buy once more information presents itself. New information will greatly reduce uncertainty and reveal much about the path forwards. If Metro reaches breakeven without raising capital it will be the most remarkable turnaround I’ve ever seen – proper hall of fame stuff. I think it will get there; but it is a hard company to own.

The second half result this year will be critical for showing the results of its initiatives to date. Visible progress on these will make it significantly easier for the path forwards to be modelled. Management has indicated it will return to providing guidance either at this result or at the first half next year. These two things combined should greatly reduce uncertainty, and make it easier to see the path forwards.

Food for thought.

I hold a small number of shares in Metro Bank. I am watching for an opportunity to add significantly to these but much depends on the uncertainty in business progress I have highlighted. Readers should not expect any disclosure of when or if I make additional trades in the stock. This is a disclosure and not a recommendation.

Changing the shape of the playing field: Content and the attention economy

Sun, 07 Nov 2021 23:56:00 GMT

Update: Following reader feedback, I have added two diagrams at the end of this post to visualise the concept. Enjoy.

I tweeted last month about the proliferation of content and storytelling roles in venture capital, after Andreessen Horowitz (a16z) went into media publishing with Future. I think that ability to propagate a viewpoint at scale is a new function in financial markets, and it is a big deal. The world is rapidly becoming an attention economy. The ability to exercise “soft power”, change the shape of the playing field, and perpetuate your own interests (and those of your network) will emerge as a superpower over the next ten years.

In the past, media outlets dominated financial discourse. These were vaguely independent and approximately concerned with the truth. This was a gated relationship where a handful of outlets would gather stories that were “important” and send them out to the world.

The other main disseminators of financial narratives were what I’ll call “intermediaries” which ran the gamut from brokers, advisors, fund managers, sell-side analysts and so on. These people manufacture and propagate financial narratives to facilitate their business of distributing products and attracting clients.

The Internet Changed Everything

So far, the primary impact of the internet has been to amplify those types of relationships. Powerful outlets distribute to a larger audience and intermediaries intermediate, but to more people.

In the past ten years, individuals have been increasingly able to amplify and propagate their own views into the marketplace. This is the podcast, Instagram, Reddit, Twitter. The noise in the marketplace has increased massively.

Entities that are amplified, benefit. This is revenue, employment, validation – deal flow, stock price, regulation.

The signal

The issue today is not how to reach a large audience. That problem has been solved by the internet. The real issue now is finding the signal, or creating one powerful enough that people will follow it.

The challenge now is how to find someone that cares. It’s how to create a message that spreads and sways large groups of people. And, more importantly, how to find enough people that care about you in great enough number that it makes a difference to you. It’s 1000 true fans, but for companies.

Anyone that has watched markets over the past five to seven years has seen the rise of the narrative as a tool of influence. Raise capital, attract investors, avoid regulation. In fact, it has been two or three years since I even heard an investor describe a company as a “story stock”, although there are more story stocks than ever. That in itself is telling, because the narrative has become the norm.

So. The world has shifted. The issue now is not propagating the message, it’s finding someone who cares. Do you see where this is going?

The audience

Warren Buffett is the world’s greatest propagator of narratives. He has a cult following of millions of people that quote his every word. Did you know that you can’t make a baby in one month by getting nine women pregnant?

He is a leader for generations of investors who all wanted to be Just Like Warren. While perhaps one of the world’s greatest domain-specific talents, Buffett is hugely underrated for building this network of narrative propagation & signalling in the pre-internet world, and it might be one of the most overlooked tools of his success. The Neckar Value newsletter wrote more about this here.

Buffett spent a whole career actively changing the shape of the playing field (to his own significant benefit), but modern venture capital and company executives have taken the Hero model to new heights.

The Hero

In the Hero model, we have an “Important Person” propagating a view. Electric cars, bitcoin, drugs that cure rare diseases, proposals to split up companies.

In the course of engaging in certain activities and pursuing these interests publicly, certain people are noticed. They go on CNBC, or Twitter, or podcasts, get a following. In doing this, they amplify themselves and create the ability to have themselves Taken Seriously. An audience becomes prepared to listen to them.

In activism, you can create presentations and sway shareholders and management to your way of thinking. Or, you can write short reports and make the stock price go down. In VC, you can attract investors, clients, partners, and attention. For this post we might think of attention as “an intangible asset that attracts a consistent, but randomly timed, future stream of investors, clients, partners, and more attention” but that is a concept best explored elsewhere.

The Hero model works very well, especially in the internet era, but is still limited. It is limited by the person. Warren Buffett is finite. Ben Horowitz is finite. There is only so much time in the day, and most people appeal to only a certain subset of a total population.

Do you see where this is going?

The message

If all of the above is true, we arrive at the need to create a capability. The capability to propagate a message, in an organized and targeted way, that finds its target audience and is amplifiable beyond the human limitations of a single person or small group of people.

In the hyper-targetable world we live in, this is no longer the model of a PR firm putting out press releases. This is content that is immediately relevant to you, in your pocket, every hour, perfectly tailored, that you CHOOSE to consume.

Of course, this capability already exists in the form of social networks. Advertisers buy your eyeballs.

It does not exist in public or private markets – yet. With some exceptions, most entities do not have the ability to effectively promulgate a message, at scale, to the whole population digitally.

(Yes, this is conceptually very similar to the metaverse. No, it is not the metaverse. This is happening already and will proceed irrespective of augmented reality.)

The capability

What a16z and others are doing is creating the capability to spread influence to every corner of the internet. It is both reaching and signalling an audience (people who care about these interests) and expanding the audience (finding new people who can be convinced to care).

If you are looking at this and saying “oh this is just about making the stock price go up” or “stockbrokers sell stories to clients every day” you are not getting it. This is about using soft power to set agendas, direct conversations, and channel influence to the advantage of one’s own network.

There is undoubtedly an element of price setting involved, because asset managers take a % of asset value in fees. In private assets you don’t need to convince a whole market; you only need to attract a small number of incremental buyers or sellers in order to find a new holding or increase the value of an existing one. These are “few to few” relationships that work extremely well with the Hero model.

Intriguingly, the only way to properly exit a mega-billion dollar company at the “right” valuation (noting where VC valuations sit) is to offload it to someone else, namely public investors. Do you see why finding an audience is so much more important than just price setting per se? On a long enough timeline, all large VC-backed companies are destined for public markets.

The attention economy

So, there is undoubtedly a direct commercial element to narrative control, especially for large VC and large corporations. However, like my friend said recently – when money is free, something else becomes the currency. The world is becoming an attention economy.

The ability to attract, direct, control, and influence that attention will be essential for survival, and absolutely critical for the survival of ecosystems, like those represented by venture capital.

It’s not about direct impacts like “I hire one writer and they find one new investor and the stock price goes up by $1”. It’s about changing the shape of the playing field.

Sway influence your way to perpetuate your own interests and those of your network, and ensure survival and prosperity. a16z Operating Partner (Marketing) Margit Wennmachers said outright that while traffic is a success metric, the organisation is also focused on “whether the targeted audience is ‘sending us around’ or ‘talking about the topics we raise’”.

Last month I said the nature of markets is changing. Actually, it’s already changed, and these are the natural consequences of those changes. It’s the creation and mechanisation of industrial-scale media to shape the playing field in favour of the participants. Marketing, but for networks.

That is what this is all about. And you are going to see this narrative propagation capability being built absolutely everywhere in the next few years.

Food for thought.

Illustrations:

The Playing Field; a simplified network of people interacting with each other, and being acted upon, by a “Hero”.

Next: Add a narrative propagation capability, and change the shape of the playing field.

Thanks for reading.

I have no financial interest in, or relationship with, any of the people or companies mentioned in this article. This is a disclosure and not a recommendation.

Stay In Touch

Read more articles here, or reach out anytime. Email sean@infinitenuance.com, or join the mailing list to receive 3-4 emails a year, whenever I publish something important.

Archive note: the original mailing-list form is no longer active.

The Rebrandening: 10footinvestor and Infinite Nuance

Thu, 14 Oct 2021 23:30:48 GMT

10footinvestor has changed.

My two personal blogs, 10footinvestor and Infinite Nuance, have merged.

The 10footinvestor site began life in February 2017 as a personal investing blog where I could research and share ideas. In the first two years, 10footinvestor published roughly once a week about stocks, investment ideas, and portfolio reviews. Most early posts were of poor quality, but later pieces identified issues with companies like Trimantium Growthops, Henry Morgan & John Bridgeman, and Updater, all of which subsequently delisted.

As research continued, the blog looked at UK capital requirements, South American online travel agents, and made suggestions on brand presentation to Oliver’s. There was even a remaster of Rudyard Kipling’s If-, adapted for modern financial audiences.

That old blog covered a lot of territory, but it fell into disrepair as work commitments grew.

Infinite Nuance

Infinite Nuance was a separate blog created to refine thoughts about management and the practise of managing. I partly encapsulated those thoughts in this post here. It is administratively complex to manage two sites and I wasn’t keen on working on two sites in parallel.

It seemed better to put the sites together, and let readers filter for themselves. A shortage of maintenance effort and SSL certificates caused 10footinvestor to be penalised by browsers & Google. My newfound interest in business and management took the content outside the realm of investment analysis.

All of these things, put together, necessitated a big refresh.

The New Site

All 10footinvestor posts have been migrated to this site, and the content has been divided into two broad categories, Investing, and Management. You can read whatever interests you, and I’ll still share it on Twitter as usual (my Twitter handle will stay as 10footinvestor).

For posterity, this is the original 10footinvestor site, created using the deprecated Bhari theme:

Function over form.

A moment’s silence for 10footinvestor

10footinvestor started off as a throwaway blog; an anonymous place to practise investing without fear of failure. Selecting a name was difficult; there were already too many investor blogs. One day I was sharing some thoughts on Genworth Mortgage Insurance when, in response, my then-colleague Mike King misquoted Buffett “remember, we are looking for 1 foot hurdles to step over, not 10 foot hurdles to jump over”.

It was a throwaway name for a throwaway blog. But then Mike came back to work early, unwell, from a skiiing holiday. He tragically died a few weeks later from an aggressive, undetected brain cancer. The name stuck.

Separately, some research I did on a company called Henry Morgan had taken on a life of its own (more on that can be found here) and 10foot, regrettably, had an audience.

The original 10foot logo.

It was tedious to explain what a 10footinvestor was (eventually people stopped asking) and that site has more than done its duty. When work intensified, rather than retire, 10footinvestor retreated into the chrysalis. It now emerges as Infinite Nuance.

So, what manner of beast is this?

Infinite Nuance, which sounded a lot better than 51 Shades Of Grey

Infinite Nuance focuses on the way the world really works. Many paths, not one. In the course of managing (investments or people), the typical process involves thousands upon thousands of iterative, incremental micro-decisions.

A previous role involved training a team of new analyst-authors to write code & algorithmic articles from scratch, and it was critical that they got up to speed fast. Typical micro-decisions in the early days were around “should I step in to help here? Are they only slightly stuck and are likely to figure it out themselves, thereby learning faster?” or “are they stuck enough to need to be given the solution, or should I just give a suggestion or a small part of the solution?”

The question was rarely “should I help or not”, instead it was always around “what degree of help should I provide”. Which and when and how much, not yes or no. Over time the decisions required were less interventionist and revolved more around refining the way we worked. “How much is the right amount of oversight to have of this project, taking into account its importance, this person’s skills, experience, & interests, the expected outcomes, and how should the level of oversight change as the project progresses?”.

Optimising for autonomy and creativity seems like a no-brainer, but these concepts are rubber-banded. The right mix changes based on the situation and there is nuance in deciding how much of X is probabilistically ideal given the desired objectives. It is then complicated to execute on that decision without micromanaging, or violating the “human use of human people”.

Incremental, iterative decisionmaking

One way I visualise these infinite layers of nuance is via a “gauge” or “dial” concept.

In life and work the questions are almost never “should we set this dial to 0, or 10”. Instead they will invariably be “this dial is on 6.5, do we need to turn it to 7 to reach our goals, especially taking into account that something else will go from 1 to 0 in the interim?”.

Some of you may recognise the repurposed Corporate Fuckery-O-Meter™

Another way I conceptualise of this nuance is as half a compass, laid out in front of you. You can only go forward in time. If you are proceeding towards a goal, the questions are always around “perhaps we should turn another 5 degrees right” or “we need a sharp course correction here”. This assumes that you are facing the right way to begin with, but in my experience, people naturally point themselves in roughly the right direction.

20 degrees left.

These, of course, are imperfect metaphors; the simplification of complex concepts into physical space to make them understandable. We are applying a round hole to a square peg.

Real companies are like neural networks moving in 3D space in real time – six axes if not more.

Which and when and where and how much?

Infinite Nuance is about these things, and how they fit into business, management, and life. So, 10footinvestor re-emerges as Infinite Nuance. Infinite Nuance is a site about investing, business, and management.

To co-opt a common phrase, if you are not selling a product, you are the product.

And that, I guess, is the story of this blog.

Thanks for reading,

Sean

Technical CEOs, transitions, and growing organisations

Thu, 26 Aug 2021 04:05:37 GMT

Something I’ve been thinking about for at least five years (and last tried to articulate here) is the transition that happens as a technical founder’s business grows. Quite often, someone with what I’ll call “technical expertise” starts a business (for the purpose of this article, we will exclude “entrepreneurs” which start with an idea or funding but hire others to do the technical work). It doesn’t matter whether their expertise is in making hot dogs, litigating, writing accounting software or manufacturing steel beams – they start the business and are the expert in delivering that business’ product or service. Maybe they come from the industry and are able to identify a new niche or develop new products or services or find a new clientele based on their experience and ideas.

If their product is good and they can sell it to people, the business will grow. As this happens, they will need to hire people to help grow the business. Inevitably (and often, it seems, without conscious thought), the founder/s will become CEO-types and move away from their technical disciplines. They increasingly work ON the business instead of IN the business. This means, for example, hiring an overseer for the steel plant instead of interacting with the customers directly or being the plant manager. Over a year it probably doesn’t change anything. But over three, five, ten years (depending on how fast the industry moves), the founders become out of touch with the technical discipline that they came from.

This type of transition is typical in every industry and the canonically correct answer in the literature is that the founder should always do the highest leverage activities in the business – which is almost always being the CEO. (I assume the answer is different if you don’t want to grow your business or if you want a lifestyle business, but that’s outside the scope of this discussion). Generally speaking, I would guess that the technical founders are not usually a clearly outstanding practitioner of their technical discipline and, even if they are, they can often add more value to the company by learning to be a good CEO and hiring someone that’s 70-90% as good as they were to replace them in the technical role.

This is all fine and good and known. What is not well known is the opposite scenario, where the founder creates more value by staying in their technical discipline and letting others build the company around them. Investment management has some examples of this, as it’s quite common for those businesses to have distinct & separate technical and company leadership (CIOs and CEOs). This is because most(?) of the value in investment management is created by either marketing or investment performance (or both), rather than by operating the investment business per se. Outside of investing I have seen very few founders remain as technical leaders.

A Hypothetical Marketplace

Imagine that you are an expert on marketplaces and you build a new eBay that’s better for [various reasons] based on your deep expertise in building marketplaces. The business grows and you become a CEO. Does the business lose some of its competitive edge once you stop focusing on how to make a good marketplace, and start focusing on building a good marketplace business? Are you replaceable?

I started thinking about companies that buck this trend, and have a founder/leader figure in a technical role and not a CEO role. The only non-investment business I can think of with that happening is Ben Thompson of Stratechery. Ben does all of the writing even though he’s hired research and admin assistants to do the other things. His view (I infer) is that he creates the unique value for that business and the business would be a lot worse off if he stopped writing. He’s probably right. Some people on Twitter shared AF Legal Group with me as an example and there’s a short article here about how AFL founder Edward Finn stepped aside to focus on digital marketing while others run the company.

And that’s it. I can’t think of any other examples, outside of investing, where a founder has stayed as a leader in their technical domain and grown the company around them.

Technical, or CEO?

The question now is when should a founder stay in their technical discipline, and when should they become a CEO? I need to make some guesses. I will assume that the aim is to grow the business at least twofold, because anything less than that can often be achieved through optimisation of marketing, pricing, product mix, and costs – and thus there is no need for a change in the founder’s role. I will also assume that the decisions made will optimise for business growth. This necessarily means not optimising for happiness or lifestyle which would presumably change the answer.

My preliminary guess at an answer comes down to where the founder adds value. If they’re only in the top quartile of software engineers or hot dog makers, it would be better to learn be a good CEO. If you’re irreplaceable and unreplicable (Ben Thompson, Warren Buffett), you would be better off finding someone else to run your business. If your primary contribution is as what I’ll call an “inventor” (better capacitive touchscreens, artificial intelligence engineering, countersunk screws) you might also want to find a CEO. This is a static analysis which overlooks changes over time (e.g. building a better touchscreen leads to an interest in building a better mobile phone, which leads to being a CEO-type to assemble the team & assets to do that) but it is my best guess. Unique and irreplaceable is a good candidate for staying in the technical role. Otherwise, progressing to CEO adds more value.

As an aside, I think that this underlying conflict explains a lot of the issues with Oliver’s Real Food (ASX:OLI) from a couple of years ago. I recognised the issue (I think) with the multiple hats that the founder was wearing but wasn’t able to clearly recognise & articulate the logical results & second order consequences that would follow from that (short version: the business would not be able to scale).

As a divergence from our traditional programming, I would be interested to hear your thoughts on this phenomenon, especially if you’ve started your own business or seen this transition happen (I have not).

I don’t have any financial interest in or relationship with any company mentioned. This is a disclosure and not a recommendation.

Sezzle’s Precipice

Wed, 18 Aug 2021 01:32:47 GMT

After Xinja’s Pivot, I’m coining Sezzle’s Precipice to describe a company that stands on the knife edge of catastrophic failure. Whether Sezzle tips over the eponymous precipice or skates along the top before riding off into the sunset is yet to be seen. (I wrote some preliminary thoughts on the company late last year).

After yesterday’s result, the state of play is much the same as when I wrote last year. Provisions for bad loans have ticked up and reflected 50% of income for the quarter (41% over the last six months). The Merchant Interest Program (MIP) is still driving the business, with the MIP equivalent to 89% of merchant payables and 19% of underlying merchant sales. Sezzle works with small merchants, and back of the envelope maths (MIP / total sales) infers merchants have around two months of underlying merchant sales held by Sezzle.

The increase in provisions for bad loans reflects poor lending quality and in combination with merchants funding Sezzle’s growth, brings some interesting risks to the table.

The biggest risk is simply that merchants are unsecured lenders to Sezzle with at-call loans (Sezzle has now clarified that it would repay any size request within 7 days). If merchants figure out that Sezzle is re-lending their money and that the loans are poor, they could pull their funds. Unlike typical financing where you borrow from a bank, here the customer and investor relationships are intertwined. You can breach covenants with a lender and get away with it if you can find another source of capital – your business will still exist and customers will still use you. Here, if you fail to repay your merchants, you risk your entire franchise, not just the funding relationship. Merchants are more likely to leave, less likely to fund you, more likely to ask for repayment, less likely to accept your product in the first place.

If that trust starts to fail it is the beginning of the end. Funding dries up and it will be hard attract more. Without funding you can’t lend. There will be a drain on the coffers and it will accelerate. It becomes a run on the bank. You will pay grievous terms to plug that hole. This is the definition of catastrophic risk.

Sezzle merchants seem satisfied with the status quo. Some smart people I know suggest that this is because Sezzle’s customers don’t have a lot of choice other than to participate in the program. I’ll let them tell that story.

So how do you mitigate this risk? It is not complicated. Transparency is the cure. Come to Jesus and let the market price the risk. Sezzle’s program is great for Sezzle if it works, and ok for merchants. Set more stringent terms on merchants. Position it as a win-win. The lack of transparency around the MIP in my mind was initially a possible indicator of fraud. I am not so sure of that anymore, but the almost total lack of disclosure of the primary engine of Sezzle’s business is a warning sign.

If the atrocious loans don’t improve and if merchant trust ever starts to waver, you will be surprised at how quickly Sezzle finds itself on that Precipice.

Food for thought.

I do not have, and have never had, any position in Sezzle. I have no relationship with anyone who has any position in Sezzle stock. This is a disclosure and not a recommendation.

Management: Infinite Nuance

Thu, 10 Jun 2021 11:11:00 GMT

In early 2020 I took on managerial responsibilities, which was the definition of being dropped in the deep end. To be a manager is to have a focus on the process that produces the output, rather than the output itself. The switch to focusing on the process clicked very quickly with me, piggybacking on years of working on an investment discipline. I’ve been investing for about twelve years and focusing on improving my process for 5-ish years (of which this blog shows the last ~4).

Another part of being a manager is being the “owner” of the output, even without producing much of the actual work. I have a core belief about leadership – to be blunt ; if you have a bad team, you don’t have a bad team – you have a bad manager. That accountability escalates as seniority increases. This is why CEOs are fired for behaviour within their organisation which they did not contribute to and had no knowledge of – it’s all their fault. (I speculate this extreme accountability is a significant contributor to high CEO pay and severance, but that’s a story for another time.)

Process versus Outcome

It comes naturally to me to understand that sometimes we try new things (a process for creating new products) and they fail either through bad luck or because it was the first time we tried it and the learning curve was steep (bad outcome). Other times it’s because we didn’t follow our plan and didn’t know what we were doing (bad process). This is a direct parallel to investing, and the manager – like the investor! – only gets measured on outcomes. It’s critical for an organisation to understand that good process will on average over time lead to good outcomes even if any individual outcomes falls short. (There are scenarios that are must-win because they carry disproportionate risk, where you need to win every time, but those are also a story for another day.)

The “hard” part of management is the infinite nuance which you grapple with once you move beyond the high level principles. High level principles might look something like this:

Good process on average over time produces good results
The output of the manager is the output of the team
The manager is responsible for the success or failure in achieving business goals

Once you get into the practicalities it gets fiendishly difficult. You start to run into paradoxes.

Paradoxical Management

People work better when they are empowered and have autonomy, but
The manager has total accountability for the output of the team, and they cannot control the output when the team has high autonomy.

How do you intermediate these opposing approaches? I have run into probably 50 of these paradoxes (which I’ll talk about more below) but so far, I have found that careful thought always reveals a third variable that allows you to discriminate between and unlock the paradox. In this example, the discriminating variable/s are what I’ll call alignment and teamwork.

Does the team deeply understand the company’s objectives and are they aligned on how the team’s work fits into those objectives? People make different decisions when they correctly understand which things are important. In practical terms this breaks down into a “should we do this project or that project, well, which project contributes more to the goal?” type of dialogue.
Does the team communicate amongst itself (many-to-many communication) or is the manager the nexus of all team information (one-to-many) ? You need many-to-many communication for the team to self-correct and own the outcome, and it’s a lot harder than it sounds.

Another way to defuse this paradox would be using productivity as the discriminating variable. The team is more productive when the manager has less input, because there is far higher leverage. If a manager has to oversee every single piece of output, the manager’s leverage is quite low (1 hour of management time for 1 hour of output). However if the team gets 100 hours of output for 40 hours of a manager’s time, the leverage is far higher and the cost of mistakes is relatively lower. When you only get 40 hours of output, a 40-hour mistake is a total write-off. However if you have 100 hours of output, you can lose 40 hours and still come out ahead. That’s grossly simplistic take, but it is still true.

Now if I was a manager by training I’m sure some of these things would be obvious. Maybe it’s just a given; the output of the manager is the output of the team and so when you reach a fork in the road, prioritise the path that improves the output of the team. Unfortunately I’m not a trained manager and despite reading a lot of books (Andy Grove is a god) there are some things you only learn through experience.

The way that I think about managing things I’ve never done before is to start with principles. How do you set up a team? I don’t know. My guess is; find a few principles that are self-evident truths about the performance of teams (see my comment on bad team = bad management, above). These are things that are absolutely true and will never change. When you get 2-3 principles you invariably find one that conflicts, like the paradox above. Then you need to find the discriminating variable to unlock the paradox and come to a decision.

Reality-check if your decision violates your principles, and if not, you’re probably good to go. (a very helpful tool is explaining the paradox and how it led to the decision to the people you work with, so that they can understand where you’re coming from and/or call you out if you’re talking nonsense).

Conclusion

As I’m writing this I noticed that there’s another Willink and Babin book, The Dichotomy of Leadership, that’s come out. I’m only partway through but it looks to tackle this exact paradox. Unfortunately the military metaphor doesn’t communicate well at all, but they absolutely nail the paradox of autonomy and management. They’re approaching with a different lens, but you can see signs of the intermediating variable there as well.

Long story short – “Manager” is an interesting role. There are many nuances, many paths, and very few problems with a single correct solutions. I am enjoying it.

Interactive Brokers: A Stock Pitch

Sun, 23 May 2021 10:03:23 GMT

I have written about Interactive Brokers (NASDAQ:IBKR) before, most notably in Xinja’s Pivot. During the Covid Crash I purchased it on valuation grounds, but I think there are a lot of fundamental merits to, and opportunity in, the business. I recently pitched the stock and I’ve tidied up my notes to publish here:

Stockbroking is a dying business. My hypothesis is the industry will branch out into value-added services like financial data & investing tools as a way of generating revenue. Interactive Brokers has a good opportunity to expand its business outside traditional brokerage. Traditionally, there were three main ways to make money in stockbroking:

Charge fees on trades
Earn interest on customer cash balances
Earn interest on margin loans which customers take out with you
(For completeness we must add a fourth leg to this three-legged stool; start a free trading app with someone else’s money.)

These three methods have been almost entirely eroded. Free trades are now the norm. Charging interest on cash balances only works if interest rates are above zero. Margin loans are still viable (and IBKR is good at this) but rates are very low. While free trading is an interesting innovation the question is always: How much value does it add to the customer?

How IBKR adds value:

Interactive Brokers has been for a long time the market leader in creating value for its users.

Pre-Robinhood, IBKR’s trades were the cheapest in the market
IBKR now has free trading for those that want it; customers that pay get better
execution
IBKR has the best execution in the industry; paid trades through IBKR get measurably
better prices. This supports the current fee structure & makes it less likely to erode.
IBKR’s margin loan rates are the lowest in the market
IBKR is regularly rated 5 stars/best broker/cheapest broker in the industry by a wide
variety of sources
IBKR also pays interest on short positions if someone borrows your stock to short sell

IBKR is a well capitalised, securely operated broker. I believe it is the best-managed broker in the world and it has never had anything close to a “blow up” since its founding in 1977. The founder, Thomas Peterffy, remains a large shareholder and is well regarded in the industry. Some competitors like Robinhood are new to running a secure operation (as recent emergency capital raise and customer hacks suggest) and have damaged brand and goodwill by costing customers money. When people store large amounts of money with you, they need to know your brokerage will not implode.

Brokerage operations like Schwab and TD face pressure on brokerage earnings as most of these fee streams are disappearing. There will need to be new revenue streams created. IBKR is well positioned because it already passes on most of the benefits of its services to its customers in the form of lower prices, interest on cash balances, better execution, and so on. Compared to competitors, there is a lot less to be eroded.

What I think will happen:

Brokers will turn to value-added services like financial data to generate revenue. You can see this playing out already with Robinhood and Stake’s paid tiers.
Erosion of traditional businesses & failure of new entrants may cause the industry to consolidate. IBKR is already the leader here in many respects and has been investing heavily in tech to provide a better user experience and acquire more customers.
IBKR already adds a massive amount of value for every account holder (sophisticated portfolio management & performance attribution, wide range of markets, best execution, monitoring, news & notifications). This is a large hurdle for other providers to compete with and there is still a lot of room for IBKR to add additional features & services that it can charge for.
IBKR will be able to take more share from incumbent providers like TD and Merrill Lynch which are far behind the curve (albeit making an attempt to modernise). IBKR already has among the best access to data in the industry and is one of the most sophisticated & secure brokers with the widest product offering.

I see IBKR emerging as one of the winners over the next 5-10 years. The strengthening of the industry structure & addition of higher margin software & services revenue from the sale of value-added products should be very positive for IBKR’s total customer count, ARPU, margins, and market share. The washing out and failure of free trading platforms will also be favourable to industry structure and competition.

Brokerage as a Destination (BaaD):

One thing that is particularly interesting about this business is that a broker is always a destination for a market participant. Regardless of who you are or what tool you use, you always need to return to a broker to transact. It is both a toll gate and a place to keep things. There is a strong case for having a suite of tools that can automatically sync with your portfolio because they both live in the same place (i.e. within IBKR). Over time I think that brokerages will attract some of the data & tools industry revenues precisely because of this anchoring. (Look at the value of businesses like Plaid that were created to help customers sync their finances across multiple services; this is a real problem).

Having said that, I also think that investing tools will stratify further; there will be a tool for all kinds of investors (momentum/growth/small cap/chartists etc) and IBKR won’t be able to serve all equally. Nonetheless, there is a large opportunity to create more value by producing tools for a target audience.

Customer acquisition:

Interactive Brokers is willing to spend over a thousand dollars in incentives (excluding marketing!!) to acquire new customers. It can reinvest more than any of the free trading apps and enjoys (I estimate) a shorter payback period. This is a very, very hard business to compete with if money is the primary driver of customer acquisition (it isn’t, but it does matter). Offsetting this is the deep pockets of the investors in free trading apps; dollar for dollar, Robinhood can probably match IBKR, at least for a while. Additionally, competitors are currently better at distributing their product. Content is effective and on that topic – there are no reddit memes about IBKR.

Risks:

Valuation is tricky.
IBKR is very poor at onboarding customers, despite offering $200 referral bonuses and 1% of your portfolio value in IBKR stock to new clients. (This is the downside of having excellent KYC & compliance).
Selling value-added services as a broker is hard, especially when these services have traditionally been bundled into brokers (mostly) for free.
Parts of the organisation may require a transition in mindset from running a brokerage company to running a data-led investing tools business with all that entails.
The industry fragments further instead of consolidating. The free trading apps build better tools and a better experience with better distribution & marketing ROI, and divide up IBKR’s business between them. IBKR is currently a relatively small player (a million accounts – Schwab has >10m) which is something of a shield in this scenario (it is not the incumbent), but not much of one.

The bottom line:

Essentially, I view this as Interactive Brokers claiming a fixed or growing percentage of a static to declining revenue pool (brokerage) and owning a small and growing share of a large and growing market in value added services in financial data and investing tools. Brokerage is procyclical (business is booming) but IBKR has very steady customers and strong retention. Margin loans and minimum account fees result in fairly consistent revenues even in the down periods. Moving into investing tools should help alleviate some of the risk in the business, but this will always be a pro-cyclical industry. What you need to watch for is a) IBKR improving its onboarding (this is the most obvious & easiest area for improvement), followed by b) improving its ability to acquire customers, and in parallel, c) the creation of new products and ability to monetise.

Food for thought.

I own shares in Interactive Brokers. A few weeks ago I sold a small number of shares above $70. This is a disclosure and not a recommendation.

Blue Ocean Strategy: A Review

Sun, 02 May 2021 10:16:20 GMT

I am reading Blue Ocean Strategy (Expanded Edition) by W. Chan Kim and Renee Mauborgne. It is solid gold and I wish I’d read it 10 years ago. The thing that surprises me most here is that nothing in here is “new”. Apart from the case studies (which are excellent), I could not put my finger on a single principle or idea that was unknown to me, but the way that it recombines existing ideas into a framework is excellent.

I think of it as some sort of weird evolution of Porter’s Five Forces, as well as the opposite side of the coin of Marty Cagan’s Inspired. Cagan advocates for talking to customers systematically to learn what they want (bottom-up approach). Blue Ocean talks about looking at the industry and competitors structurally to reinvent market boundaries and find areas without competition (top-down approach). The thing that I find most interesting about this book is the idea that there is a systematic way of generating innovation and identifying areas without competition, and that it is consistent across (an extremely wide range of) companies and industries.

The essence of Blue Ocean Strategy is this:

You can unlock a dramatic step-change in value creation by finding areas without competition to operate in (duh), and those opportunities can be identified systematically (aha).

Most companies in every industry tend to compete on 6 or so common factors – price, convenience, quality, brand perception, etc.

Companies that find new areas of value to exploit (“blue oceans”) typically find 2-3 of these elements to excel at, ignore the rest, and add several more elements hitherto unknown to the industry. Costco competes on scale and price, doesn’t care about convenience, and invented subscription sales as the way to monetise.

To find new areas of value creation, successful companies tend to follow a 4 step process:

Eliminate (what is not necessary that we can do away with)
Reduce (what still needs to exist that we don’t need as much of?)
Raise (what do we need to improve to compete here?)
Create (what do we invent from scratch to unlock that blue ocean opportunity?)

Here’s an example from Casella Wines, which is Australian and whose Yellow Tail wine is (apparently) one of the most successful wines in the world:

Another way to look at this is Casella’s strategy canvas versus the rest of the industry. It ignores several factors and invented new factors to compete on:

There is a systematic way of looking for ideas to create these “blue ocean” opportunities:

Look across alternative industries. Financial software, accountants, and DIY all compete for the same thing – “help me do my taxes” – even though they are often treated as being different industries and viewed as such. The traditional approach is to think that accountants and financial software are not in the same industry (“services” vs “information technology”) but actually they both aim to solve the same problem for the customer and are therefore the same thing. I oversimplify, but I hope that illustrates the point. (This is where a jobs to be done approach may come in handy – Cagan’s book is a better fit here).
Look within and across strategic groups in your own industry. Automotive brands used to be split into mass market (Toyota) and upmarket (Mercedes) with the industry competing on price and quality. This created opportunity to create “masstige” (mass market prestige) brands like Lexus that were a mix of factors – higher quality and exclusivity at a higher price, but not as expensive as a Mercedes. (This is probably one of the weakest examples in the book in my view as it is still basically competing on the same factors – price, quality, exclusivity – as the rest of the industry, but hopefully the point holds).
Look across the chain of buyers. Who is the end buyer of the product? In many cases it’s the person that pays the money, not the user. Simple examples are parents buying toys for their children or a purchasing arm of an organisation buying software for its teams. There are advantages to be gained when the pendulum swings too far in either direction (a toy that focuses too heavily on marketing to parents may be unwanted by children, for example). This is probably the weakest point in the book as it’s well covered in basically any book on business, but it’s correct nonetheless.
Look across complementary product and service offerings. Probably the second weakest point in the book and it is covered in part by the “emotional & functional aspects” point below. What do people also buy when they buy your product? It’s not as simple as “new phone” and “headphones” but more complicated like what can you do with a phone and therefore what other services do you need (telecoms have latched onto phone and internet, for example). There’s not a lot of value in this point, if only because most consumer industries, including software and ecommerce, are all over this approach already and there are better books out there.
Look across emotional & functional aspects of a business. Does the product serve a functional need (“do X thing”) or does it serve an emotional need (status signalling, providing trust and recourse, etc). A common trend is for emotion-laden purchases to become more functional (e.g. financial services like banking and accounting that were built on reputations, becoming more automated and functional) and vice versa. The example given was Cemex in Mexico setting up a program to make purchasing cement an emotional purchase (“building a future” as opposed to “buying a bag of cement”) that was incredibly successful at growing the business and improving its financials. You can see this idea playing out with brands everywhere.
Look across time. Look at the product life cycle to gain insights. Many products are not a “one and done”, but have follow-up requirements in terms of maintenance, repair, updates, et cetera. Often these products are pitched to investors as a positive (“recurring revenue”, “locked-in customers”, etc) but actually these products may be ripe for a reclassification by a company that goes in a different direction. The example given in the book is the invention of the fibreglass bus to greatly reduce emissions and repair costs, while building the bus cheaper to a higher spec. Repeat relationships may be vulnerable to a one and done product, and vice versa. SaaS comes to mind here because the recurring revenue aspect of the business model is so ingrained – it is the holy bible of the industry – I suspect it is likely vulnerable to reinvention and redefinition.

A key idea that is developed in some depth is that technological innovation is not required to create highly profitable niches. It is all about consumer value, and creating a step change in consumer value requires both value and price innovation. I can’t do these ideas justice in a few sentences, but (obviously) consumers want to get more value for less. However, the way value is defined is typically falsely constrained by industry norms (the idea a faster car delivers more consumer value, for example) and that price innovation does not simply mean making things cheaper. In fact many of the examples in the book created huge and obvious consumer value while putting prices up.

Following this, the book progresses into how to identify your current strategy, how to craft a new strategy (hint: talk to customers – Inspired fits in well here), how to position your product in the market, how to price it, how to defend it from customers especially if the idea is replicable and not patentable. As a whole, this book converges massively with Marty Cagan’s Inspired, but they look at the same problem from different perspectives. In my view, Blue Ocean is far more useful for investors.

It’s an excellent book. A business book written by professors just begs to have a price tag put on it and I thought about this for awhile. Gun to my head: The value I got out of this book was at least $500. The consumer surplus is high. I recommend it.

There are no affiliate links in this article and I was not compensated in any way for writing this review.

How to conduct a performance review

Wed, 17 Feb 2021 19:52:00 GMT

This is a tricky topic. To conduct a performance review you need to know a) what is the performance you are measuring and b) what will you change as a result of that measurement, and c) how will that affect your employee. Is your review process about coaching? Or is it about salary? Is it about measurement? Perhaps ironically, those are all topics outside the scope of today’s update, which is just about how to conduct a performance review.

Performance reviews are stressful. They are threatening. It shouldn’t be that way, but most people rely on their job to make a living, so anything that places that at risk will be viewed with a gimlet eye. Plus, common wisdom suggests you should “let go” of poor performers, which explicitly places a severe consequence in front of people who, on average, need a job.

Taking that into account, good performance management is about measurement. It is about fairness. The conclusions drawn in performance reviews should be extremely obvious. If someone doesn’t know they’re doing a bad job, and they don’t find out until a performance review, your whole performance measurement process has failed. This is because you have given that person no opportunity to self-correct.

What you want is a process of constant feedback, realignment, and encouragement throughout the year. This allows people to redirect in a low energy way without feeling threatened. Through this feedback they get an understanding of what their weaknesses and strengths are. This makes performance reviews easier because both parties are able to agree on most of the main points.

People also grow faster with more frequent input and encouragement (assuming it is constructive and they are able to process it without feeling threatened), creating a positive feedback loop. The trouble is that many businesses do not really understand how to promote and measure the behaviours they are looking for, so ideal performance from a manager’s perspective is “just do your job please and don’t make my life harder”, and from the employee’s it’s “what the fuck do they want me to do now?“.

There is a better way.

What the ideal performance review looks like

In a perfect world, manager and employee should walk into a performance review and agree on everything that gets discussed. How could it be otherwise? If someone walks into a performance review and disagrees majorly on several items – either they’re badly wrong, or you are. You’ve either failed to measure accurately what you are supposed to be measuring, or failed to communicate it.

The only way to reach agreement here is to have many small discussions and provide regular feedback throughout the year. You will need to:

set up performance measurement standards
inform people of what the standards are at least 6 months in advance of any review process
find a way to (kindly) let them know where they are at relative to those performance standards (again, well in advance of any actual review)
understand where each person is at and where they want to head with their career. Many jobs require more than 1 skill/domain and people may want to excel in one, or progress across multiple domains into another job entirely. You need to learn this and structure feedback and guidance accordingly.

I assume that you have a criteria on which to conduct reviews and ratings or milestones that let you discriminate between different levels of performance. You should be able to discriminate between skill levels along the lines of “yes you can do a backflip, but you need to be able to do a backflip and land on both feet simultaneously, without wobbling on landing, in order to reach the next level“. If you can quantify your requirements at this level of specificity, and give people tangible feedback on how to get there, it will make your review SO MUCH EASIER.

Plus, people will respect you more because you can provide them tangible advice and feedback on what to improve instead of being the pointy-haired wanker from Dilbert.

How to introduce a performance review process

Once you have your criteria, introduce the concept of performance reviews to your team in a very nonthreatening way, usually 6-9 months in advance. This acclimatises people to the process and lets you refine it before judging people for real. Explain to your team why the reviews matter and how they help the business. It is very important to phrase this discussion in a constructive way.

You must commit to delivering what you promise. If there’s no intention to use performance reviews as an input into salary discussions, do not say that there is. People want to work at a business that is constructive, helps them improve and gives them tangible feedback. Unsurprisingly, people don’t like to be brutally demoralised by a heavy-handed power trip or treated like a disposable minion. If you invest in people and support them – and this includes giving kind and constructive feedback about what is not working well and what they could do better – you will be pleased with the results.

With your team, hold a discussion on the process you intend to implement. Walk them through some slides, which should be very detailed and contain step by step instructions on how the review and measurement process will work. Clarify how the whole process will work and how often the reviews will happen. Detail builds security and psychological safety because people know exactly what to expect. You will probably field some questions around “how does this impact salary” or “why are we measuring this way”. It goes without saying you should have answers, but be flexible and incorporate feedback. The goal is a good process, not “I invented this thing and therefore that is what we are going to use”.

Conduct a practice performance review

Once you have established the criteria, conduct a practice performance review (I will talk about how to actually do this a bit later) with no consequences. Introduce a practice review 6-9 months before the first real review, giving people time to get used to it, and time for you to measure. Treat the practice review seriously and put the same amount of work in as you would if it was a real review and you knew that you had to make a decision on salary immediately after.

I explain to people that the review is me in my role as manager, forming the business’ view on them as an employee. For this reason, it is important they read the review carefully and clarify anything they disagree with or are uncertain about. It is critically important that you approach the reviews in a non-adversarial way. You are not “judging” them. You (as manager) are facilitating the forming of a view which will be used as an input into promotion and salary and what have you.

Remember; you are representing the business and must provide your judgement on how the employee measures against the independent criteria, but you are not the supreme arbiter of people and all that is good in the world. The review requires judgement but it is not actually *about* your judgement. It is about data and measurement. You must be well prepared with examples for each measurement that you provide.

Once the initial presentation and “test review” (with no consequences) is done, tell people to think about it for a few days. Follow up 2-3 days later to see if there was any further feedback on the process itself. If not, proceed with implementing your process (including any adjustments that may have come up during your presentation). Congrats – you now have a performance review process. The next bit is a fair bit harder.

The way I conduct performance reviews is like this:

Before the review:

Set a mutually convenient time for a review.
2-3 days before the review, I provide a “draft”. This is “final” on my part (nothing else to add) but give the person time to read over it and comment. The review usually has 3-5 criteria, and ratings from 1 – 5 in each criteria. Provide detailed comments on why that rating was chosen, with examples where relevant, and actionable ways to improve. I keep the language non-emotive and write in the third person. “John is satisfactory on criteria X. This work was good, on some other work he struggled with [thing]. John will improve by [action].” Writing in first person is also fine – whatever works for you.
I make it clear that the draft is exactly that. We will talk through the rating and their comments in the meeting and (ideally) agree on the final version. There are really only three outcomes to this discussion:
- A) I am accurate and fair in all of my comments and they agree with everything.
- B) Some of my comments are inaccurate, wrong, poorly phrased or otherwise misunderstood. We discuss it and amend the comment in light of the ensuing discussion. It is perfectly okay to change or remove a criticism or score after reexamining the situation. However, if there are badly wrong scores (say you rate someone 2/5 and then change it to 4/5) this is a warning sign that you need to rethink your process. Excluding mistakes, which we all make, you should never repeatedly find that someone goes from “inadequate” to “adequate” after a discussion. If you do, it is a sign that there are problems with your process. Either you are too busy, not measuring correctly, not collecting enough evidence, allowing yourself to be too easily swayed by debate, or what have you.
- C) The employee disagrees with comments or scores, and I decide to keep the ratings and explain why. I make sure to record their comments on why they disagreed with the rating. This is very important for feeling like they are being taken seriously. With low ratings, it is extra-important to provide a clear path to improve. It is okay to be not of a good enough standard IF (IF!) there is an achieveable way to progress and the person trusts you to help them.

Holding the actual performance review

Once the person has read the draft review and added comments/questions, proceed. I personally choose not to read their comments before the review meeting. This is for a few reasons:
- I want to avoid setting up a confrontational dynamic where I’m composing responses to their disagreement even before we talk.
- It equalises the power imbalance somewhat because the employee has had time to prepare, whereas I must respond on the spot. I take a very high-ownership approach to this. If I haven’t thought about my review in detail and can’t thoroughly justify a certain rating or comment, I have no business providing this sort of review.
- For new managers this may be intimidating; it is perfectly okay to prepare your responses in advance. Do what you can to reduce the power imbalance where possible.
Once we are in the meeting, we talk through the document line by line. “I wrote here that we would like to see a little bit more initiative taken on [blah]. These are some examples [blah] and this is [what we would have liked to see you do instead]. Does that make sense? What are your thoughts?” In an ideal world, they will agree a lot of the time. Sometimes they have questions or comments. Sometimes I am wrong or have misunderstood something and we make changes. Much less frequently, I amend a rating as well. The goal is a fair and constructive discussion, as much as is possible in an environment of power imbalance.

Next Steps

Following this, we discuss development – what they want to work on improving, or what we need them to improve. I ask for their ideas on how to improve, and record them at the bottom of the review.
At the end of the meeting, I make it clear that the review is over and thank them for taking the time to sit down with me.
- I provide information on next steps. “I will email a copy of this final review to the HR team with your comments and cc you in the email as well.”
- If there’s a performance management or learning & development element indicated by the review, I set time to sit down and talk through this. Usually the onus is on the person to come up with some ideas on how to improve which we can iterate on.
- If there is a salary review upcoming I mention when that will be (I generally try to have a two week interval between them, but I’ll talk about that another time).

That’s it! All told, the review generally takes about 60-75 minutes.

Following the review and once I complete any follow-up actions around salary etc, I provide the person with a rating scale on me as a manager. I ask them to rate me, explain each rating, and suggest ways to improve. I make sure that this rating is separate from the review process. There should never be a question of the manager manipulating a person’s outcomes in response to a poor rating they received.

Thanks for reading. If you have some feedback, would like to share differences in the way that you conduct reviews, or suggest topics for future consideration, I’m all ears. Cheers.

Notes & Further Resources:

Indeed and Robert Half have some useful tips on the more high level considerations of performance reviews, like when in the year to schedule them.

How to conduct an employee evaluation (Indeed)
Performance reviews (Robert Half)

Nb: There are a bunch of closely related concepts here that I didn’t have space to discuss in this article. The generally accepted practice is to separate the salary review from the performance review. Businesses should consider salary relevant to changes in role & responsibilities, peers and the market, not just performance. Additionally, larger companies often separate performance measurement from salary to avoid conflicts. Other things not addressed here but immediately relevant & worth thinking about are:

How to get honest feedback from employees as a manager
How to set up performance measurement criteria
What to do with people that are failing at their job,
How to manage differently if you are a manager as opposed to a combined manager + team lead
Whether & how to use a peer rating of skills if you are not a technical manager

Airtasker IPO Raises Valuation Questions

Tue, 02 Feb 2021 07:54:55 GMT

The Airtasker IPO is shaping up to be interesting. It’s one of my favourite niche topics – private market valuation meets public market investors. My perception of Airtasker is that there has been a mismatch between perceived growth potential of the business (as measured by valuation) and its actual performance. That disconnect was arrested painfully in 2019, but I’d argue the correction is ongoing.

Airtasker Historical Valuation:

2017: $220m

2019: Targeting $75m raise at $500m-$1bn valuation (it later raised $33m; I couldn’t establish the valuation)

2019: $250m (this is a prime opportunity for a “how 2019 started / how it’s going now” meme)

2021: $257m Enterprise Value at IPO

The use of EV as a metric for the float is interesting, but what you’re seeing here is essentially the same valuation that the company held two years ago despite ~18 months of growth in the interim. For that matter, three years of growth since 2017 has led to a ~15% increase in shareholder value, assuming the EV = the market cap. The business could have shrunk if there is debt involved, or it could be larger if Airtasker has a fair bit of net cash (why EV?). Either way, it’s clear this business has been optimistically priced for a long time and the valuation has been steadily correcting itself in the background.

IPO pricing of 10x revenues (according to AFR) is well below the spicy multiples seen elsewhere and substantially below the failed raise in 2019 that must have been at more like 30-40x revenues. Airtasker did well when it raised equity in 2017, and investors then likely overpaid. (your regular reminder that it takes two to make a market, and both sides are self-interested)

It’s pretty widely known that Airtasker cut its headcount by a quarter in the past 2 years or so; it needed to cut costs after it was hit with the R&D claim from the tax office. Rumour suggests that the inability to get away the $75m raise in early 2019 exaggerated the impact.

I only trust what I’ve seen in the news, but looking at this from the outside, my perception is that this float is being driven by backers rather than by Airtasker seeking the optimal time to sell its equity. Ordinarily I would question if the dire financials necessitate a float, but the fact that (according to AFR) Airtasker is only raising $15m and the rest of the ~$80m IPO proceeds are to departing shareholders, it seems likely this is driven by its backers. It’s either backers wanting an exit, or Airtasker wanting backers off the register – hard to say but my money’s on the former. It does not make any sense for Airtasker to get rid of backers that have demonstrated the willingness to invest millions at optimistic valuations; as a result I conclude that shareholders want out.

Seven West Ventures originally invested $22m in Airtasker in 2016. At the current valuation it looks like Seven has roughly doubled its money since 2016. Not bad, but given the business has grown revenues fivefold, it’s probably not a great result (better than those that invested later, though).

I basically think when you see a business in the process of repricing itself like this and going public reluctantly, you have a few of the ingredients in place for a poor IPO. Looking from the outside; every investor since 2017 has made barely any money or potentially lost money.

There are two other things which may or may not have a bearing on the IPO.

Airtasker is one of the leading Australian startup/VC investments. Are there any implications for private valuations following this IPO, or is this situation unusual?
There’s a vicious rumour doing the rounds that Airtasker muffed its cap table and now a lot of employee options are worthless at the current IPO price. Edit: A read of the prospectus shows that ex-employees and consultants had some of their out of the money options cancelled during the IPO process.

So. Airtasker. I’ve written about private markets before, and I’m wondering if any of that is going to be on display here. My preliminary judgement right now is a No to the IPO but a Maybe to a post-IPO purchase if the IPO fizzles, which feels like a distinct possibility. I have some thoughts on the business model, specifically the size of the target market (small), the value prop to users, and the gradation from a generalised marketplace to a specialised marketplace (e.g. Uber), but that’s a story for another time.

Right now I’m in the market for an Airtasker roadshow prezzo. Cheers.

I have no position in or relationship with Airtasker or any of its shareholders or parties involved in the IPO. This is a disclosure and not a recommendation.

Intangible assets need maintenance too

Mon, 11 Jan 2021 02:04:50 GMT

“Soft” assets like brand and software are typically (but not always) created by investing through the income statement where the investment in the assets is expensed rather than capitalised as an intangible asset. This concept is widespread in investing and well understood.

What I find really interesting is how this plays out in the explicit comparison between “asset-light” and “capital intensive” businesses made by every investor. I feel like investors often overlook the amount of reinvestment that is required to maintain intangible assets.

Capital-light

Yes, capital-light businesses have the primary advantage of not needing large amounts of money up-front. It’s a true advantage, but focusing on capital alone limits our perspective. At many capital-light businesses, the “asset” is perpetually “under construction”. It’s not immediately obvious that a significant amount of expenditure is required to “maintain” that asset.

I would suggest that, unlike a factory, there will never be a time at which these businesses do not have to pay substantial maintenance on their intangible assets. The rate of decline of intangibles appears to be much faster than on physical assets. While you can run a software business with a handful of people, obsolescence is typically rapid and you can’t neglect reinvestment nearly as long as you can with an oil tanker.

Brand and software are two obvious examples, and at software companies, this is particularly acute. Most of the costs of building a software company are paying the people to build the digital factory for the digital products you want to sell. (this is a complicated field that I am grossly oversimplifying – think about branded or software products that are manufactured, physical assets that are high-maintenance, & “evergreen” intangible assets like art or music or royalties).

Depreciation

Once the software is built and as it scales, an ever-larger number of engineers and support staff are required to maintain it. I would bet the implicit rate of depreciation on a software asset runs a hell of a lot higher than the ~4% per annum on a factory or an aircraft engine (i.e. an implied 25-year asset life). For illustration, 25 years takes us back to 1996 and Windows 95. Since then we’ve seen Windows 98, Windows 2000, Windows ME (Millennium), Windows Vista, Windows 7, Windows 8, and Windows 10.

Capital-light businesses are generally favourable, but they’re not exempt from maintenance expenditure, and intangible asset maintenance is much more significant than is widely accepted.

It is true that you didn’t need capital to create the asset in the first place, so we’re not initially talking large sums of money for maintenance. However, once you reach scale with your intangible asset, the maintenance costs are high and they don’t go away. Most software businesses need to invest heavily in improvements to fend off younger competition that would otherwise obsolesce the incumbent solution.

I am thinking mostly about software here but I suspect this is true for brands and intellectual property as well. My best guess when I was evaluating Xero (ASX:XRO) was that about 30-40% of its annual marketing spend was basically “stay-in-business” marketing for supporting the brand, which implies a short shelf life on that asset. On the plus side, at least brand investment compounds over time. Coca-Cola could stop advertising tomorrow and be comfortable for a few decades. Marlboro hasn’t advertised since 1971(!) and is still the world’s 25th most valuable brand. (the Forbes methodology is not perfect, but as an illustration, it gives us a talking point)

Measuring the rate of decline of intangible assets

One of the most interesting ways I’ve seen of valuing intangible assets involves taking the income statement expenditure, calculating what proportion of it is “investment”, capitalising that on the balance sheet as an asset and then amortising it at the appropriate rate. This understates costs in the P&L but provides a reasonable picture of how much value exists in the asset versus value which requires ongoing output from employees. The estimated amortisation expense on this asset ballparks how much of the investment is going to maintenance.

(This is a paper exercise at best because nobody knows the “true” rate of decline of an intangible asset. I doubt even the company itself knows what % of the cost base is truly building the asset vs being short-lived output. Still, it gives us a useful starting point).

It might be a moot point, because software companies are always going to employ engineers and invest in their assets. Brands are always going to employ visionaries and marketers. However, it provides an interesting lens for looking at companies that don’t reach scale (for example, local businesses with a finite TAM). Are there scenarios where these assets can be created and then operated with low to no cost and low risk of obsolescence? Does the focus on companies solving big problems lead to less interest in smaller, capital-light businesses that can be created faster with higher and more sustainable levels of profitability?

Food for thought.

I have no position in any company mentioned. I may have positions I am unaware of via my superannuation fund. This is a disclaimer and not a recommendation.

Team Alignment: Good transitions make it easier, and less stressful

Fri, 08 Jan 2021 06:20:32 GMT

A challenging task in management is achieving team alignment during a transition. In both fast- and slow-moving businesses, change can be punishing and it is hard to redirect energy to new problems and keep teams engaged in the process. Fast-moving businesses change too fast for comfort with the pace, and slow-moving organisations make people too comfortable to change. Investing in a smooth transition makes change easier and leads to better team alignment and a happier organisation.

A “transition” here could be anything from a change in strategic direction to a new role or responsibilities, growing the team, attracting more public scrutiny, raising money, having new investors on the register, receiving results of new research, new rules and regulations…the list is endless. Anything that changes in business is a transition, and the more effort you put in upfront, the faster and smoother the transition. Your team will get to the desired end-state faster and with less stress.

For brevity, I assume that you know what team alignment is and why we care, but if not, a simple overview of the benefits can be found in this blog post here. Alternatively – there’s a Dilbert cartoon for that:

Invest in good transitions

To get a good transition there are four things that need to happen:

Priming
Planning, instruction, and guidance
Remove the training wheels
Feedback

The result of this process is good team alignment on the new project. I only have space to address Priming in detail here, but I will cover all four in time.

Priming

Priming is technically a psychological phenomenon. Someone who has been “primed” with a stimulus is more likely to respond favourably to that stimulus later. Imagine that you are hungry and I show you a picture of peanuts, then five minutes later I offer you a choice of peanuts or a sandwich. You are more likely to choose the peanuts because you have already been thinking about them. Priming is incredibly common in branding – it’s why you see Apple Macbooks and Ford Mustangs in movies. It’s called “brand recognition” there, but it’s the same thing. Basically, stimuli that are familiar to us are easier to approach and interact with.

In a business context, Priming should be used to build familiarity with changes that may bring stress and discomfort. Talk about the changes in advance, explain what is happening and why and – most critically – discuss how people might feel and what sort of problems they might run into during this transition.

Depending on your role it might be difficult to envisage how priming can work at your level of responsibility. I’ll give three examples below:

Priming in real life

The most obvious time to use Priming is when a team changes direction, structure, function, or purpose. Imagine that a team used to work on project X but is now required to work on (very different) project Y instead. People can feel stressed in several different ways:

Important projects that they contributed to are now no longer in development
Resources are being allocated away from things that they previously believed were important
They have been “replaced” on a project by other people
Valued colleagues and friends are moving to different teams, or new people are coming in
The working environment/ team dynamic is changing
People lose the feeling of mastery moving from a successful workflow to one that is nascent and less well defined
(this list can get much longer if you think about it for a bit)

This rightfully results in lower team alignment, more stress, and feeling like the team is pulling in many different directions at once. Getting the transition right makes it much easier for people to pick up the new stream of work.

The reason Why is all-important here. People are losing things that they created, and starting again on something that they don’t understand and potentially don’t care about. The very first step – even before talking about the actual change – is to start explaining Why change is necessary. Outline the circumstances that are driving the change. In presenting this information, I always use the format:

the past -> new information -> the future -> the change

This approach is very effective because it gives people a narrative and shows where they fit in the story. It provides direction and purpose. I’ll give you a real-life example from a transition I’m working on right now:

“In (the past), we had a goal of providing news coverage for every company in the world and created content with the goal of the broadest coverage. Now that we’ve achieved that goal, we’re finding that we now actually have too much coverage and it is crowding our channels (new information/ the problem). In (the future), we need our content to be more relevant and actually a bit more scarce and higher value. One of the most obvious ways we can think of improving this at the moment is by _________ (the possible change).”

That’s how I did it. In practice, Priming conversations should take much longer. For larger changes, you should even have three or four conversations, spread out over time as the transition approaches. Here is how they might look:

Change in team direction or workflow

Start simply by explaining why the change is necessary. If you’re in the position of making the decision to change, you are typically in a position of authority. You will (should!) have much more context than the people working with you who will be carrying out the changes.

a) “As you know, we’ve been doing Project X so far, with [these results] which have been [good or bad]. What we’ve found is that [additional information has arisen] which has highlighted [promising new opportunities]. We really need to start working on [Project Y] now to get [Desired Result] which is especially important now because [reasons]. The reason that [this team] has been selected is that we have [insert true reason here] and we’re in the best position to start soon. If we succeed, customers/the business will have [outcome] which will lead to [benefits for the thing that we care about]”.

note: You need to be flexible enough to reframe this conversation based on the context. Obviously, if The Roof Is On Fire, it will come across false and overly corporate to present firefighting as “promising new opportunities”. The general format of “the past -> new information -> the future -> the change” works well, but choose your words to fit the context.

Prime the team for possible changes

b) “There are a couple of problems that we’re likely to run into. Firstly; we haven’t done this before. Ideally, we’ll be able to get the answers to the big unknowns before we proceed with major initiatives. However, we might have to make a judgement call on a few things and be willing to adjust quickly as we learn more. As it’s a new project, it seems likely that it’ll be more important than usual to measure what we’re doing, as we need to know if our work is actually having the impact we want. “

c) “We might make mistakes. Despite using our best judgement on a solution, we might find that it doesn’t work because of some larger underlying problems we weren’t aware of. Working on this project might be different because it overlaps with another team’s responsibilities more than we’re used to. They might feel proprietary about Problem Y because they’ve done some work on it already. We might have to put some effort into keeping them up to date so that they feel like their baby is in good hands. That’s something we’ll have to keep an eye on as we learn new things and invest more time into this project.”

d) “what do you think?”

Opening the floor for discussion is crucial. This is what lets people clarify concerns and misunderstandings. This is how a team builds familiarity and confidence with the transition you are describing.

Priming in a dynamic environment is really hard to describe in scenarios because there’s infinite nuance in the real world, but hopefully, this illustrates the concept of what I am talking about. Priming improves resilience and openness to change by teaching people about prospective changes and problems in advance.

Here is another example of a different kind of transition, which might affect an executive team:

New Investors

A new investor has joined the register of the company where you are a senior executive. This investor is now the largest single shareholder, although they don’t have a majority. Their holding gives them substantial influence in choosing the directors who can appoint/remove key executives, and could indirectly cause a change in business strategy.

The transition here is that the CEO and executive team have no choice but to engage with this new investor. They may lose some of their ability to steer the ship according to their own judgement, which could lead to a drastic change in perceived freedom to operate and execute.

The way I would present this transition conversation is:

Improve team alignment by providing context on the transition

a) “These individuals have become large shareholders of the company, which will give them a substantial amount of say in the way the business is run. While nothing is changing at the moment and they have made no requests, we might find that they want to see a change in direction in the business.”

b) “They might, for example, want to see a greater focus on paying out cashflow or a clearer path to profitability and ROI on new projects. Two of our major initiatives in the past few years haven’t seen the results we expected when we committed funding to them. It’s unlikely but possible that they might also seek to change directors and the executive teams. Activist shareholder campaigns often demand higher shareholder returns, and our investors might want less reinvestment and higher dividend payments. Now, they might also be perfectly happy with how the company performs, but it seems likely that we will need to spend more time managing their expectations and building a relationship with our investors.”

Priming the team for possible changes

c) “If that’s true, we’ll probably have to get better at getting buy-in from stakeholders before we commit to large projects. Shareholders might also want more contact with management, which could add increased overhead and necessitate more transparency. I am guessing, but it will probably be increasingly important that our investors understand our strategy and what we are doing. We need to make sure we are communicating our strategy clearly and understandably. We also need to listen to our shareholders, understand their concerns and make sure that we are addressing them well.”

d) “The other thing I would add is that we don’t have a monopoly on ideas. We might even find that investors with a strong interest in our business can bring new insights to the table. All things considered, it’s not clear that we need to take any action just yet. Still, I would like everything to think about this – maybe I’m wrong on some things or I haven’t fully understood all of the nuances of this news. Now that we’re aware of the changes that could happen, we will be in a much better position to respond when we need to. “

d) “What do you think?”

Again, that’s where the first conversation should end. You’ve talked through what event is happening and given some examples of a laundry list of possible changes that could arise. The conversation is sufficiently vague – and it does not end with concrete changes – that people are less likely to feel threatened by it.

The Takeaway

By Priming, you are creating a baseline for understanding that lets people more easily assimilate later information as it arises. For example – when you get that first letter from your investors, demanding that you cut costs and stop spending on [perceived wasteful project X], people will be familiar with the threat because you’ve already discussed it at length. This familiarity allows for faster responses – and better team alignment on how to respond – with lower stress. Plus, people have been thinking about the problem and there are probably ideas in the pipeline already.

Priming can also work the opposite way, by familiarising people with opportunities and the potential to have an impact. This can be powerful for getting a team motivated and excited by new opportunities. Depending on the organisation, my view is that you should Prime both the opportunities and the problems. A balance of both is required to be an effective manager. People will not follow untamed pessimism, and unbridled optimism causes more problems than it solves.

A final note on Priming – the leader of the team needs to do it. Leaders generally have a clearer view of the big picture across teams and business functions. It’s very difficult to use Priming in a team if your view conflicts with the manager.

Food for thought.

Xinja’s Pivot

Wed, 16 Dec 2020 21:50:41 GMT

I’m coining a new phrase, Xinja’s Pivot, to describe “bad-to-worse” changes in business direction. Mark my words, three years from now it’ll be a hall-of-famer alongside Occam’s Razor and Maslow’s Hammer.

Neobanking

The thing about neobanks is that if you take the fees out of banking, you take most of the profits out too. What’s left is a sub-scale company with reverse operating leverage that has to pay more for funding, charge less on loans, and pay through the nose for customer acquisition (because there is no brand). By contrast, Commonwealth Bank of Australia can borrow money almost as cheaply as the Australian sovereign. There is a reason the Big 4 are the dominant providers in the space, and it’s the same reason Bendigo Bank still hasn’t made it the Big 5 (we are ignoring MacBank for now, mostly out of spite). If you’re a neobank, you’re pushing a gigantic ball of shit up a fucking long hill just to get a toehold in the space – not even to succeed, just to earn the right to exist.

The result is unprofitable neobanks (re-)inventing ~~the square wheel~~ old ways of making money, like charging account fees. Some new financial providers have gone one step further and are un-inventing solved problems. Beam customers can’t withdraw their money, and Robinhood hackers accessed customer accounts.

Xinja is a case in point. The neobank gave up on banking today and is returning its banking license and giving deposits back to customers. The company blamed COVID, due to:

“an increasingly difficult capital raising environment affecting who is willing to invest in a new bank”

I call bullshit. The business model was unsustainable, and it failed. I’m not without sympathy; Xinja didn’t have the resources it needed to succeed. I wouldn’t attempt to build a bank with less than a billion dollars (plus additional funding for loans). Banking is hard work.

Xinja’s Pivot

What’s really igniting my “old man yells at cloud” instinct is Xinja’s decision to pivot to focus on its US stock-trading platform, Dabble. The grand, cosmic irony of shifting from a business model where there is no profit (neobanking) to a model where there is literally no fucking revenue (stock trading apps) is off the charts. I rolled my eyeballs so hard they fell out of my head and dropped onto the floor. (I put my computer monitor in between my feet so I could type this post).

From a business perspective, I get it. The core model failed, you want to salvage what’s left, so, you pivot to something else that’s working. Stock trading is booming – Interactive Broker (IBKR)’s volumes in November were up 175% year on year on a 3% increase in client accounts. Xinja could even do ok from here if it gets acquired. But seriously, stockbroking is not a good industry to be entering right now. It might be easier than banking, but that’s not saying much.

There is an influx of capital and a fuckload* of new start-ups in the brokerage space. Most of them are weak and will fail. Some will be acquired by stodgy old brokers trying to reinvent themselves. If you’ll permit me a pivot of my own, these thoughts lead directly to my IBKR thesis which I’ve summarised below.

* fuckload = more than a lot but less than a plethora

Why IBKR?

The old monetisation model for broking is outdated (fees are trending towards zero) and interest rates are zero (eliminating the other main source of revenue)
- As a result, brokers will increasingly focus on value-added services like portfolio monitoring and stock picking tools, data and research
Brokers will become more like financial product suites, not just a place to trade & hold stocks
IBKR has solved all of the brokerage problems and is moving further into monitoring and research
IBKR is the best-run broker out there and has enough capital. It is going to wipe the floor with most of these new entrants. Over time, I expect the industry will consolidate.

Problems IBKR needs to overcome:

It’s not clear yet if one large global platform can win against local providers, because regulation and customer needs vary from market to market. Most financial businesses find it hard to expand beyond their home markets for this reason.
The customer onboarding process is bad. In addition to filling out many pages of forms, I had to send a letter (an actual letter) to the local IB office in Sydney to verify my identity and open my account. It’s not clear yet if IBKR can actually grow its customer accounts enough to take market share.
The IB platform is pretty hard to use. The overall UI/UX experience is still suboptimal, but IB has visibly spent millions of dollars improving it since I became a customer last September.

So. Xinja’s jumping out of the frying pan into the fire, and IBKR is well worth a look on the assumption that the industry will bundle up and consolidate over the next five years.

Food for thought.

I own shares in Interactive Brokers. In my superannuation fund, I may have positions in Australian banks that I am not aware of. This is a disclosure and not a recommendation.

Sezzle’s (ASX:SZL) Meteoric Rise Raises More Questions Than Answers

Sat, 12 Dec 2020 08:09:52 GMT

Sezzle Inc (ASX:SZL) is an Australian Buy-Now Pay-Later (BNPL) company. It is domiciled in the US and the majority of its operations are in that country. Underlying merchant sales are approaching a $1bn per year run-rate, which is not large – but not trivial, either. Sezzle has a $1.1bn market cap on $32m in revenue for the twelve months to June 2020, and is a small player in a red-hot space.

When I look at Sezzle, I have four fundamental thoughts.

Why are fees so high and do these cast doubt on the “financial freedom” the business aims to deliver?
Why was the Merchant Interest Program (MIP) not disclosed sooner, and is the accounting of this program correct?
What is the value prop of the MIP for a small retailer, and are retailers fully apprised of the risks they run with this program?
There is a large amount of stock coming out of escrow in July 2021.

Merchant Fees

In the third quarter of 2020, Sezzle earned fees equivalent to 5.8% of the underlying merchant sales (UMS). This is one of the highest rates in the industry and increased from 4.8% at the end of 2018. While this is a positive from a business perspective, there are limits on the amount that can be charged to retailers, especially given standard credit card processing fees are a fraction of the cost. According to the Merchant Agreement, Sezzle’s standard fee is 6% of the transaction value plus $0.30 per transaction (section 5.2).

It is difficult to form a comparison because Sezzle’s customer base is diverse, but 5.8% could be a quarter or more of a retailer’s pre-tax margins, after accounting for processing fees that would otherwise occur on credit card transactions.

For a rough comparison, a $100 purchase on a credit card might cost the retailer 1%-2% to process. The interest on a $100 credit card purchase at ~17%p.a. over 6 weeks (the same time as Sezzle’s repayment terms) is another ~2%. This is a total transaction cost of 3%-4%, which is far below the 5.8% Sezzle is earning. Admittedly, with a credit card the interest on the purchase is charged to the user (instead of the merchant), but clearly the overall cost to the system of Sezzle’s solution is much higher.

I would ask:

For a business that is presenting itself as financially responsible by making credit more accessible, is this actually a better outcome?
Does this make Sezzle vulnerable to competition from incumbents who can implement a lower-cost solution at greater scale?
A large benefit of BNPL solutions is lower friction for the buyer and retailer; can you be a low-friction solution if you are a high-cost provider?

Interestingly, Sezzle offers to defray high fees by paying merchants interest on unpaid balances, which leads us to…

The Merchant Interest Program (MIP)

When a Sezzle transaction completes, the merchant ships the product to the customer, and Sezzle becomes liable to pay the merchant for that purchase. The customer, in turn, becomes liable to repay Sezzle for that transaction over a 6-week period. However, in some scenarios, merchants can elect not to receive payment but instead let Sezzle keep the money and earn interest on the balance. Merchants can earn up to 8% interest per year on these funds (currently 5%).

Merchants who want to withdraw their funds can expect to be repaid in 7 days for withdrawals larger than $250,000. However, Sezzle reserves the right to impose limits on your Merchant Interest Program and make changes to your Merchant Interest Program without notice or limits. This includes the withdrawal amount and withdrawal frequency.

As of June 2020, 86% of Sezzle’s outstanding payables to merchants are in the Merchant Interest Program. There has been a massive increase in the size of the MIP over the past 6 months, indeed it is plausible that a large part of Sezzle’s growth has been funded through this program.

On the face of it, we have a very interesting invention – a better mousetrap. Merchants are able to earn a reasonable rate of interest and Sezzle is able to obtain cheap funding to continue its growth. Sezzle pitches the MIP as a great way to save on fees – while getting two bites at the apple via cheaper funding – which is cheeky but not illegal. It is a tacit acknowledgement of the high level of fees, however.

“Start to earn back the money taken out for fees.” (source: Sezzle website)

It’s clever. I’ve never seen anything like it. It’s borderline genius. But it also raises a lot more questions than it answers.

Disclosure

The first question is simply around disclosure. Sezzle did not disclose the MIP program until July 2020, despite revealing in the 2020 half-yearly report that it had $10.05m in the MIP at the end of December 2019. This was ~76% of outstanding payables to merchants at the end of 2019. What’s more, the annual report for 2019 does not disclose interest payments to merchants on these amounts, stating only that an increase in interest payments were driven by use of the company’s revolving credit facility (page 34 of the 2019 annual report).

Quarterly reports in the first part of 2020 also do not disclose the program, stating again that increase in interest payments were due to mandatory borrowing levels on the revolving credit facility. As far as I can tell there has been no disclosure around when the program began. This raises several important questions:

When did merchant participation in this program first commence and why was it not disclosed at that time?
Why was such an important source of funding not disclosed in the audited annual report in 2019?
Was auditor Baker Tilly aware of this program at the time it signed off on the annual report?
- Did Baker Tilly approve of the accounting treatment of the MIP?
Was the market fully informed of the importance of the merchant interest program at the time of the capital raise in July 2020?
- I can see a mention of the MIP in that presentation, but no explanation of what it is or how important it has been historically
- July 2020 was the first mention of the MIP I have seen in Sezzle’s ASX announcements.

From my perspective, it looks an awful lot like Sezzle has a few quirks in its business model, and has managed disclosure carefully to reach that first capital raise in July without having to fully open the kimono.

I would also highlight the way that the Merchant Interest Program is recorded in the accounts. The MIP appears to be recorded as an account payable rather than short term debt in the current liabilities section of the balance sheet. This means that the MIP inflows stay as an operating cash flow item rather than moving to cash flows from financing. This has the effect of making operating cash flow look a lot better than it is, while also understating debt levels. I am not an accountant so take this with many grains of salt, but it seems to me that an interest-bearing liability should be recorded as debt and as financing cash flows, not as accounts payable and operating cash.

Noting the apparent non-disclosure of the MIP, I would be interested to know if auditor Baker Tilly was aware of the existence of this program and if it approved the accounting treatment of this liability.

Funding Risk

The importance of the MIP as a source of funding has been diminished with recent capital raises, but is nonetheless a very material part of the business model.

What is the median length (in months) and size (in dollars) of merchant participation in the MIP?
What is the median size of participation in the MIP, relative to each merchant’s underlying merchant sales?
Are MIP liabilities concentrated among certain MIP participants?
- Sezzle reports no concentration risk among customers, so concentration in the MIP would be unusual.
Has Sezzle ever refused or delayed a merchant’s attempt to withdraw funds from the MIP?
- How many times has this happened, what quantity of funds was affected, and for how long?

Separately, I would question if Sezzle is skirting the edge of legality by advertising the MIP as being “like a savings account”. Sezzle also does not, as far as I could see in the Merchant Agreement, highlight the risks of becoming a creditor of Sezzle. More questions:

Is Sezzle legally able to, under its licenses, describe the MIP as being “like a savings account” ?
Is Sezzle required to obtain additional licenses to let merchants open “interest-bearing accounts”?
Is Sezzle legally required to disclose to merchants the risks of becoming a creditor of Sezzle?
- Does Sezzle currently make these disclosures to merchants?

There are laws governing this type of claim. source: Sezzle website

If there is no FDIC deposit insurance, I would politely opine that Sezzle’s balance is not “like a savings account”.

So Many Questions

Lastly, I would highlight the risks to merchants:

Do merchants have any security over the funds in the MIP?
- If no – why are merchants comfortable becoming an unsecured creditor of Sezzle?
Are merchants given any extra disclosure that would permit them to better assess the credit-worthiness of Sezzle?
Who are all these small merchants that can afford to sell products and not get paid for them?
- Almost all of these businesses look like they sell physical inventory, which has a cost.
- It would be unusual for a small merchant to have a larger working capital burden by leaving the cash with Sezzle.
Why are these businesses bloating their funding requirements in return for 5% interest from Sezzle?
- Inventory finance typically costs more than 5%, so what is the actual benefit to merchant participants?

So many questions, so few answers. There’s a lot of stock coming out of escrow in July 2021, so it will be interesting if there is clarification before then.

Food for thought.

I have no position whatsoever in Sezzle or any other buy-now pay-later stock. This is a disclosure and not a recommendation.

A simple framework to reduce workplace stress

Sat, 17 Oct 2020 01:34:27 GMT

Workplace stress is about clarity. It is about priorities, capacity, and expectations. When you get those three right, the work environment is much less stressful. If you get it wrong, you’re gonna have a bad time. It is not rocket science, but it’s hard.

For the purposes of this post, I plucked an academic publication at random from the ether. The Victorian Government organisation, VicHealth, conducted an excellent review in 2012 of workplace stress. Not surprisingly, one of the high level findings was:

Workplace stress refers to distress
resulting from a situation where
the demands of a job are not matched
by the resources provided to get the
job done.”

That’s correct, of course. Yet in my personal experience, this type of workplace stress can be sub-divided further into four constituent concepts. When people feel overwhelmed, have too much to do, not enough time to do it in and are uncertain about expectations, they have problems with at least one of the following four elements:

Priorities + Capacity + Expectations = Clarity

That’s not a literal equation, just a metaphorical way of abstracting the concept into a recognisable form.

When you get the Priorities right, you know what work is most important and impactful for the organisation. As a result, you can focus your efforts in the right place and, in good conscience, let less important tasks slip. If you find that you have too many equally urgent priorities, you either haven’t prioritised well enough, or you have a problem with Capacity or Expectations. Alternatively, it may be that The Roof Is On Fire, but that is (usually) a separate point-in-time problem rather than a fault of your overall management process.

When you get Capacity right, you know how roughly much output you are capable of achieving in the time available. This lets you align the amount of work you can produce with the amount of effort required to solve the most important Priority. Sure, estimation mistakes and unforeseen complexities in tasks are common, but there are always finite limits on output. If you have too much to do, you either got the Priorities or Capacity wrong, or Expectations are too high.

When you get the Expectations right, you have aligned the organisation’s Expectations with what you have Prioritised and have Capacity to produce. If you have an accurate handle on Priorities and Capacity and have communicated these well, unreasonable Expectations shouldn’t be a problem. However, if Expectations seem too high, and you have the right Priorities and are using your Capacity efficiently, you need to realign Expectations. If Expectations stay too high for too long, you are setting yourself up for failure.

Result = Clarity

When you have Clarity, you have solved the above three problems. You have approximately aligned the organisation’s Expectations and Priorities with your Capacity to produce. When this happens, people are happy with what you deliver and you succeed in your role. Clarity is not a one-off thing to be obtained. It is the outcome of a process of regular communication and realignment of Priorities, Capacity, and Expectations as new information comes to light. It’s not just about your boss but also about the organisation, the team and other stakeholders in the business being up to speed on the latest developments in your domain.

Of course, there are many other facets that contribute to stress that I haven’t discussed here. How do you decide what is the highest Priority? What if you need to improve your team’s Capacity to meet a normal level of Expectations? How about if you can’t realign Expectations because you don’t have a strong relationship with the person setting them? What if you don’t know where your work fits in the bigger picture and thus can’t solve for Priorities, Capacity, or Expectations?

These are all real problems, but they are not the same problem, and are a story for another time.

Food for thought.

Henry Morgan – 3 Years On

Sat, 11 Jul 2020 04:14:59 GMT

A bit over three years ago I began researching a company called Henry Morgan (ASX:HML), its sister company Benjamin Hornigold (ASX:BHD) and their investment manager, John Bridgeman (NSX:JBL). During my research I posted on this blog, writing that “something doesn’t add up and I remain gravely concerned about the way that Henry Morgan and co are creating value for their shareholders”. I thought that something was “fucking rotten”. Later, these companies sued my web host to get my identity, and the story was subsequently written up by the AFR. I wrote a brief post about the experience here.

Last year, Gary Miller, Sulieman Ravell and Michael Glennon gathered enough shareholder votes to oust management at one of the funds, Benjamin Hornigold, and that company recently returned to trade after two(?) years in suspension. I assisted these men in the Takeovers Panel application that led to the recovery of several million dollars in shareholder funds (there’s a whole other story about Gary, Sulieman, and Michael’s work there). Henry Morgan stayed in suspension so long that it has now been delisted from the ASX, and John Bridgeman is in a curious situation at the moment (and suing its exchange operator, the NSX). That chapter of my life was winding down and the AFR recently covered the pyrrhic victory of this incredibly protracted process.

What’s not widely known is that three years ago – July 2017 – I lodged a Freedom of Information (FOI) request with ASIC. I was hoping to obtain ASIC’s Statement of Concerns and Statement of Reasons behind its decision to block Henry Morgan from issuing options. Three years later, after numerous objections from pirate lawyers, the FOI request travelled to the OAIC (the independent arbiter of FOI requests), which this week approved the release of the documents I had requested.

I have read these documents and they demonstrate that ASIC shared similar concerns. ASIC felt that Henry Morgan produced materially misleading statements, and ASIC was concerned about the valuation methodology for the unlisted assets. There is more information in these documents that I did not have access to in the public accounts, but the broad concerns map 1:1 with what I wrote in my reports. The screenshots below come from both the Statement of Concerns and the Statement of Reasons, and may have different meanings or levels of certainty under the law – nonetheless, they are illuminating:

Huge increase in valuation between late 2016 and January 2017:

ASIC was concerned that the valuations may not have a reasonable basis. Company documents suggest that announcements of valuation increases were not reflected in the company’s own books and records:

ASIC is concerned about the forecast profits of the JBFG business and has formed the initial view that the monthly NTA calculations released to the ASX are misleading:

The information ASIC has received does not support the conclusion that the NTA calculations have a reasonable basis.

Said they’d roll out more stores but didn’t have evidence to back it up.

This was known already but is too good not to include again – announcing $96m in revenue when it didn’t have anywhere close to that:

And lastly:

All I can say is that I called it like I saw it, and it looks like ASIC saw it much the same way. I feel that my concerns were substantially vindicated. Yet on the other hand, ASIC spotted these issues three years ago(!!) and took no substantive action – to say nothing of all HML/BHD/JBLs activity since. Enforcement, where art thou?

When I read the issues that ASIC raised, I think about this chart:

Speaks for itself, really.

There is more to tell, about why ASIC took no action, and the hard work of Messrs Miller, Ravell, Glennon – but those stories will have to wait for another time.

I have no financial interest in any company or individual mentioned. I would like to thank the Australian Securities and Investment Commission for releasing the FOI documents, and for electing not to charge for the release of the information. The FOI documents can be requested via a link on this page.

FEAR

Thu, 19 Mar 2020 08:56:26 GMT

Note to readers today: This post was published at the very lowest point of the Covid Crash in 2020. It is designed to be bombastic and provocative, and at that, I think it succeeds. – Sean

Can you feel it?

FEAR

If you do not look it in the eye, it cannot GET YOU

Let me tell you about FEAR:

In my mis-spent youth I got a psychology degree (for which I still owe the government twenty thousand dollars – student debt forgiveness stimulus please). FEAR leads to fight or flight response. The purpose of FEAR is to motivate you to act.

Insufficiently afraid and you will not act. Too AFRAID, and you will freeze.

Let me tell you about AROUSAL:

Speaks for itself, really.

Ironically, peak fear can also coincide with ABJECT TERROR that leads to us RUNNING FOR THE HILLS instead of FREEZING. It’s not easy to distinguish between these outcomes. I would speculate that if you are Overly Aroused and are subconsciously propelled to act, you will flee. If you don’t act, you will freeze. The perceived immediacy of the threat is probably the discriminating factor – do you need to RUN AWAY BEFORE IT GETS YOU or can you HIDE and HOPE THE BAD MAN DOES NOT FIND YOU.

FEAR is an extremely powerful motivator. It has the power to subconsciously and unwillingly compel us to do things we are rationally aware are not wise. Let us accept for the purpose of this post that we care about three states of FEAR:

Insufficiently Aroused
Optimally Aroused
Overly Aroused

Insufficiently Aroused

Moving from Insufficiently Aroused to Optimally Aroused is not hard. What’s really fun is when you are INSUFFICIENTLY AROUSED and NEED TO GET MORE AROUSED IN A HURRY. (I’ve used the word aroused enough by now you probably forgot you were waiting for a penis joke)

One way to become Aroused is to YELL AT PEOPLE A LOT. Increasing the absolute arousal of your environment narrows the gap between how aroused you are and how much more intimidating an external threat is.

I don’t know why I put a picture of Christian Bale from The Big Short here.

It’s not conducive to good thinking and I don’t advocate yelling at people. But it’s good for Arousal.

Speaking of Arousal. Did you ever hear about THE MAN WHO PUNCHED THE SHARK? He had no choice.

There is a SHARK on the page just below us. It is FRIGHTENING. Scroll quickly, because the good advice starts after that.

From the movie Great White, although it could have just been called: FEAR

Overly Aroused

Moving from Overly Aroused back down to Optimum Arousal is many, many times more difficult. FEAR is, for the purposes of our talk, the result of a stressor that feeds a subconscious biofeedback mechanism. Many skilled psychologists are capable of inducing actual panic attacks in Overly Aroused clients. Simply amplify the stress and watch the subject’s breathing become more rapid and shallow. More shallow breathing leads to a shortage of oxygen and escalating fear at the lack of oxygenation, which in turn leads to more fear and before you know it YOU ARE HAVING A PANIC ATTACK.

The greatest irony of the biofeedback mechanism is that stress itself induces elevated heart rate and shortage of breath which together provide tangible proof that THERE IS SOMETHING TO WORRY ABOUT. Fear feeds on itself. You might not be feeling anxious (men duck the Anxiety Label faster than politicians dodge the draft) but the mechanism is the same. There are many ways to treat acute Over-Arousal and they all involve reprogramming or otherwise short-circuiting the biofeedback mechanism.

Among the most reliable is exercise. The body is a machine and as demand for oxygen increases the heart will beat faster. Sustain a high heart rate long enough and the body will need to rest, leading to a lower heart rate and lower anxiety. This is an extremely reliable approach. It is not magic – it is a law of physics. Another effective mechanism is a simple breathing exercise – stop all activity, close your eyes, breathe in for a 5 count, hold for 5, out for 5. Do this fifty times.

Systematic desensitisation is a reliable approach for avoiding becoming Overly Aroused in the first place. At its best this is employed by skilled therapists to treat phobias, and many phobias are today curable through this specialised treatment. I personally have witnessed a recorded three hour therapy session where a snake phobia client is cured with the use of a live snake.

The downside is there are no PLEASE HELP ME MY RETIREMENT IS BEING BUTCHERED IN FRONT OF ME therapists out there. I will instead give a hypothetical example of a systematic desensitisation-style approach from martial arts training.

Systematic Desensitisation In Real Life

Conflict does not come naturally, and most people find it intimidating and uncomfortable. It is, like FEAR itself, a highly aversive stimulus (something we will take action to avoid). The easiest way to think about how to approach conflict is to think about training somebody for conflict. Martial arts training is a good example.

The instructor needs to teach their charge to become comfortable with a) hitting somebody and b) being struck in turn, both of which are unnatural acts. Third, there are a lot of threatening body-language cues that we are not aware of but subconsciously are very powerful motivators of behaviour. Standing face to face with someone inside their personal space is a good example.

To overcome this the instructor will teach a student, for example, some pattern of punches. After the student finishes punching pads that the instructor holds, the instructor will make some THREATENING RESPONSE, such as walking forward and bumping into the student (even in training, this can be more intimidating than it sounds). The student will be taught to step left or right to avoid the instructor.

What the instructor does next is most interesting. The pace of the exercise will increase to the point where the novice student’s brain physically cannot keep up with processing of the patterns and movement (again, it’s much harder than it sounds). Bad instructors will use the threatening gestures to bully or intimidate the student, escalating the fear and uncertainty instead of promoting proactive processing of the situation. Good instructors will lift the tempo until the student is right at their limit (maybe even a little beyond) and then slow down very slightly to the point where the student is able to process the correct responses and avoid the situation. The student thus learns subconsciously to firstly process (interpret and process the threatening gesture) and then respond (decide to take action and then actually move). In this way the student learns both to engage with and then resolve a threat.

Following a period of practice, a good instructor will increase the tempo. The pace will become faster and the fear and threat (walking into the student) will progressively escalate (walking into them and shoving them, for example). Again the exercise will continue until the student is at their limit, and then slack off just enough to allow them the mental space to process and respond to the situation and build a sense of threat-response-reward in their brain that eventually becomes subconscious. There are many names for this type of process, but even a total beginner will make remarkable progress in an hour or less using this type of method.

Because the student has been taught how to process and avoid the threatening situation, their anxiety levels stay low and they are able to work their way through the problem. When the training intensifies and the fear/threat levels creep up, the fear is channeled productively:

HOLY SHIT I NEED TO MOVE FASTER AND GET OUT OF THE WAY. The fear does not degenerate into a negative biofeedback loop, the student does not have the time to ruminate on it, and there is a perceived exit from every situation which the student becomes confident is attainable.

An alternative approach

I explain the above so that you can get a visceral grasp of the thought processes that are involved in being trained to deal with threats. Many people understand this intuitively, but when you say “come up with a plan for how to respond to threats” this is pretty abstract advice and not helpful.

Another way to look at responses to threatening situations is Martin Seligman’s Learned Optimism. Seligman is one of the greatest psychologists of last century and I read his book (and most of the research papers that underpinned it) in uni. At the recommendation of a friend I’ve recently been rereading it. I will give you a little snapshot. This is the core of Seligman’s theory, paraphrased:

First, there is some threat against which you believe you are helpless. Second, you look for the threat’s cause, and, if you are a pessimist, the cause you arrive at is permanent, pervasive, and personal.

Permanent (depth of problem): Stocks are going down and its gonna take 10 years for them to come back (“my problems are permanent”)

Pervasive (breadth of problem): Investments all lose money and there is no safe way to make money investing (“I am helpless in a wide range of scenarios”)

Personal: I am a bad investor and i can never do any better than this (“the problems are specifically my fault”)

If this is your attitude you are going to be pretty rooted when it comes to market upsets. But pessimism is curable. Buy the book. Martin E. Seligman. Learned Optimism. Knopf Doubleday Publishing Group.

An alternative way to look at fearful situations is by applying the basic approach of cognitive psychology, a philosophical descendant of Seligman. This approach is functionally a scientific fact at this point and, like Seligman’s work, extremely well validated. I quote:

First, learn to recognize the automatic thoughts flitting through your consciousness at the times you feel worst.

Stocks are going down and its gonna take 10 years for them to come back

Second, learn to dispute the automatic thoughts by marshalling contrary evidence.

Actually, most downturns last 1-3 years. Burning the dead wood strengthens business discipline, capital allocation, and thus enhances future performance.

Third, learn to make different explanations, called reattributions, and use them to dispute your automatic thoughts.

My retirement is ruined –> My companies are going to be a lot more robust after this upset. Strong competitive positions will get stronger.

Fourth, learn how to distract yourself from depressing thoughts.

I am sitting on Twitter pressing F5 watching coronavirus spread when I should really be out kicking the dog or playing with the kids or both.

Fifth, learn to recognize and question the depression-sowing assumptions governing so much of what you do:

Maybe I am setting myself up for failure by telling myself stocks are going down for The Big One?

NAH THAT CAN’T BE RIGHT EVERYTHING’S FUCKED

Investing

The lessons are simple.

Regulate your heart rate – go for a run or get on the bike. You will be fine. Make decisions while you run (exercise enhances analysis and decision-making both during and afterwards, plus contains arousal afterwards)
Rewrite the negative narratives that you are telling yourself
Find a proactive strategy to think productively and avoid taking counterproductive thoughts or actions
Control your caffeine intake. The symptoms of too much caffeine can contribute to biofeedback
Channel the fear productively, either as an asset to be used (buying in spite of fear) or an enemy to be defeated (holding steady despite fear)

Refuse to want to fear and you start acquiring a constancy of character that makes it impossible for another to do you wrong. Threats have no effect unless you FEAR. (source)

The great irony is that controlling your fear doesn’t get you any closer to making actual good decisions – but that’s your job, not mine. Food for thought.

P.S. – if you read this far and are wondering why I spent the last few weeks talking about FEAR, or why half of the words in this post are capitalised, there is a method to the madness. But that is a story for another time. Remind me in a month.

I have no relationship whatsoever with Seligman. This is a disclosure and not a recommendation.

The Evolution Of A Hypothetical Start-Up

Thu, 31 Oct 2019 00:02:54 GMT

I’ve been pretty busy lately on a couple of projects. As always, inspiration strikes at the strangest of times and I have been assembling some thoughts on the challenges faced by growing businesses, from the perspective of an investor who has followed a couple of reasonably large ones like Nearmap and Xero through their many evolutions.

I’ve been nibbling away at this post for about six months, although realistically it’s been probably four years in the making. You see some pretty interesting things in growing businesses, especially when senior executives get forced out. I guess this is a fanciful look at some of the challenges a growing business might run into.

An imaginary start-up

At the root of any start-up it seems intuitive that there is some problem that drives progress. A founder-type has an idea, usually to solve a problem that is so annoying and seemingly can’t be handled with any existing solutions. “I could do this so much better”, or “this problem shouldn’t exist.”

So you, Founder, get organised and work furiously on your idea. You don’t really know what you’re doing, but you know for sure where you don’t want to be (existing solutions) and so you go off in some other direction.

After a few weeks or months of work there is some incredulity “this actually works pretty well.” Yeah it’s ugly but it hits the nail on the head and the user just clicks a few buttons and their problem is actually solved. Now maybe all the idea needs is to be fleshed out a little.

So you get some seed or early stage venture funding. Emboldened by the money and also more than slightly intimidated at stewarding half a million dollars of someone else’s cash, you return to work towards your next milestone. Maybe there is some new equipment purchased, or a new skillset hired, or you get a salary.

A few months on from this, there is actually a working solution that is in the early stages of being sold to customers.

At this point, maybe there’s some more money invested. Or not. But the solution progresses, and before you know it there’s a new hire, or maybe your own office (or both).

Two years go by. Everyone is earning a salary, the business is ticking over, there’s a customer support person and a salesperson. There is starting to be a genuinely fun approach to work. A lot of the stress of bootstrapping has receded now that the business has meaningful revenues. The founders love working for themselves, making decisions and collaborating. Each finds it vaguely hilarious that they’re being paid to pursue their crazy idea. They still profess to have no idea what they’re doing, although an outside observer would recognise the beginnings of deep competence in their area of work.

Somewhere along the line, and sooner rather than later, the company becomes large enough that it hires staff that expect an organised working environment. You (read: CEO) start to realise that it is pretty damn annoying having to do all the busywork instead of just producing new features and new ideas.

It is even more annoying when decisions that you wanted to make get made without you (are you not the CEO?!) because you got annoyed by a trivial question last time and people didn’t want to interrupt you this time. You don’t realise what a pain in the ass maternity leave is until your chief back-end engineer needs six months off. And yes, your staff do expect to be paid on the same day every week.

Little of the overall atmosphere changes though. It’s still a fun place to work and there’s no real hierarchy. When your aerial mapping solution crashes, it’s because “the satellite is on holiday” not because part of your software is still running on dodgy code that you cobbled together at 3am a couple of years ago. (“Satellites have feelings too”).

Somewhere in there though, you hit 30 employees. The business is not yet profitable (although it is financially secure), and the CEO is now the Chief Errand Officer. There needs to be enough desks. Replacement monitors and cables need to be ordered. You need to find a new office to hold all the staff (it sure would be nice to have a window, but a hundred thousand dollars for an office is a lot of money…). In your rational moments you completely grasp that the cost of an office is approximately five per cent of your annual salary expense, but bootstrapping nailed rigorous cost discipline to your forehead and every dollar hurts.

Your ability to work on any of your big ideas is compromised by the fact that all decisions still seem to be running through you, including relatively trivial ones such as how should the sales pitch work and what does the company’s brand stand for? It is not intuitively obvious to you that the beliefs of the founders are de facto the company’s brand, and so you can’t understand why you are simultaneously annoyed by having to work on the sales pitch – yet you’re even more annoyed when work gets done on it without you, because it doesn’t align with how you think it should sound and what your vision of the company is all about.

You’re smart though, and you gradually realise that the key executives are the bottlenecks on the organisation. A decision follows to push authority down to people that are closer to the problem and better equipped to deal with it. You implement a system where things come to you for approval, rather than you being personally involved in their actual creation.

At around the same time, you’re starting to hire actual professionals. It’s no longer young employees, early in their career, willing to take a gamble on a start-up. You’ve lured away a Salesforce executive to take business to the next level. You got a product manager from Microsoft. These employees almost subconsciously set about bringing your organisation up to the required standard.

Some are more vocal than others.

You’re bluntly informed that it’s grotesquely inappropriate for your automatic street-mapping solution to be taking pictures of children playing unsupervised in front of their house. OK, you’ve known for a while that it’s a little weird, but now you’re faced with a strident employee emphasizing that it’s a Big Deal that needs to be solved right now. You accept their feedback politely and privately disagree. It’s nearly impossible to keep all competing interests in check and some things need to take second (or fifth) place. It’s been a problem for two years – surely it can wait a little longer? There’s been no negative feedback. None of your customers seem to be complaining. It’s just part and parcel of creating a new system – of course there will be flaws. Everything can be fixed in time. It’s much more important to make sure that users can actually login – there’s been some serious problems with the latest iPhone update.

It’s hard for you to get motivated to fix the issue. Not that you don’t think it’s a problem, or that you don’t respect the employee – not at all. It’s just there are so many other responsibilities on your plate, you’re trying to juggle revenue, if your users can’t login you can’t generate revenue – the risk of regulatory response over the privacy invasion seems trivial. You’re right about that too – the average cost of improbable but high-impact events is quite low (but a few individual companies will go out of business). A couple of your staff have children. A few others like to solve problems. One of your subordinates, with a little wider perspective and a little more time on her hands (by dint of not being the CEO), gets an ad-hoc working group to look into the issue.

It’s a multidisciplinary problem but the company is still small enough and well-run enough that it is not completely siloed. Your subordinate gathers a few people, and they sit down and fix the problem. With no executive oversight it’s fixed almost before anyone notices the absence of the staff involved. You hear a week later that a fix is being rolled out. This is a key tipping point for any leader. Your authority has been undermined by being cut out of the loop on that decision. (If you think about it, it’s not entirely clear that you were even undermined – people knew you had other priorities and decided to solve the problem for you – but the way you react will be telling). Some CEOs will kind of be vaguely surprised that it got solved without their input and mumble something like “oh good” before moving onto the next issue. The very best and brightest leaders will realise at this point that their job is building systems of people that build systems – and not being personally involved in the operation of each system.

A small handful of bad leaders will stamp and scream and insist that they should be part every key product decision – doing long term damage to the organisation and their credibility in the process.

Somewhere in there, in between these issues and dozens of others like them, the influx of professionals moulds your little start-up into a world-class organisation. You might only have eighty employees but they’re all motivated and the blossoming professionalism – which has almost imperceptibly stamped out a thousand little brushfires and plugged innumerable leaky buckets along the way – has changed your life. You don’t even realise it, but the numbers look good and the organisation is humming.

Imagine you’re one of the best and brightest CEOs. You devote serious time to designing an organisation that can operate without you. It’s the only way to achieve real scale. Except now – you start to realise that you’re dispensable. You’re not, but with your absence no longer a problem (and in some cases, strongly preferred) for the day-to-day operation of the business’ divisions, it sure feels that way.

It never gets any easier to hear employees talking dispassionately about the – your – business. It’s worse when you realise that 95% of the business is operating as though you don’t exist, and a majority of the key decisions on things like sales, security, HR, and so on get made without your input. You know can interject whenever you want, and people admire and respect your input. But there’s only so many things you can cover, so you (mostly) devote yourself to a certain narrow sphere of excellence. Maybe you spend a little more time on Twitter than previously. You tweet about your sweet new mountain bike and your travels through the hills of New Zealand. You take a long weekend every now and then to go for a long ride.

You admit to yourself in quiet moments that your specialist employees are much more competent than you were, back when you were doing their job. Some of your old ideas were pretty dumb, in fact, and their new ones are pretty good. You’ve managed to keep the enthusiasm alive all these years, and you’re quick to grab new ideas and run with them. Better yet, you’ve got an organisation behind you to handle all of the details of execution.

Five years and five hundred employees later, you finally go public. Now instead of 30 investors, you’ve got thirty thousand. Reporting and compliance obligations go through the roof. You actually have to answer to independent directors on the Board, and one of their chief objectives is to make sure you don’t squander too much money and you’re remunerated appropriately. It’s not that your independence has been compromised in any way – people have voted with their feet to (wholeheartedly) back the maverick CEO leading this wonderful new company. But the additional work is substantial and you feel like something has been lost in the transition to public ownership and the entrance to public life.

There’s a second half to this story…but it’s a tale for some time in the future. Give it a few more years.

I have no investment in any company mentioned in this post. The examples of situations in this post are a product of the author’s imagination and not intended to reflect any real-life individual or company.

The Challenge Of Selling A Managed Fund

Wed, 30 Oct 2019 21:39:41 GMT

I have a friend who is starting a funds management business. I joked with him that, in order to market to investors, he should say that he is a long-only value investor that believes in Warren Buffet, only holds high quality stocks for the long term, real money is made in the holding, lower prices are simply an opportunity to buy more, and the ideal holding period is forever.

Of course, I’ve just described every funds management organisation in existence – therein lies the joke.

Almost every fund manager I know of has had occasional struggles with “distribution”, which I define as “getting people to invest in my fund”. It is, simply put, very hard to sell a differentiated long-only value investing fund, which is why so much of the industry revolves around controlling distribution and advisor networks.

Selling a “1 & 10”, long only, value investing managed fund on its own merits and differentiating it from thousands of similar funds is even more difficult on the ASX because the market is so small that you invariably wind up owning the same stocks as many other managers. This makes it hard for investors to differentiate between funds based on strategy, given similar portfolio construction. In one way or another, many fund management businesses turn to marketing ploys, such as “ethical” funds or “China” funds to differentiate their offering and grow FUM.

About 18 months ago I wrote on this topic at length , but ultimately ended up pulling the post down because it was unsatisfying and did not really hone in on the driving factor of what sells a funds management business. I want to revisit the topic because I am sure that there must be a formula for marketing a fund that does not involve either becoming a prominent key man figure, controlling FUM flows, or telling lies to unsophisticated investors.

I have two new perspectives that I want to bring to the table for another attempt. This article necessarily focuses mostly around the problem of selling a small funds management offering. I have not spoken to distribution or managers at the large fund houses such as IOOF, Perpetual, or Platinum, so I don’t know what the experience looks like over there.

Malcolm Gladwell in his book Tipping Point refers to a problem of what he refers to as “stickiness” – ensuring that the message becomes actionable to the customer. Below is a concise example from his book. I have paraphrased heavily for brevity, but the text is as in the original:

Consider, for example, the so-called fear experiments conducted by the social psychologist Howard Levanthal (who) wanted to see if he could persuade a group of college seniors at Yale University to get a tetanus shot. He… gave all of them a seven-page booklet explaining the dangers of tetanus, the importance of inoculation, and the fact that the university was offering free tetanus shots at the campus health center. Some of the students were given a “high fear” version, which… included color photographs of a child having a tetanus seizure and others… with urinary catheters, tracheotomy wounds, and nasal tubes. In the “low fear” version, the language describing the risks of tetanus was toned down, and the photographs were omitted. When they were given a questionnaire later, all the students appeared to be well educated about the dangers of tetanus. But those who were given the high-fear booklet were more convinced of the dangers of tetanus, more convinced of the importance of shots, and were more likely to say that they intended to get inoculated.

All of those differences evaporated, however, when Levanthal looked at how many of the students actually went and got a shot. One month after the experiments, almost none of the subjects — a mere 3 percent — had actually gone to the health center to get inoculated. Why?

…when Levanthal redid the experiment, one small change was sufficient to tip the vaccination rate up to 28 percent. It was simply including a map of the campus, with the university health building circled and the times that shots were available clearly listed. There are two interesting results of this study. The first is that of the 28 percent who got inoculated, an equal number were from the high-fear and the low-fear group. Whatever extra persuasive muscle was found in the highfear booklet was clearly irrelevant. The students knew, without seeing gory pictures, what the dangers of tetanus were, and what they ought to be doing. The second interesting thing is that, of course, as seniors they must have already known where the health center was, and doubtless had visited it several times already. It is doubtful that any of them would ever actually have used the map.

In other words, what the tetanus intervention needed in order to tip was not an avalanche of new or additional information. What it needed was a subtle but significant change in presentation. The students needed to know how to fit the tetanus stuff into their lives; the addition of the map and the times when the shots were available shifted the booklet from an abstract lesson in medical risk — a lesson no different from the countless other academic lessons they had received over their academic career — to a practical and personal piece of medical advice. And once the advice became practical and personal, it became memorable.

He is right. But I mentally think of the same concept in a different way. All of the students already had all of the information they needed to make a decision. What they had not done was create a link between “tetanus is dangerous” and “you can get free tetanus shots”. What needed to happen was to create some sort of state where the two separate pieces of information were linked in a way that caused the student to take action, i.e: “this is a problem for me and I will solve it by getting vaccinated”. Maybe this was done by providing a map. Maybe it could have been done another way. But the mental link needed to be created.

I think this the correct way to think about a sales process. In my mind there are three conceptual aspects to any sale. First is the “I have a problem” (tetanus is dangerous) status of the customer. Second is the sales and product aspect “you can buy our product to solve your problem” (vaccinations).

The first is easy – people always have problems to solve. The second is difficult but not impossible; by listening to the customer and knowing your business it is possible to create a good product (that solves a problem) and a good sales process (that makes the product buyable). People need good investment managers, and most fund management businesses have at least a passable product that is sold reasonably well and is therefore purchasable.

The third and most overlooked aspect is getting the customer to take action – the actual purchase event. There needs to be buy-in from the user. Regardless of how good the product and sales approach is, the target customer actually needs to reach out their hand to grab your product. They need to sign up for your newsletter, or lift your product off the shelf, or….fill out your forms and send you money.

Yes, you can make the sales approach much more efficient. You can also make the purchase process (once the customer has evinced interest in the product) much more efficient by streamlining the forms to be filled out and similar. But what is extremely difficult to do, and key to the whole process, is to turn a cold/warm lead into a hot one, triggering the moment where the customer, in their mind’s eye, sees themselves investing in your fund.

Product <–> Connection <–> Customer

It’s relatively easy to refine a sales pitch and quite difficult to make the customer reach out and grab your product, especially in something that cannot easily be impulse-sold, like a large investment in a managed fund. That will not stop fund managers using excitement and tales of huge winners to generate interest; excitement is perhaps the oldest tool in sales. Nonetheless, it is a blunt instrument and prone to backfiring; excitement can come at the cost of authenticity.

In my anecdotal observations, fund pitches are well practiced and the fund managers themselves are typically good storytellers, so the sales pitch is strong. The professionals are capable, confident and knowledgeable. The investment approach makes sense – the product is credible. The hard part is always getting the customer over the line to say yes. I’m told that, if successful, it takes around 6-7 touch points (meetings, pitches, phone calls) to get a multi-million dollar commitment.

Assuming a reasonable quality product, the problem lies not in making people want the investment product (tetanus shot), it’s in making them actually commit (go and get an injection). That’s my first insight, if you can call it that.

The second insight, remembering that I am talking about small funds, is that I think a common approach to selling a fund misses the mark in a few small but crucial ways. The sales process tends to focus on what people say they want, rather than what problems they actually experience.

People like franking credits and dividends? Better advertise our dividend.
People don’t like discounts to NTA on listed vehicles? We can set up a system to buy investors back at NTA after certain criteria are met.
Ethical investing is getting a lot of airtime? Let’s launch an ethical fund to grow our FUM.

Some of these are problems that I think don’t really exist. Investors like franking credits and dividends, sure, but I suspect the core problems that investors are trying to solve with a managed fund are not the franking credits or the ethical aspect.

When investors are focused on franking credits, what they are really saying is “I need to generate a yield of at least X after tax”. When they look at ethics I think sometimes what they are really saying is “I don’t want to invest in losing industries like coal”.

Here is an example list of problems that I think investors might want to solve:

I need to earn a certain rate of return to grow my investments (or maintain my retirement)
I need to generate a certain income yield on my investment
I can’t handle a portfolio that drops in value by more than 20% at any time
I need a reliable source of returns over the long term
I want to get international diversification without sacrificing returns (vis a vis franking credits / low benchmarks)
I need somebody that is trustworthy and competent that will look after my money diligently
I need somebody who is authentic and is not just selling me a good line to get my money
I need somebody I can talk to, to get advice on what I should be doing with my investments

By solving some or all of these problems, by directly speaking to the things that people are worried about, the fund gets that much closer to making a personal connection to the customer, and correspondingly that much closer to a sale. (When it comes to making the sale, a related factor that I think is critical is authenticity, which I am convinced is required in order to create a saleable fund and attract loyal FUM. However, this must be addressed at further length at a later date).

It becomes more complex once the role of advisors and asset consultants is taken into account. On an advisor level (think of them as an aggregator of retail and HNW money) the decision can still be made on a personal level because the advisor can meet with the manager. An advisor that knows manager John Smith may also back the manager’s new venture because of personal trust, even if the new fund is not directly managed by John.

Asset consultants in theory should take all of the personal decisions out of the mix, because they operate with strict criteria. In practice there is probably still some personal influence as well as some cases where bad decisions get made due to inflexible criteria.

Still, with every type of financial product, the approach should be the same.

What problems are the customers (investor/advisor/consultant) really worried about?

How does our fund solve these problems?

How do we get to the point where a customer wants to, with minimal prompting, reach out and grab our product?

A small fund manager has something like five jobs. They are chief investment officer, chief compliance officer, chief marketing officer, CEO of the funds management business, and Chief Personnel Manager to boot. By definition they cannot be expert at all of them because the time requirements are too large and because the usual career path of a fund manager does not grant experience in all of those roles.

There are too many competing demands for time for the small manager to be good at everything. I think an unintended side effect of this is that many funds don’t systematise the process of solving problems for clients when creating new investment products.

Maybe they should.

I have no investment in, nor relationship with, any firm mentioned. I do not work in funds management or fund sales. I may have some money in these firms via my superannuation fund which I am not aware of. This is a disclosure and not a recommendation.

Revenue Is A Trailing Metric

Thu, 25 Jul 2019 23:12:18 GMT

An interesting discussion I heard recently was “how can we enhance an organisation’s ability to hit its targets”? The natural response is to ask “how do you hit a target” and the answer of course is that you can’t. You can’t go out and hit a target because the target (sales, in this case) is a trailing metric. To hit a sales target, you need to make sales. To make sales, you need to perform some kind of sales activity, i.e. get in touch with customers. So it follows that hitting target is not an activity, but an outcome, and performing sales activities is one predictor for whether you reach this outcome or not.

An easy way to reverse engineer this logic is to ask:

What are the lead metrics for [ desired outcome ]?

A lead metric is a metric that predicts the subsequent performance of another metric in some relatively reliable manner – that is to say there is at least a somewhat mechanical relationship between them.

If your goal is to hit a sales target, the lead metric for a sales target might be the number of sales calls you make. But of course sales calls itself is only an intermediary lead metric. What is a lead metric for sales calls? There are multiple factors involved in hitting sales targets (staff quality, motivation, incentives, etc), but a decent lead metric for the number of successful sales calls might be the number of high quality leads generated.

You may or may not have any control over lead generation and there are various types of lead generation. For example web traffic is, in an increasingly large number of cases, a lead metric for lead generation. What is the lead metric for web traffic, or what if you have no web traffic? Your lead metric might be advertising dollars, activity in your distribution channel (what/how many campaigns did you run?), content marketing quality/volume (advertising by another name), or something else entirely, such as participation at trade shows or the ability to get featured in the media or important journals.

Lead metrics are also tricky – for example, the amount of steel ordered by a manufacturer is a lead metric for the number of cars manufactured, which is an important lead metric in the number of cars sold, which clearly leads revenue and profit. Yet it is hard to see steel purchased as a reliable predictor of earnings because car sales as a metric is entirely dependent on the ability to sell a car. I doubt if it’s possible to quantitatively screen car manufacturers for their intrinsic ability to sell a car, but that I suspect that is the truly crucial metric. (A decent lead metric for a change in car sales might be changes in the availability of financing). Likewise, hours/dollars spent on software development is a vital lead metric for the production of good software, which is vital for revenues and customer retention. But then, a lot of start-ups fail and pure hours spent on a task don’t guarantee any sort of quality or outcome. Similarly, many “mediocre” products succeed because they nail distribution and the sales process.

Likewise, it is not always easy to define the correct lead metric to focus on. You might think the whole purpose of a gold miner is to mine gold. But is its true purpose to mine gold (volume) or to maximise the price it receives for the gold it mines (value creation)? If you think about a business for a while, you can often come to some interesting conclusions.

It’s not easy to find “truth” in lead metrics, but through the process of asking questions, you can pretty easily reverse engineer a customer funnel. It is widest at its top (web traffic), gets narrower down the middle (number of people that sign up for your free trial), and pretty skinny down the bottom (people in your credit card funnel entering their payment details in). This approach ignores conversion – if you can sell a product better, you don’t have to grow your lead metrics – but that’s a story for another time.

The point to my story is that revenue exists at the very end of this process. Revenue is a trailing metric for all of the activity that has gone before.

A common investing trap is to look at the cart before the horse. Setting aside bad accounting for now, revenue is – on average and across the business universe – an OK lead metric for gross profits and EBITDA and net profit and cash flow. If you have a software company with 80% gross margin and strong retention, revenue of course is an excellent predictor of the intrinsic value of the business. Yet revenue itself is a trailing metric for a substantial amount of process that is not superficially visible. The implications of this are strong and not new – they go at least as far back as Phillip Fisher’s “scuttlebutt” method in Common Stocks and Uncommon Profits.

Still, if true, this statement implies that by the time you are buying a company with strong revenue growth (trailing metric), this has already potentially been priced in by more sophisticated investors (we have seen stark examples of both under- and over- priced stocks with growing revenue in Australia in recent years). The other side of the coin is that if you pay more attention to lead metrics, you may be able to be quicker on the uptake, arrive earlier on the scene, and achieve generally better performance than the wider market.

There are various approaches for evaluating lead metrics and I am no sage when it comes to benefiting from them. However, there several methods that I am aware of and use myself. In no particular order – first is a metric that I call “Marketing ROI”. It is somewhat company-specific, but I define it as average new customer revenue added in the current year divided by average marketing spend in the current/prior year (depends on revenue recognition policy and is particularly useful for a subscription product). It is not great because it is a bit slow and there is not always a direct relationship (some % of marketing spend is always about brand recognition, not customer acquisition), but if you can understand the quantitative elements that will drive sales, you can use this metric to validate whether the qualitative process is working (Xero performed excellently on this metric).

Second, R&D spend as a percentage of sales is a decent predictor of future growth in many cases, albeit very well known. Third, web traffic is another obvious one and many professional investors watch Alexa rankings and similar. Fourth, the number of features added and the length of the development cycle may be a reasonable measure for software companies (in concert with some kind of quantitative R&D spend metric and/or a qualitative customer response metric). Fifth, many professionals track metrics like number of developers or number of sales staff added, number of new leases acquired, traffic in car parks/truck volumes, et cetera. Sixth, in primary and secondary industries it’s usually very possible to get good lead metrics on pricing, capacity expansion and similar – but hard if you’re not in the industry. Seventh, many investors track customer reviews and I have heard theories that some barrier such as > 4.5 star rating may be decent for discriminating between between growing and flat same store sales. Eighth; scuttlebutt.

Lastly, from a more theoretical perspective, it ought to be possible to adjust “growth stock” earnings to arrive at some kind of measure of “reinvestment value added”. For example if you have two identical businesses and one of them reinvests 95% of its profits in R&D and hiring new staff (and the latter reinvests nothing), the former should theoretically trade at a substantially higher P/E multiple (because its profits are far lower due to this reinvestment, plus its future growth prospects should be stronger). However this is more or less the “holy grail” of detecting attractive investment prospects via accounting, and there are a large number of VC and private equity firms trying to directly and indirectly capture this possibility via a variety of strategies. Nevertheless I think it is an important concept to keep in mind.

I expect there will be many other methods that I’m not aware of – not least because the most powerful ones are potentially quite profitable. And then you could approach lead metrics from the opposite end and ask: Are people even willing to spend money on this product? Lead metrics are imperfect, but the point is well worth considering:

Revenue is a trailing metric and investors will benefit from increasing their focus on the metrics that lead revenue.

Food for thought.

I have no position in any stocks mentioned. This is a disclosure and not a recommendation.

Private Markets Hide All Manner Of Sins

Fri, 15 Mar 2019 09:22:26 GMT

A number of notable companies and investors today appear largely unaware of the relationship, and potential disconnect, between growth and financial sustainability.

It is all well and good to own part of a technology firm that is growing revenue and users rapidly and burning cash. It is also fine to systematically bet on small tech co’s based on the odds of finding a unicorn. Still… It is entirely less good if your business (investment manager) is highly dependent on raising new money to pay your fees and operating costs because you invest in non-yielding businesses that cannot be easily sold.

Companies like WeWork, Softbank, and Tesla spring to mind. Funds like Blue Sky (ASX:BLA), and the myriad VC investors and institutions that invest in private businesses (including your superannuation fund). And a few other special creatures here and there…

Imagine

Imagine that interest rates are low and public equities are expensive and investors are desperate to earn returns. Now imagine that there is a VC investor, who we’ll call Seleukos Percival Ioannou V (SPIV – Percy for short), that offers investors the opportunity to contribute capital to a VC fund with proven private investment expertise. This firm will invest in the most attractive private companies with an IRR target of at least 12% per annum – higher than typical stock market returns to account for the illiquidity and additional risk.

Our mate Percival raises a hundred million.

He invests this money into a selection of smallish tech companies as well as some property development projects in grossly undersupplied property markets. Very cool.

As the unprofitable tech companies grow revenue, their valuation rises. In true VC style they are hopelessly unprofitable – in fact they are burning cash, because they are all trying to exploit the S-curve of user adoption by hiring rapidly and jamming as much customer acquisition $$ into the market as they can afford. Still, they’re growing nicely, user count is up, revenue is up, customer retention is up, and valuations sensibly increase. As the companies mature, the price to sales multiple they are valued at also expands – let’s say from 3x to 5x. Through this mechanism, a company with $1 of revenue, valued at $3 on a 3x sales multiple, growing revenue at 30% p.a., becomes worth $10.985 in 3 years time at a 5x sales multiple. Three bags in three years – not bad, pal!

Property Always Wins

Percival’s property development projects are also going OK – everybody likes property; the asset class that always goes up. He puts down 20% equity investments/deposits and borrows the remaining 80%. The properties are progressively revalued as they approach completion. As the building is half-finished, it’s worth 50% of the estimated fair value of the property once completed. How do you value a building? Well, just maybe, our dealmaker Percival decides he’s going to forecast 8% per annum property price growth and then value the development based on estimated future property prices. Let’s say it takes 3 years to build a large apartment building from the pre-approval phase; a $100 building growing at 8% per annum will be valued at $126 in 3 years. When half complete, it’s worth $63. The initial $50 investment to half-build it (of which only $20 is equity), is then worth $63 – a 26% return in 18 months. Very credible, and the ROE looks even better!

Let’s say Percy’s put $60m of his initial $100m into tech companies, and the other $40m into property development. After three years at 30% revenue growth and the P/S multiple moving from 3x to 5x, his tech assets are valued at $219.7 million, and the gross value of his property (20% deposit, 80% loan, ignoring all finance costs) is $251.94 million.

Based on these revaluations, Percy records $159.7m profit before tax on his tech co’s, and earned $51.94m on the $40m he put into property (ignoring finance costs for simplicity). That’s $211.64 million profit and assuming a flat 30% tax rate, $148.148 million in profit after tax.

Pretty astonishing performance for an initial $100m investment – except Percy made a boo-boo. He’s put all of his $100m into investments and has nothing remaining to either a) keep the firm operating (listing fees, staff salary, bonuses, audit fees, valuer fees, office rental, etc) or b) pay his management & performance fees for running the business. The timeline of any sale process is also uncertain – it can take many months to structure a major sale, and that’s before you consider that you would be silly to sell a tech co that has (deservedly) grown its valuation 3x within the last 3 years. Fortunately for Percy, the market can see that his asset valuations have risen rapidly, and is very willing to give him money. Percy raises a billion buckaroos, pays his management fees, and puts all of the rest into new investments. Genius that he is, he’s just learned that he can raise new capital when he needs it, so financial prudence is the last thing on his mind.

Or maybe – just maybe – he’s learned that he has a lot of latitude in valuing investments, so he’ll make a ton of money from performance fees either way…

The Funding Game

So after starting with $100m and growing it, Percy raises $1bn in new money. He pays all his fees and such and puts the money into new investments. Unbeknownst to him, however – with the ability to set his own valuation for investments and charge a fixed fee per annum based on those valuations (revenue is growing…we get a third party valuation bi-annually…) – the market is about to enter a downturn. What does that look like?

Percival, emphatically not at all blinded by his past success and ridiculous incentives, continues to assume that property grows at 8% per annum. He puts 40% of his fund into property. He puts the other 60% into tech, except a bunch of VC firms have raised billions and starting investing in private co’s in order to emulate his success, good deals are getting harder to find, and Percy gets a bit excited by the bull market “tech is changing the world” meme. Nevertheless, Percival is a smart man who is pretty sure he knows how to find deals, as his previous success shows.

The tech firms continue to grow – or at least, Percival’s valuations for them – grow at 30% per annum. The property grows at 8%. In this way, $1 of tech revenue (and $3 of valuation) turns into $10.985 in 3 years at a 5x multiple. $100 of property value (20% equity) turns into $125.972. Percival dutifully levies his management and performance fee.

Except this time, some body or some thing shows up to throw a spanner in the works.

Glaucus calls you a Ponzi scheme
The GFC eliminates the ability to roll over debt or raise new capital (fear increases/ rates go up)
You need too much money relative to your (inflated) valuations for a cap raising to be realistic
Cumulative losses and/or diminishing returns on incremental spend reduce investor appetite for your vehicle

Ponzi Scheme

A rough definition of a Ponzi scheme is “using money from later investors to pay returns to earlier investors”. If you are invested in illiquid assets with no cash flow, are on the hook for future equity injections, or if you have no exit event but set up some kind of exit facility for a small number of investors – or if you simply need the money to pay your operating costs – you are dependent on new money coming in to keep the show on the road.

You might not technically be a Ponzi scheme, but you are dependent on external funding and there is an obvious, massive, single point of failure if you are dependent on the vagaries of investor and market psychology for getting new money when you need it. This is especially true if you have external obligations to contribute further money at a later date.

The problem is not that you are investing in unprofitable businesses or that the market is in a downturn. The problem is not even that you run out of cash and require additional funding. The problem is that you are caught at a fulcrum where you desperately need money to keep the lights on and so your funding provider has leverage. Your valuations come unstuck because you have to take whatever price is on offer. You can’t easily sell your businesses because sales take time to structure and when you sell a loss-making business above a certain size, what you are really selling is an open-ended liability to your buyer (these are not easy to sell, for obvious reasons).

Short sellers, of which there is a growing number of decently aggressive ones, are in a prime position to exploit this. If you are fragile and need additional money, and a short thesis (well-founded or otherwise) can deprive you of the confidence you need to raise that money, you are f-u-c-k-e-d. Doubly so if your valuations are a little loose or you have high liabilities, because these can serve to “validate” the short thesis.

There were other problems, but fundamentally this appears to be the crux of what wrecked Blue Sky Alternative Investments (ASX:BLA).

Structural Profitability

Second to the acute cash requirements, to my mind the intermediating factor here is the “structural profitability” (or lack of) of the businesses that have been invested in. Many companies that VC/private investors invest in appear to be what I’ll call “structurally unprofitable” (in a loose sense). They might be profitable at scale, but they are not profitable now and could not become profitable next year or the year after by cutting expenses, for example. If the investors are tapped out, and if the company itself cannot sell a product profitably, the customer acquisition costs cannot be sustained, and thus the growth cannot continue, and the whole thing grinds to a halt – including the valuation, which typically relies (to some degree or another) on strong revenue growth. Because of this fragility, I feel there is a certain naiveté in some of the “private markets are better than public markets” stories going around, and I would be very surprised if there were not already a few of these types of ticking time bombs dotted about the place.

I could go on – this phenomenon also applies to many individual companies, far more so than asset managers – but I think the point is clear.

It is my view that a meaningful number of market participants are in for a wake-up call. The bill is already in the post. It’s not entirely clear when it will arrive, but as an investor, you emphatically do not want to be there when it does.

I have no position in, and no financial relationship with, any company or firm mentioned in this article. It is not my intention to paint private market investors as incompetent or short sellers as aggressive; this is simply a caricature of a hypothetical situation that I think will become more common in the future. This is a disclosure and not a recommendation.

Getswift Comes Full Circle

Fri, 22 Feb 2019 10:18:23 GMT

Well well. In a pleasing dose of regulatory aggressiveness, The Australian Securities and Investment Commission (ASIC) has filed a Federal Court lawsuit against Bane Hunter and Joel MacDonald of the infamous Getswift (ASX: GSW) – reporting in well under their usual 3 year lead time, I might add. And they would be silly not to, because the case looks like a total slam dunk. I’ve detailed some of Getswift’s shenanigans previously and the AFR took a leading role in discrediting many of the company’s claims last year.

The whole Getswift saga started after Nick Fabrio of Longhorn Capital posted a note outlining inconsistencies in various of Getswift’s claims. Getswift threatened to litigate against him but – oh dear – it later turned out that Nick’s comments were spot on and Getswift itself was suspended from trade and found to have almost certainly misled the market by not fully disclosing details of various contracts (which is part of what the ASIC suit alleges). You can find a link to Nick’s note and the subsequent legal response here:

Letter to N Fabrio – 10.11.2017 (PDF 1mb)

Getswift also claimed a partnership with Amazon and another with NA Williams that would lead to millions of dollars in revenue that never eventuated. Getswift later confessed that it was actually not able to quantify the deal with Amazon.

And this is all a teensy bit problematic, because Getswift raised a hundred million dollars from your friendly neighbour start-up financier, Fidelity. As I said at the time:

How much hubris do you need to have to go out there and say that our new software solution with no switching costs, no exit fees, and currently in a pre-pilot phase will, fo shizzle, “result in over 257,400,000 deliveries on its platform over the next five years, with an estimated aggregate transaction value of $9 billion.”

Getswift was aided and abetted by bullish analyst forecasts, one in particular which estimated the company would grow its revenue 9400% (nine thousand, four hundred percent) YoY from 2017 to 2018 with 99% (ninety-nine per cent) Gross Margins:

The forecasts were highly questionable at the time, are obviously bullshit now, and Getswift itself is a titanic pile of bullshit. How did our heroes arrive at such figures?

What is also very interesting is the role that analysts and advisers played in promoting Getswift to the market. Let us not forget young Sam Kiki of the capital raising, himself reportedly a former employee of Fidelity, and immortalised alongside GSW management in this timeless snapshot:

Consider the history made, gents.

Were I in ASIC’s shoes I would also be investigating if a) the Fidelity money may have been raised on knowingly false information, and/or b) whether any individuals may have been shadow directors of Getswift at any time, and/or c) whether there are any related party contracts or deals that might not have been fully disclosed. I am not alleging that these things have happened – I do not know if they have – but it seems to me that these would be reasonable lines of enquiry for a regulator making these types of allegations.

Were I in Fidelity’s shoes – sans a hundred million dollars of my investors’ money – I would be extremely tempted to throw a few rocks through the Getswift office windows and/or litigate the company and its officers into penury. I am not Fidelity, but it is my fondest hope that company is taking aggressive action to recover its investors’ assets before the class action gets them.

I strongly encourage you to read ASIC’s concise statement regarding its GSW allegations. Most legal documents are boring – this one is not. The issues raised in there, including many covered at length by the AFR and others, if true, suggest Getswift’s directors may be well and truly cooked. If Hunter and MacDonald are guilty of what ASIC is accusing them of, I hope that they are barred from being a director for a very long time.

As to Getswift, I give it my highest accolade:

Speaks for itself, really.

P.S. Big Un – you’re next.

P.P.S. Don’t follow Australian sportsmen into investments.

I have no financial position in and no relationship whatsoever with any of the individuals or entities mentioned in this article. This article reflects the personal opinion of the author only. This is a disclosure and not a recommendation.

10foot reading list

Mon, 14 Jan 2019 09:50:59 GMT

I was recently flattered to receive an email asking if I had a reading list that would help somebody who wanted to learn about investing. I thought that I would tidy my emailed response up further and publish it for the benefit of all.

With the caveat that I am not a professional investor and not qualified or licensed to provide financial advice, this is my list.

Probably the most important book for a beginning investor would be either Barefoot Investor (which I have not read) or the Richest Man in Babylon, as these will help you learn to think about money the right way. I’ve read Richest Man in Babylon (George S. Clason) and recommend it. It is also a good introduction to thinking about the basics of investment and concepts like a circle of competence. After this, consider:

Beginners:

One Up On Wall Street (Peter Lynch) – Lynch is an entertaining communicator and his book is engaging. In my opinion this is the first investing book you should read as it will give you an overview of common investment situations and ways to win or lose. There is also a fun speech from him here.

Letters to Shareholders of Berkshire Hathaway (Warren Buffett) – A long read but will give you a decent overview of the way Uncle Warren thinks about insurance, businesses, and growing shareholder value.

Forager Funds Bristlemouth Blog – Sometimes a little technical, but an excellent blog by an Australian investment manager targeted mostly at a non-investing audience. Often gives explanations of how various businesses really work and how to think about valuation. I’d suggest reading the whole thing over time.

Education of a Value Investor (Guy Spier) – This book is mainly about the psychology of investing. You won’t actually learn anything about investing per se, but if you are impulsive or a known sucker for share price movements or the noise of financial markets, this book may help you.

Unskilled and Unaware of it (Dunning & Kruger) – This is a classic paper about the “Dunning Kruger effect” whose title says it all: “Difficulties in recognizing one’s own incompetence leads to inflated self-assessments” – the root of countless investing mistakes. A dry read but you can just flick through and get the gist of it: https://www.researchgate.net/publication/12688660_Unskilled_and_Unaware_of_It_How_Difficulties_in_Recognizing_One’s_Own_Incompetence_Lead_to_Inflated_Self-Assessments

EGP Capital Blog (Tony Hansen). An investment manager who, in his words, is “notoriously tight” with money and runs a no-performance no-fee fund. His blog is a bit like the Richest Man in Babylon but more advanced and more investing focused (rather than personal finance), so if you like that book then read this blog.

Intermediate reads:

Taxlosstrades: An unintentional omission from the original list, primarily due to how infrequently he(?) publishes, Taxlosstrades is a snarky, insightful (and hilarious) take on some of the doublespeak in Australian listed companies. Coining terms such as “shit sandwich” (give investors some good news, then some bad news, then some good news), I always get a laugh out of taxloss.
https://taxlosstrades.tumblr.com/

Six months of panic (Trevor Sykes) – Covers the GFC in Australia. This book details 3-4 main types of business failure you will run into time and time again as an investor, so this is well worth reading.

Long term front running (Michael Fritzell) – This is a short, cheap, and simple book about how to find investment ideas by identifying expectations that are wrong and looking out a little further into the future than the market does.

Capital Returns (Edward Chancellor/ Marathon Asset Management) – This is a book explaining the capital cycle, with good anecdotes. It is a bit involved but very valuable because a lot of new investors, including me, sacrifice money on the altar of capital intensive businesses in the wrong part of the cycle.

Common stocks and uncommon profits (Phil Fisher) – this is probably the only “how do I actually invest?” book on the list. It is a timeless classic and for good reason. A must read.

Margin of Safety (Seth Klarman) – This is a popular book, and it is worthwhile – if you don’t know what a margin of safety is, you should read it. However I did not really value it. Howard Marks’ The Most Important Thing falls into the same category for me, only less important than Margin of Safety.

Bronte Capital blog (John Hempton) – Blog of a well known hedge fund manager that often does deep dives into businesses and investing concepts. This post and its prequel are particularly poignant for those who have already started investing: http://brontecapital.blogspot.com/2017/01/when-do-you-average-down.html

Advanced reads:

Confidence Game (Christine Richard) – Bill Ackman’s long running battle with complex insurer MBIA and its financial mis-statements. Excellent for learning about complex financial companies and their risks.

The Smartest Guys in the Room (Bethany Maclean) – Classic read about a “high quality” company, massive, persistent fraud, and management self-enrichment. We discover that the best and brightest individuals are not always particularly capable (this is a recurring theme in most investing books).

Fooling some of the people all of the time (David Einhorn) – one of my favourite books because the author’s voice really shines through (I hear Einhorn speak when I read). An exhaustive look at a comprehensive fraud where the bad guys and girls got away with the loot. It also offers an excellent outline of the fundamental issues that investors in unlisted assets face (e.g. ASX:BLA in 2018).

When Genius Failed (Roger Lowenstein) – about the collapse of Long Term Capital Management. An excellent lesson in hubris and also a passable overview of complex trades, circle of competence, and the risks of leverage.

The Big Short (Michael Lewis) – A thoroughly brilliant story – the book is better but the film is easier to understand. The underlying finance that is going on is very complex and if you’re a beginning investor it will take you several years to fully understand the depths of the fraud implied.

Findthemoat – Another very popular Australian blog (for good reason), findthemoat no longer publishes, but his/her site is good for a detailed walk through various businesses.

Measuring the Moat (Michael Mauboussin) – you should be able to find this for free. A dry but useful technical text about competitive advantages. I found this more valuable than Competitive Strategy, below, but both are useful.

Competitive Strategy (Michael Porter) – I don’t have much to say about this one as I didn’t particularly enjoy it, but it’s a classic for a reason.

This is a Twitter link that contains links to free versions of several of these texts:
https://twitter.com/trengriffin/status/1087015138610180096

Miscellaneous:

Stockdale on Stoicism I and II –

https://www.usna.edu/Ethics/_files/documents/stoicism1.pdf – The Stoic Warrior’s Triad

https://www.usna.edu/Ethics/_files/documents/Stoicism2.pdf – Master of My Fate

The Discourses of Epictetus – this and Stockdale’s lectures above are probably the best lessons you will ever get on psychology. If you have a different mindset to me then you may not find them as valuable, but I internalised their lessons at a young age and find that they are important for maintaining my equilibrium in a field like investing where something as subtle as fatigue or mood (or an interesting stock recommendation from a smart person) can drastically alter your perception on investments.

Pierpont (Trevor Sykes) – Pierpont is a column by veteran journo Trevor Sykes who writes about various shenanigans (some real, some fictional) in a humorous way. This is a truly excellent, all-encompassing list of scams, swindles, and ways that management screws shareholders. However, if you read it too soon (assuming you understand what’s going on), you’ll never put any money in the market at all. In my opinion, read this only when you’re more experienced and have already made a couple of investments.

Ben Graham’s Intelligent Investor -I think this is excruciatingly boring and its main strategy of buying “net-nets” is no longer really viable. It’s an OK book for beginners who are still learning but for myself I read it once and will probably never read it again. Other blogs or books on this list will teach similar lessons suited to the modern investor.

Some thoughts on media/podcasts:

This may sound counterintuitive given the investment blogs I suggest above, but in general I believe beginning investors should avoid consuming too much fund manager content. Fund management people are far too smart and as a beginner you don’t want to find yourself trying to imitate parts of some complex strategy that is going to lead to sub-par outcomes for you.

Generally speaking, if you are a beginner, I think the goal should be to gather the experience and wisdom of fund managers, not their investment strategies or ideas.

That said, a crucial question for beginner investors to answer is whether you are able to invest successfully on your own, or if you would be better off selecting a skilled and honest manager to do it for you. Either way, learning to understand investments and finance for yourself will assist you in finding a manager.

If you must podcast, these podcasts are generally excellent, with the above caveat that most of them are fund managers. Tony Hansen and Wayne Peters interviews would be suitable for beginners:

Australian Investors’ Podcast

TV/Media

I generally think most financial media and content is rubbish. TV is particularly insidious – mainly because it puts low quality people on the same platform as high quality ones, and it’s not easy to tell the difference if you’re a newbie. There is also nothing less useful than watching a great fund manager having to answer audience questions or commentate on some “stock of the day” he’s probably spent no time on, has no position in, and doesn’t care about.

Worse, you don’t want to be in a position of taking recommendations from some guy who might be trying to encourage more people to buy XYZ stock so that his fund can sell out of it without losing too much money. (this is known to happen, by the way).

I read a fair number of fund manager letters and they are often valuable, but if you are new to investing I would avoid it until you have more experience.

Where to start?

For a beginner investor I would say go with One Up On Wall Street as your first read as it is engaging. Then in no particular order, Letters to Shareholders of Berkshire Hathaway, the Forager Funds Bristlemouth blog, the EGP Capital blog, and Common Stocks and Uncommon Profits. Also have a dabble in the Dunning Kruger paper as that is a huge and persistent investor error – even experienced professionals get stung by that one from time to time.

I think those are the must-reads, but I’m not sure of prospective readers’ financial knowledge/ experience. Hopefully I’ve picked well!

I have no financial relationship with any of the people/organisations mentioned in this article. I am not a qualified or licensed financial professional or adviser. This post reflects my personal opinion only. This is a disclosure and not a recommendation.

Some brief thoughts on ownership

Sat, 17 Nov 2018 04:17:16 GMT

I recently read a letter from Edelweiss Holdings that has both prompted some new thoughts and sharpened up some old thoughts about a crucial concept in finance – ownership.

The whole letter is worth a read, but this quote in particular threw bare some implicit assumptions that I had largely taken at face value:

“A promise to pay is not money. How many really understand this? We dress it up as a bank deposit, a treasury bill or some variation thereto and insist on calling it an asset. But we also laugh at the man who chooses to keep his cash in gold.“

The implications of that are fairly wide reaching, and you don’t have to agree with them. But I think it is totally true that very few assets in today’s world are unquestionably yours in every possible circumstance, and I think this comment exposes a major implicit assumption in financial markets.

Obviously there are things like credit risk and capital structure (debt > equity) which are understandable – the lender is the owner – but the wider implications of ownership are not something I’ve thought deeply about previously. What do you actually own when you own a share? Is it the same for a US share as for an Australian (or Chinese or Brazilian) share? Does your custodian (the place where you store your shares) have the ability to sell it or pledge it? What happens if the custodian goes bankrupt?

It’s necessary to distinguish between actual ownership (what the law says you own) and functional ownership (what you actually exert control over). I might own shares on a margin loan, but I certainly don’t have full control over them – and I won’t own them at all if I get margin called. Debt is the obvious way where ownership is illusory, but political and fiduciary illusions can be even more insidious.

Like everything in financial markets, the concept of ownership works most of the time. It’s at the extremes where ownership (and a separate but related concept – control) breaks down.

For example, the law (probably) says that you can take your money out of the bank whenever you want. But the physical nature of banks and fractional reserve lending means that it is physically impossible at many banks for every depositor to withdraw all of their assets at the same time. So you conceivably have a situation where your ownership is totally unquestionable, yet you cannot exercise the rights or enjoy the benefits of ownership.

There are relative degrees of severity of this concept (and laws and regulations to protect ownership), but at the extremes, you get Bear Stearns or a bank bail-in. How safe is your bank? How would you know? If you’re not an investor, have you even thought about it?

China is another good example. It is my personal view that China investors are largely buying that which cannot be sold – Chinese assets and cash flows. In the final analysis, I think that all Chinese businesses, cash flows, and even people are “owned” by the Chinese government. This might not be true in Chinese law, but I think it is probably functionally true, and it appears to be getting more true over time as the country increasingly cracks down on capital flight and political dissent.

Look at Alibaba. I don’t understand the company’s structure, but BABA shareholders essentially own a Cayman Islands holding company that “owns” the Chinese businesses via “contractual relationships”. Sometimes it owns a Virgin Islands company which owns these contractual relationships! However, a few key personnel are the actual registered owners of the Chinese businesses in Chinese law. Consider this statement from the latest annual filing:

“In order to further improve our control over our material variable interest entities, reduce key man risks associated with having certain individuals be the equity holders of the material variable interest entities, and address the uncertainty resulting from any potential disputes between us and the individual equity holders of the material variable interest entities that may arise, we are in the process of enhancing the structure of our material variable interest entities and certain other variable interest entities, or the VIE Structure Enhancement.”

That paragraph is pretty spooky, but the next sentence is the knockout:

Prior to the completion of the VIE Structure Enhancement, the variable interest entities were owned, or are owned, by a few PRC citizens who are our founders or employees or by PRC entities owned by these PRC citizens.

apologies for the formatting…am using a Mac for the first time and not sure how to correct it

ownership porn

So BABA is a company, where the primary assets are contracts with operating companies, that are wholly owned by PRC citizens, whose continued existence is presumably contingent on favourable relationships with the ruling party. The contracts themselves are of course dependent on Chinese law because – even if written in Cayman Islands / US law – how do you enforce them if the Chinese government or judiciary is unwilling?

I’m sure that’s a gross generalisation (deep throat ipo blog is all over it), but from an ownership perspective, surely this is massively problematic. It’s easy to overlook this type of risk because there’s a market in Alibaba shares that provides the illusion of ownership, but if for example there’s some kind of edge case, what are your chances as a shareholder of actually being able to apply your owner (“owner”) rights to these assets that you don’t actually own?

Surely you’d handicap the probability at marginally less than “snowball in hell rolling uphill”?

Ultimately your ability to control any of that asset is potentially circumscribed. Even in developed markets, the ability of shareholders to do anything without a major lawsuit is slim.

Think about the extremes. If the regulator was asleep or even just slow to react, and you were unable or unwilling to litigate, management and the board could do almost anything they wanted – and in some cases, they have.

Even ignoring the question of illegal or criminal behaviour, there must be thousands of examples of market participants giving up an element of control or ownership and having that come back to bite them: Storm Financial, Tricom, Bear Sterns, LTCM, etc.

I found that Edelweiss letter interesting because it prompted me to stop asking “do i own this asset” and instead ask “forget about the law, in what circumstances do I functionally not own this asset?”

Kind of like the old saying: “Tell me where I’ll die so I don’t go there”.

Food for thought.

I have no financial interest in any company mentioned. I do not have any financial interest in any Chinese companies. It’s possible my super fund has Chinese exposure that I am not aware of. This is a disclosure and not a recommendation.

An Update on the Henry Morgan saga

Mon, 27 Aug 2018 09:42:33 GMT

Following the surprise appearance of an article in AFR this morning about the results of a lawsuit against my web host, Dreamscape, and the law firm that represented me, BTLawyers Brisbane, I thought readers might be interested in a brief timeline of events.

Mid-last year I began writing a series of posts about Henry Morgan (ASX:HML), Benjamin Hornigold (ASX:BHD), John Bridgeman (NSX:JBL), and unlisted subsidiaries and investments including Bartholomew Roberts (BRL) and JB Financial Group (JBFG) among others.

Shortly after I began looking, Henry Morgan entered voluntary suspension in June 2017. At the time the suspension was due to a pending announcement relating to an Interim Stop Order from ASIC regarding HML’s proposed options prospectus. ASIC subsequently issued a Final Stop Order for this prospectus. HML has remained suspended since this date.

In August 2017, Henry Morgan published a list of corrective disclosures to the ASX. If you are looking to get a quick handle on the HML story, the corrective disclosure provides an overview of some of ASX’s concerns.

In December 2017 I received an email from lawyers jointly representing HML/JBL/BHD, insisting that I remove my posts, publish an apology, and reveal my identity within a very short deadline.

Without either being a lawyer myself or having a lawyer on retainer at the time, I thought it was best to pull the posts down from my website while I sought legal advice.I would like to thank BTLawyers for their capable advice and for being so quick to respond during what was a time sensitive matter.

After some back and forth between my lawyers and HML’s lawyers, no agreement was reached.

Several weeks later BTLawyers and Dreamscape were served with court proceedings.

Four months after the hearing in April 2018, the court posted its orders and judgement late last week. These are available here:

https://www.comcourts.gov.au/file/Federal/P/QUD131/2018/actions

http://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2018/2018fca1279

Lawyer-readers may find part of this case interesting, in that HML’s lawyers attempted to access my identity from before I had signed a fee agreement with my lawyer. When I first approached BT Lawyers for advice on maintaining my anonymity, I gave him my name and details so that he could prepare a fee agreement. Lawyers for HML argued that this information, given before a formal arrangement existed between myself and my lawyer, was not subject to client confidentiality. The court found that in this case it was still confidential. This is what I took away from the judgement:

27 A client’s communication of his or her name to a lawyer is not usually privileged.

41 In this case, one aspect of the state of facts that the publisher communicated to the solicitors was that he , “X”, (i.e., me) was the publisher of the articles. The very purpose for which the publisher communicated his name was to obtain legal advice about avoiding disclosure of his name as the publisher. The communication of his name was inextricably intertwined with the advice he was seeking.

42 The case falls within the exception identified in Coombes where the client’s identity is so intertwined with the confidential communication that to disclose the identity would be to disclose the communication. For the solicitors to disclose the publisher’s name would be to disclose the substance of a confidential communication, namely his identity as the publisher of the blog. For these reasons, legal professional privilege attaches to the publisher’s communication of his name to the solicitors.

There is also this aspect of the judgement:

13 The publisher’s solicitors (i.e., me/BTLawyers) submit that the prospective applicants cannot demonstrate any arguable case of breach of s 18 of the Australian Consumer Law because the material published on the website was not published in trade or commerce. The prospective applicants (HML’s lawyers) concede this point. The solicitors submit that if the prospective applicants sued for defamation or injurious falsehood alone, this Court would have no jurisdiction in respect of the proceeding. The prospective applicants also concede this point. That leaves the question of whether the prospective applicants may have a right to obtain relief for breach of s 1041H of the Corporations Act.

Of course, once HML and co obtain my identity, it may be possible to launch additional lawsuits alleging defamation and what have you. However at this point, this proceeding appears to have hinged on section 1041H of the Corporations Act. Given that this is a corporate case I question whether HML/BHD/JBL shareholders are effectively footing the bill for these proceedings.

In the interim, while this legal action played out, ASX has criticised Henry Morgan on 22 May 2018 for “quibbling“. ASX stated in the same announcement that “ASIC has expressed a number of concerns (which are shared by ASX) about the values ascribed to HML’s unlisted assets in its NTA calculations and the methodology used to calculate those values.”

As of 13 August 2018, Henry Morgan’s voluntary suspension looks to have now become an involuntary suspension at ASX’s discretion under listing rule 17.3.

Henry Morgan itself has noted on 22 August 2018 that ASX is “not minded to lift the suspension at this time”, pending further queries.

Subsequent to this quibbling comment from ASX, another ASX-listed entity Benjamin Hornigold (ASX: BHD) was also suspended on 30 July under listing rule 17.3 pending further queries from ASX.

Food for thought.

I have no, and have never had any, financial interest whatsoever in any company mentioned. I have no financial relationship with, or ownership interest in, BTLawyers, other than the relationship which exists between a fee-paying client and his lawyer. I am not a lawyer so my interpretation of the linked court judgement may be incorrect. This is a disclosure and not a recommendation.

Updater Inc: Saved by the bell?

Mon, 20 Aug 2018 06:01:03 GMT

Updater Inc (ASX: UPD) is an ASX-listed, USA-domiciled company that provides services to people who are moving house. Updater’s “digital tools help people find and reserve trustworthy moving companies, connect TV and internet, forward their mail, transfer utilities, update accounts, and much more – all in one easy-to-use platform.”

I believe that there are a number of unanswered questions at Updater that make the company difficult to understand from an investment perspective. As a general rule I also believe that a lack of transparency makes companies harder to value, and increases the risk to shareholders as relevant risks cannot be easily analyzed before the fact.

See the performance of opaque business models at Blue Sky (down 80% TTM), Big Un Limited (stock suspended with main subsidiary in administration), and Getswift (down 60% TTM) for recent examples of times when nondisclosure of parts of the business model was not in shareholders’ interests, despite it being part of each firm’s “competitive advantage”.

Market capitalisation

As of its latest 3B and the time of writing, Updater has 21.83m shares of common stock on issue, 5.09m unlisted options, and 0.23m warrants. Each share is equivalent to 25 CDIs (Chess Depository Interests) which trade on the ASX.

Fully diluted, Updater has 27.15m shares on issue which are equivalent to 678.75m CDIs as of 2 August 2018. This gives the company a fully diluted market capitalisation of approximately A$821.3m at A$1.21 per CDI.

This is equivalent to approximately US$607 million in market capitalisation. All figures below will be USD unless otherwise specified.

In the first two quarters of 2018, Updater recorded $7.3 million in bookings (revenue) and $5.35m in cash receipts from customers. The company burned $9.8 million in operating cash flow to achieve this level of sales.

Management reaffirmed guidance for $19m-23m in full year revenue, pricing the company at around 30x full year revenue.

What is Updater?

Updater is a technology platform that helps users book services associated with moving house. Updater partners with property managers who then offer Updater’s services to clients. If you are a client of a property manager that has signed up with Updater, you will receive an invitation via email to use Updater’s services. The user then signs up to Updater’s app, entering their address and other personal information.

According to Updater research, when consumers are moving house, they are more likely to switch providers for products like insurance, internet, etc compared to when they are not moving. Companies are likely to pay up for the ability to target customers as they move, because this type of advertising should have a higher ROI and conversion rate. This intuitively makes sense, and Updater has research that shows a higher rate of engagement with ads provided on their platform, supporting this idea.

Once signed up to Updater, the user can be presented with recommendations for services such as removalists, insurers, cable tv providers and so on. Users that purchase these services through Updater’s platform generate revenue for the vendor and a commission for Updater. Updater can also advertise to its users by running paid programs paid for by vendors.

As of August 2018, Updater currently has 5 “verticals” including, in order of pilot program completion, Insurance, Moving, Pay TV, DIY Moving, and Local Services.

Updater should, in theory, be a good business. If it can generate a virtuous cycle of network effects where more users use the platform, which leads to successful advertising and conversion for vendors, which in turn leads to more users and greater investment and commissions from vendors, Updater should see steadily rising advertisement and commission revenues and may also be able to raise prices in time. This will effectively take marketing dollars from other customer acquisition channels and move them onto Updater’s platform.

However if this virtuous cycle does not happen, Updater in effect becomes just another digital channel (instead of the channel) for insurers and removalists to distribute their products. It will be subject to competition and there will be a risk that large providers can develop ways to bypass it or that large property managers refuse to use the platform.

This is a rough diagram showing how I conceptualise of the Updater model:

There is a software business, MoveHQ, which I have not included in this diagram but expect may become an important part of the business in time.

With any network business, the strength of the network effects are important, and enhancing them is key to the business. If the network effect is not continually being strengthened then Updater, in my opinion, will likely fail. The same is true of any pre-scale platform.

Updater does not appear to disclose much in the way of information that would allow investors to evaluate the strength of these network effects. Below is a brief list of my concerns with Updater.

List of concerns:

Weak corporate governance including a lack of a remuneration report
Lack of consistent disclosure around key metrics and customer conversion
Lack of consistent disclosure around growth of verticals
High ROI claims in Updater’s verticals
Acquired profitable and mature software businesses but immediately cut revenue generating activity at those businesses
Questionable financial decisions including hiring of Nomad Financial
Unsure why Updater became an insurance distributor, which would potentially see it competing with its own customers
Lack of disclosure around costs of accessing tenant lists & likely evolution of this relationship over time
Focus on presenting big-picture numbers like total market size instead of more granular info like customer conversion
Where’s the S-curve of product adoption?

Weak corporate governance

There are a number of concerns with governance that are detailed in Updater’s 2017 annual report on page 44. These include a lack of independent audit function, no remuneration committee, and the Chairman of the Board of Directors is also the CEO (and, possibly involved in setting CEO remuneration?).

from FY17 annual report

The company’s incentive option scheme is not easy to follow as it refers to common stock with exercise prices of $20+, not the ASX listed CDIs – further complicated by the necessity of a conversion from USD into AUD. This gives the perception that stock options are far out of the money, when in fact all or most outstanding options appear to be currently in the money. The criteria for option awards and conversion is, in my opinion, opaque and set by the (not so independent) board.

I acknowledge that in mission-driven, founder-led companies with a strong focus on financial sustainability, non-independent boards can be significantly value accretive if directors have substantial industry experience and ownership interests out of proportion with their director fees.

Still, as far as I can tell, Updater does not disclose a remuneration report with executive payments and incentives. It also does not always disclose the hurdles that must be met in order to trigger incentive payments. As far as I can tell the only way for investors to determine what senior executives and directors are being paid is to track the payments to related parties in the notes to the quarterly reports (item 6). This information does not even appear to be available in the 2017 annual report that I could see. It is also an open question of whether these figures actually include CEO salary or if it is just director fees with additional undisclosed CEO salary/perks paid on top.

I believe under Delaware law Updater is not required to disclose a remuneration report. There are also several other ‘outs’ under Delaware law (in FY17 report, p31 & p44) that I find concerning from a governance perspective.

I would politely suggest that if Updater likes the idea of becoming a multibillion dollar enterprise, it will need to live up to the standards of the largest listed companies, instead of living down to Delaware law. I find it strange that Updater expects shareholders to own – and to contribute substantial new capital to – an $600 million enterprise seemingly without knowing what the CEO is being paid or what his incentive targets are.

Imagine owning a $600m business without knowing what you pay the CEO?

On a separate note, I have examined the registered histories of Updater’s acquisitions IGC and ACI. These appear to be real businesses with histories going back many years. Updater’s insurance subsidiary VerticalOne does appear to have insurance licenses in the US states that I checked.

The size of the funnel / user engagement

I am concerned that Updater typically appears to talk only about the top of the customer funnel (moves processed/total market size) instead of more granular statistics on user conversion lower down the funnel.

The “Moves Processed” statistic used by the company appears to indicate the very top of the funnel, i.e., the number of customers being presented with the app (I assume), or possibly even simply receiving an invitation email? Moves Processed does not appear to measure user engagement with, conversion to, or expenditure on, any of the verticals. Disclosure of other conversion rates is sporadic at best. What exactly constitutes a Move Processed?

Is it when the property manager sends an email invite to the tenant? (pre – sign up?)
Is it when the tenant does the brief sign-up and looks at the app?
Is it when they actually use a function within the app?

I could not clearly determine this from Updater’s presentations. This lack of disclosure vaguely reminds me of Getswift’s “deliveries” figure. Getswift was charging varying delivery prices depending on client (some were on free trials), yet the company’s heavy promotion of delivery #s as a leading indicator invited investors to multiply delivery numbers by the company’s headline $0.29/ delivery fee to arrive at a revenue estimate. Yet in reality, many clients were on lower-priced arrangements or free trials. These trials and discounts may have boosted delivery numbers in a way that could have resulted in the triggering of significant incentive awards to executives. I question whether growing Moves Processed is a similarly low hurdle for Updater.

There are other metrics that I question, for example in the recent privatisation announcement Updater reported “This past week the Purchase Rate jumped above 8%. This rate is materially higher than analyst consensus forecasts, which did not expect rates in this range until FY2020. Further, management is excited to see consistently weekly improvements…”

As far as I can determine, Updater has not consistently reported Purchase Rates for its verticals and I question why it hasn’t. I also question why a one-week Purchase Rate of 8% is notable but the rate since inception of the vertical is seemingly not worth reporting. I note that use of the word “jumped” implies a significant uplift and I question whether this metric could have been cherry picked. What was the level prior to improvement? Were there one-off impacts like promotions or holidays that might have impacted it? Like many of Updater’s figures, this new and improved 8% (higher than expectations! improving weekly!) invites the investor to apply this number out to a very large market size. It is not all that useful in evaluating or valuing the business given it is only a small piece of the puzzle from a single snapshot in time.

The 8% figure does however give the investor something to work with from a calculation perspective. I found this chart from the privatisation announcement interesting:

Updater shareholders will recognise the chart on the left. This is the Moves Processed chart that Updater has touted previously. Updater’s share of Moves Processed is 18% of the total market. However the conversion rate of Movers to Users is only ~35%. How is user conversion defined? Is that somebody that purchases a product?

Note that User conversion does not appear to be the same as a Purchase Rate (which is presumably the purchase decision where $$ changes hands). It is not clear what the difference between Conversion and Purchase Rate is. However if I understand this correctly, Updater is “Moves Processing” 18% of the total addressable market. 35% of this, or ~6.3% of the market has been Converted to being a user (I assume). I question if User Conversion simply means the user has signed up for the app.

The purchase rate of 8% I would assume is calculated on the 35% of moves processed that Updater has converted. I.e., 8% of 35% = 2.8% of Updater users are purchasing PayTV through Updater? 8% of the 6.3% of the market that Updater has converted = 0.5% of the total “Moves Processed market” is currently making PayTV purchases through Updater?

If this is correct, the numbers from a prior quarterly (Q317), show that Updater had a 16.59% market share of Moves Processed, which equated to 765,809 moves processed. That number is larger today, with current market share of 18% implying around 831,000 Moves Processed, assuming constant total market size. If 0.5% of this market is making PayTv purchases, does that imply that around 4155 people made a PayTv purchase through Updater? Uninspiring if true.

Is that right? Is it wrong? There is a decent chance I’m wrong, and I will be happy to publish a correction if somebody can explain to me how it works. Or, here’s a crazy idea, Updater could provide more consistent disclosure around how its verticals work.

Still I think this is symptomatic of the problem which is that, in my opinion, Updater does not clearly explain what many of its numbers or metrics represent. This company is on its way to being worth a billion dollars Australian and I find this lack of clarity problematic.

If the 4000 PayTv purchasers figure is correct, I would conclude that Updater is a long way from building a meaningful network effect. If this figure is correct, then the company also appears to be a long way from generating significant revenues from this vertical. If there are 4000 PayTv users at ~18% market penetration, does this work out to say ~22,000 users at 100% market penetration? It would be concerning if the implied user numbers are so low.

I question what the conversion and purchase rates are like in the other verticals and why these have not been disclosed.

Lack of disclosure of business and vertical product performance

I find it concerning that Updater does not disclose any kind of break-down of revenue by vertical. This makes it difficult to evaluate how much these businesses could someday be worth to the company.

source: UPD quarterly reports and presentations. Data directly from company 4Cs. May contain slight errors due to rounding of numbers. Numbers are unaudited as far as I know. Click to enlarge.

On the face of it, Updater is forecasting and achieving substantial revenue growth. However, at least some of this likely comes from adding new verticals and the acquisition of software businesses IGC and ACI, rather than growth in existing verticals. Not disclosing the breakdown of revenue or growth in each vertical, as well as the core real estate product revenues, makes it difficult to determine if the company is gaining traction with its network effects. It is not clear if the pilot programs contribute to revenue or if rising revenue reflects growth in other areas of the business. Note that the acquisition of IGC/ACI has effectively added at least one or more additional sources of revenue, making it even harder to gauge growth in each part of the business, in my opinion.

It is also not clear how much additional spending is required to help the business scale up. As of the 2017 annual report Updater only employed ~5 customer service staff and ~15 relationship management/client onboarding staff.

I believe this is a concern because if the granular performance of each part of the Updater business is not disclosed, this encourages the investor to rely on Updater’s numbers regarding estimated return on investment (ROI) and total market size for each of its verticals. I believe these numbers are optimistic, as I’ll detail below.

High ROI claims in Updater’s verticals

Updater makes a number of claims about the potential market size and estimated benefits to Updater or its partners (platform vendors/ advertisers). There is a lack of clarity about these estimates and I think there are unanswered questions regarding the likely penetration of the Updater business model. Take the insurance vertical for example.

Updater first establishes that there is an attractive market for insurance:

https://www.asx.com.au/asxpdf/20170317/pdf/43gw4127q8h2dl.pdf UPD ann 17 March 2017

On the back of this, Updater then conducts a pilot test:

This seems a sensible approach to developing a new product. Updater then calculates a rough ballpark of what the likely ROI could look like for users of its platform:

https://www.asx.com.au/asxpdf/20170320/pdf/43gxfysb8kpplz.pdf UPD 17 Mar 2017

This is where I think the numbers fall short.

This might be called the “if we had a fire we could roast some marshmallows, if we had any marshmallows” method of measuring market size and value – not least because Updater does not appear to consistently disclose conversion rates (“Mover Acquisition Rate of Partners” in the above diagram), making it hard to determine if these numbers are reasonable.

I understand that these are just ballpark preliminary figures and for discussion purposes only. Even so, at least two issues stand out to me about this presentation. First is the estimated 50% ROI for partners. It’s not clear how this is calculated.

Assuming I understand correctly, in return for spending $100 million on commissions to Updater, the insurers (“Profit to Partners”) would earn $50 million in profit after subtracting the $100m in commissions, hence the 50% ROI.

The lifetime revenue per policy figure is also worth examining closer. I am no expert on US insurance pricing but $9000 would look to be at around ~4(?) years of customer premiums? This is questionable because Updater is apparently supposed to present new product options every time the user moves house.

How often do people move house?
If presented with offers every time they move house, is Updater’s app likely to increase the frequency that customers switch providers?
Therefore does the Updater platform actually lower switching costs for users (and correspondingly increase churn for providers?)
Would this lower the Lifetime Revenue per Policy?
Does Updater’s ability to earn commissions on sales promote churning activity? Is this likely to reduce the value (or commissions payable) for insurers that use the platform?

Updater notes in the company’s own research that customers are ~4 times more likely to switch products when they move.

The PayTV pilot ROI calculations (below) work using a similar methodology:

https://www.asx.com.au/asxpdf/20171205/pdf/43px0tlrngdcsh.pdf presentation December 2017

In this case, $85 million spent on revenue generates a 75% ROI. Actually I think it’s a 175% ROI – $85m x 1.75 = $148.75, or approx $150m. Honestly I have no idea if that’s correct, it seems a weird way of calculating it. It’s not clear if the Updater Revenue Potential is a direct commission expense for products sold, or if it is paid advertising or some mix thereof.

Imagine that you are a large insurer or cable provider and trying to grow revenues and profits, and you come across a new distribution channel that gives a 50%-75% ROI on money invested – what do you do? You probably stuff as much investment in there as the channel will take – after all, for every $1 put in you get $0.50 back.

However, what happens when there are multiple insurers competing for the same customers on the same platform? Does this result in price based competition? What does this imply for margins and the efficacy of advertising/ commission expenditure? What does this imply for churn and the cost of acquiring a customer? I would assume that there are functional limits on the amount of investment that can be made in the Updater platform. Given the lack of disclosure of the number of purchasers on the platform, in my opinion it is difficult to gauge the market size or growth (or other stats like user demographic/target customer) and thus it is hard to form a rough estimate in the limits of advertising $ that can be effectively deployed on Updater’s platform.

The Updater platform could of course still be a great business, by claiming commissions and advertising revenues on growing volumes moving through its platform. However I am not convinced the above – static – examples of market size and ROI are realistic and persistent when the business is operating at scale.

The real driver of this business opportunity in my opinion is not the ROI for vendors (though this important) but what sort of network effects can be generated through the platform, and can the network become strong enough to essentially force vendors to advertise on it. I.e., can Updater aggregate so many customers and fulfil their needs so well that vendors have no choice but to be on the Updater platform?

This is also relevant because if Updater is getting large insurers using its platform, how is Updater different from, and how does it compete better than, aggregator websites like iSelect? (iSelect is Australian but I’m sure there are US equivalents). In my opinion, Updater at present looks a lot like an aggregator business, albeit with a better method for targeting and acquiring customers.

Updater should provide greater ongoing measures of user engagement, conversion, and spending (e.g. ARPU). Updater should also ask vendors how they measure ROI on Updater’s platform and then provide information about vendor ROI to permit investors to make better decisions about whether Updater’s platform is working.

Again, I think the problem is not just whether these numbers are accurate, the problem is that very large numbers have been provided in UPD company examples, yet it is very difficult to determine if these are realistic, or measure Updater’s actual progress towards these.

Somewhere in here it may be worth noting that three of Updater’s staff key staff that established the insurance division, and “certain other leaders”, took a hike at the end of Q218 (p7), which seems odd given that this business is supposed to be just starting to hit its stride.

Updater acquired profitable and mature businesses and then immediately cut their revenue generating activities

Updater is developing a moving software program called MoveHQ. Updater acquired two well established moving software businesses, IGC Software (“IGC”) and Asset Controls Inc. (“ACI”) in September/October 2017. The purpose of these acquisitions was to integrate IGC and ACI and create a software solution, MoveHQ, that would integrate with Updater’s systems.

It appears that MoveHQ would essentially give Updater the ability to reach into moving companies workflow and use this as another point of contact with the consumer.

https://www.asx.com.au/asxpdf/20170906/pdf/43m3qrx8mn82kz.pdf September 2017

However, Updater immediately “materially reduced” the “certain core revenue-generating products/services” of both IGC and ACI.

https://www.asx.com.au/asxpdf/20180320/pdf/43skv6m85939d9.pdf March 2018

This makes sense as there is not much point continuing with ancillary activities such as custom engineering when the focus is now redoubled on the core moving software.

However, Updater did not disclose how much the revenue generating activities had been reduced by. Updater also did not appear to disclose the actual revenue contribution of these businesses in the quarter. According to Updater’s announcement at the time of purchase, IGC and ACI generated approximately $7.2 million in annual revenue in 2016, or in simple terms around $1.8 million per quarter.

Updater’s total revenue in calendar year 2017 was approximately $2.4 million according to its 4Q report. This suggests that the majority of Updater’s annual revenue in 2017 may have come from IGC and ACI. You will note in the below chart that revenue hockey-sticked in Q4 after the acquisition, and cash receipts from customers of $1.7 million in the 4th quarter are close to the $1.8m/quarter that would be expected from the two acquired businesses.

At least one anecdotal report from a professional investor suggests that Updater screened out a question about how much these acquisitions contributed to Updater’s revenue during a quarterly conference call. There have been several other anecdotal reports suggesting the company has either screened questions or only taken pre-written questions on conference calls.

source: Company announcements. Click to enlarge.

I am not suggesting there is anything sinister in this. However, the lack of disclosure both masks the ongoing performance of the core real estate product revenues as well as contributions from the Insurance and Moving verticals. The acquisition also makes it easier for the company to hit its full year revenue guidance of $19 million to $23 million this year.

I question why Updater is not providing consistent reporting on growth in real estate product revenue as well as its vertical revenues. I also question why it is necessary to withhold answers from investors on such basic topics.

Companies with an outstanding value proposition are, in my experience, typically very happy to explain how the business works and how it is performing because by definition these companies are smarter and better than competitors – having built a better mousetrap/ solved a key problem for users – and successful companies naturally enjoy explaining the nuances of their genius. Coming from this perspective I view Updater’s lack of disclosure as a sign for caution.

While this might seem like needless quibbling, my point is not whether Updater earned $1m in this quarter or that quarter. The point, in my opinion, is that this is a US$600 million dollar business that provides investors with very low visibility into the underlying sales and user engagement with each of its products.

Questionable expenditure

I struggle to understand some of Updater’s financial decisions. When Updater researches a new vertical, it launches a pilot program to test that vertical and determine whether customers on Updater’s platform are more likely to engage with the new vertical, relative to a control group.

Updater measures the difference in performance between the two groups using statistics and reports a confidence interval. This Pay TV Pilot provides an example:

I.e., there is a significant difference (p<0.01) between the purchasing habits of customers exposed to Updater Communications compared to baseline. That is as it may be.

However, Updater then hires Nomad Financial to audit the statistical result:

https://www.asx.com.au/asxpdf/20171205/pdf/43px08zt34mbpr.pdf page 7. Click to enlarge.

As a data and technology company, it should not be necessary for Updater to outsource this analysis, and I struggle to see the point of Nomad Financial’s work. This type of statistical test is very simple to run and can be done by an amateur with a few clicks in an analytical program such as SPSS. I assume Updater has the appropriate statistical skills on staff.

Notably, Nomad Financial does not guarantee the accuracy of the underlying data used to conduct the statistical analysis.

It is possible that Nomad was hired to provide additional confidence in Updater’s numbers. However, if there is reason to doubt Updater’s numbers (and I am not saying that there is) then the viewer questioning the conclusions would also need to question the underlying data. If there’s no guarantee on the underlying data then Nomad’s work does not add any value to the sceptical viewer, in my opinion.

For the record I don’t have any reason to question the data and I accept Updater’s results at face value. I am just questioning why Nomad Financial has to be hired to calculate the p values. I struggle to see the purpose to this expenditure.

I also question this focus on proving things with statistical significance. Why bother? Statistics do not sell products. If a product is working really well, it’s typically extremely obvious.

https://www.asx.com.au/asxpdf/20180815/pdf/43xbzc4d3pck2b.pdf 15 August 2018.

A strategic mis-step?

In addition to the Nomad Financial expenditure, I am unsure about Updater’s decision to become an insurance distributor. I’m not familiar with US insurance law, so if Updater requires insurance distribution licenses in order to permit third party insurers to sell or advertise insurance on the Updater platform, then this particular comment may be invalid.

It appears that Updater is negotiating to become an active distributor of insurance policies for large US insurers, not just an advertising channel. I am curious how this will work while Updater is at the same time a platform for insurers to advertise and reach customers on.

As a platform business, Updater is effectively selling influence and network effects to the insurer. By creating the best platform possible, it gives the best experience to the user (customer) and attracts more users, maximising ROI on marketing dollars for the vendor (insurer), and maximising Updater’s own revenue as a result.

Updater says in some of its filings that it generally seeks to sell access to the platform, not commissions for products sold. However it does disclose elsewhere that may expect “performance fees” (p20).

I think there is a definite grey area in there between being a passive platform (even if UPD gets commissions/performance fees) and being an active distributor of products. Note in that above linked presentation above that Updater says it is developing key strategic partnerships and working to develop retention and acquisition products.

The risk with becoming more active in distributing policies on behalf of insurers is, in my opinion, that it risks damaging the attractiveness of the Updater platform. There is a potential conflict between being the platform operator (i.e., a relatively open marketplace) and simultaneously trying to partner with insurers to sell a specific insurer’s product. For example could the size of performance fees, or the closeness of the “strategic partnership” then determine which insurance policies get sold? Might this reduce the inclination of either users or vendors to use the Updater platform? Recall my earlier questions about whether Updater’s platform might increase insurer churn and lower switching costs? You can see how this could potentially deliver sub-par outcomes to consumers as well as risk turning some insurers away from the platform.

Why would a non-affiliated insurer want to use Updater’s platform if it has to compete with Updater’s own strategic partners? If insurers stop using the platform or if customers are not getting the best deal, that will weaken the network effects because customers may be able to get other attractive products or deals outside Updater.

There are of course businesses where the platform operator can effectively compete with its customers (Amazon). However I question whether Updater’s network effects are strong enough yet that it can risk taking such a step itself. A simple measure of revenue would suggest, in my opinion, that Updater is not at that stage yet.

Again my point is not that these things will or won’t happen. My point is that this is a very large business that isn’t clear with these issues in its public filings and presentations. I believe Updater needs to spend substantially more time clarifying the mechanics and the why of its strategic decisions.

What is the cost of partnering with real estate agents?

Lastly I question what is the cost of obtaining the customer lists that Updater is using to push its product. The business appears strongly dependent on the ability to source customers via partnering with property managers. The ability to continue to source this data would appear to be key to the business until the network effects kick in, or the company finds alternative ways of sourcing customers (e.g., repeat customers).

What is the cost of acquiring this data and what is the cost likely to look like in the future? I don’t recall seeing that addressed in any presentations.

It appears at present that property managers may pay a fee to use the Updater platform. This Youtube video https://www.youtube.com/watch?v=-n0Uc3BqqyM states in the description “To purchase an Updater agent account, visit updater.com/agents.” which implies that agents pay for the app. Is this the source of Updater’s pre-IGC/ACI revenues?

If agents are paying for their accounts, does this mean that Updater is at the mercy of agent purchasing decisions? I.e., if agents don’t purchase the app & then push the platform on users, does Updater lose its market penetration (moves processed)? If Updater’s market penetration is dependent on this channel that is a major risk. Updater reports “very low churn” from property agents but does not appear to consistently disclose how much churn it is actually experiencing. I question the length of the contracts/deals with property agents. Is churn low because contracts are structured over a long period of time (e.g. several years) and renewal dates have not been reached?

What does the agent gain from the relationship and is this relationship strong enough to let Updater build a big business on top of it without substantially higher costs?

Updater should provide substantial more clarification around its relationships with and remuneration to or from agents, and what the standard terms of these agent/property manager deals look like.

Where’s the S-curve?

One possible (admittedly imperfect) Updater comparison is Xero. Xero is useful because it is a classic example of a new tech product running massive losses to exploit the S-curve of user adoption. Bronte Capital recently stated that Xero had mis-stepped by managing the company to break even instead of raising as much capital as possible and growing as quickly as possible. That is as it may be. However, Xero was likely profitable as a corporation on an underlying basis (ex- growth marketing expense) as early as 2013. Xero unquestionably had an outstanding product that could already be sold profitably and would grow very rapidly if more money was poured into acquiring more customers.

I believe that the case of Updater is not quite so clear cut. Despite claiming 18% of the market, Updater has invested massively in its cost base to create new verticals to add revenue. This is because growing market penetration alone (18% Moves Processed) hasn’t added significant revenue relative to the cost base. Additionally Updater, to my mind (unlike Xero), hasn’t yet got a track record with the products/verticals that are going to bring it substantial revenues. Indeed Updater has only just rolled out these verticals relatively recently. Meanwhile the company is supporting a monstrous cost base without (until recently) the revenue improvement to justify it.

Creating multiple verticals seems a sensible strategic decision, and the verticals themselves make sense. However Updater still seems to be struggling to convert customers – although I could be wrong because Updater doesn’t disclose much, as noted above. Still, by the time Xero had 18% market share, it was generating millions of revenue from a single core product, and was ready to invest heavily in acquiring more customers.

To my mind, Updater hasn’t yet shown that its product/s are hitting the classic S-curve adoption of new technologies that companies like Xero and Afterpay have seen. The next couple of quarters would have let investors see progress in this respect more clearly – except, of course, that Updater is now trying to go private before it’s really hit full stride. This is why I view the lack of disclosure and the possible privatisation as a meaningful concern.

One interesting question I think is Updater’s relatively recent creation of its verticals even though Updater has been around since 2012. Why is Updater only developing the verticals now in 2017? I wonder if it would have made sense to start developing the verticals earlier – surely these would have been key in building a network effect? I believe Updater states that the company wanted to win a large user base first, but usually product and user base are developed in lockstep – great products attract great users, and this is a network/platform style business.

I note that Updater has been around since 2012 but seemingly did not take on major private capital, instead opting for an ASX listing. I find it strange that the company is going private now because it’s announced it wants a lot more money to invest in growth.

Call to action?

I originally intended to end this post with a call to action for Updater to greatly enhance its disclosure. I still think it should but it’s kind of ironic that, despite all of these concerns, the company has decided to move in the opposite direction by going private and delisting (subject to shareholder vote etc). I’m certain that the idea of raising multiple millions and relisting at a billion dollar valuation in a couple of years is much more sexy than explaining how the business works and defending its valuation to the market.

After all, in the private markets, you can value yourself however you want!

Look, I think there are clear concerns with Updater given the lack of disclosure and the recent founder sell-down. I think that it’s very difficult to determine the probability of Updater either winning or failing. My opinion is that some of the company’s numbers are quite woolly, and I find it telling that instead of improving disclosure and allowing the market to better gauge the company’s progress, Updater has elected to go private, which will likely result in further reductions in disclosure. You only have to look at Netflix, Amazon, Afterpay, Getswift (ha) to see how easy it is for promising, rapidly growing businesses to raise oodles of capital – whether publicly listed or private, and whether here or in the USA.

At certain times I feel like Updater is in love with the idea of being a big tech company with the ability to spend loads of cash, have fancy offices, win awards for being a great place to work etc. Updater wants to go private again so it can raise substantial new money and move aggressively towards 35% market penetration. (This may still be a sensible strategic decision). In my view it is not clear if the company is making concrete progress towards generating network effects.

I note that Updater has put a positive spin on the delisting by stating that “Australian investors that seek equity in Updater should consider buying CDIs in advance of delisting (as there may not be a further chance to invest in Updater once private)”. Better get in while the getting’s good! However, I note that several large funds hold Updater shares and I question whether these funds will be able to hold the shares once Updater goes private. If they cannot hold private companies, I question if there will be substantial selling on the open market (potentially affecting the share price) if a privatisation vote is approved. Updater’s buyback does not appear to be large enough to accommodate possible institutional selling. I also question why the investors that want to invest in a privatised Updater were seemingly not interested in bidding for the shares of large public investors pre-privatisation.

I note that Updater has stated that numerous financial investors and strategic parties have expressed significant interest in Updater as a private company yet UPD has not disclosed any serious approaches to the market – which it would surely be required to do under ASX listing rules? As far as I am aware, there’s no public proof of any substantial interest from private funding. Updater has raised $5m in the US previously but the last time it needed A$50 million (for a US$ acquisition no less) it raised the money from Australian investors.

I have been told that during the recent conference call (which I missed and could not source a recording or transcript for), Updater stated that they had received interest from private entities in investing in a privatised Updater at a valuation of up to $1bn. However if there are any firm offers, this information should surely have been disclosed to investors as part of the recent presentation? A firm offer to invest in Updater contingent to a successful de-listing would surely be relevant information to investors who are deciding whether to sell their shares or hold the private entity. As no formal offers were disclosed, it seems prudent to assume that there are no firm or guaranteed offers to invest in Updater at a higher valuation once privatised.

Readers will have their own opinion on this matter. I note that Tesla has funding secured for its privatisation also.

I also question why the idea of raising more capital at a $1 billion valuation is so attractive as to be worth the hassle of privatisation. Updater is already worth US$0.6 billion, or A$0.8bn. The company is within spitting distance of being a unicorn and if it can grow at anything like the rate of Afterpay, Netflix, it will have zero trouble reaching the magic nine zeroes – in fact it could do it in twelve months if current forecast revenue growth is maintained. There are already enough supportive investors in Australia to raise another $100m to accelerate growth further. I question if there is an alternative reason for Updater’s privatisation plans.

I note that Updater has announced it will be looking to rapidly scale up its business to 10+ verticals within 2 years and 35% market penetration ASAP. If prior experience is any guide this will cost an enormous amount of money. Yet I also note that Updater intends to secure further private investment to fund acceleration of growth and/or “potential future buy-back(s).“

https://www.asx.com.au/asxpdf/20180815/pdf/43xbz78m95645z.pdf

Love or hate Updater, in what universe does a buy-back make sense for a loss-making company aggressively investing in growing to scale?

I question why a company like Updater would go private right as things are seemingly starting to take off in terms of revenue growth. I question whether Updater is aggressively adding verticals (and cost base) as a way of showing revenue growth and masking lack of progress in existing products/ verticals.

All things considered, I feel like the core question, whether Updater is successfully building network effects and growing customer conversion, has not yet been answered comprehensively by business performance. I feel like the company is going private right at a time when the next two quarters or so would prove quite enlightening regarding the progress of the business.

The bottom line

There are many questions, and no easy answers. I can see a path to Updater becoming a multi-billion $ company – with me as a shareholder. I can see a path to it asymptoting zero. I can also see a middle ground where it becomes a solid, niche marketing/commission business without being spectacular – although I think the company’s grandiose ambitions make this outcome very unlikely without a drastic change of strategy. The probability of the two polar outcomes occurring I think is difficult to determine and without greater disclosure, Updater makes itself very hard to invest in, particularly at the current valuation.

Again the problem is not just the questions and risks in the business strategy. The problem is that there are so many concerns, in my opinion, with lack of disclosure and large, woolly numbers that it makes it very difficult to get comfortable with Updater.

One of the biggest risks of investing in Updater in my opinion is that the lack of tangible information about the performance of the company’s verticals invites the investor to paint a blank canvas using the very large, top of the funnel metrics that Updater has presented to the market. After all, these are multi-billion dollar target markets. Whether Updater can convert them successfully or not I believe is still an open question. As I said earlier:

If we had a fire, we could roast some marshmallows – if we had any marshmallows.

Caveat emptor.

Disclaimer: This post reflects my personal opinion only and is not a recommendation to buy or sell any mentioned securities. All readers should always do their own research and seek appropriate professional advice before making any investment decision. I have no, and have never had, any financial interest in or relationship with Updater. I do not stand to financially benefit in any way by the publication of this post or any subsequent market activity in Updater shares. This is a disclosure and not a recommendation.

Do currency exchange rates impact inbound tourism?

Sat, 07 Jul 2018 06:33:01 GMT

I recently read an article about tourism stocks that said something like “the lower Australian dollar is great for tourism demand.” It was implied that this is a tailwind for tourism companies.

That’s the consensus view and intuitively it makes sense. If 10,000 Chinese Yuan buys you A$2000, that’s not cool as if it buys you A$2500. From an economic and a rational perspective you would think that an Australian holiday is less attractive at a 1 : $0.20 exchange rate than at 1 : $0.25.

However I think that this is incorrect. While I could be convinced that there is such an effect, I think it is mild enough to be almost irrelevant.

According to Tourism Australia there were 9 million inbound tourists in the year to April 2018. 1.4 million or 15.5% of these were from China. China is not a great example of this effect for a number of reasons, but it will be suitable for this post:

data from Tourism Australia and xe.com on 07.07.2018. Click to enlarge.

Chinese tourist numbers going up like a rocket. Exchange rate – flat out like a lizard on a rock.

Here is the UK:

data from Tourism Australia and xe.com on 07.07.2018. Click to enlarge.

You can see some apparent links at various points but this could also be explained by political or economic impacts, not just currency.

Here is New Zealand, the second largest contributor to Australian inbound tourist numbers:

data from Tourism Australia and xe.com on 07.07.2018. Click to enlarge.

New Zealand is actually very interesting because it’s the one place where the underlying drivers of tourism are not changing much or quickly – unlike China. Where the financial and social circumstances of the pool of prospective tourists is much more stable, as it is in New Zealand, I would be more willing to believe in a currency effect (and it might be easier to spot).

My analysis is neither conclusive nor comprehensive, but prima facie it is pretty hard to see any kind of relationship between inbound visitor numbers and forex rates. I think there are likely a number of secondary reasons for this, and one major one.

First, the minor reasons.

Air travel is getting cheaper both in absolute terms and relative to people’s wages, especially in emerging countries. Thus the ability to go overseas is not really constrained by forex rates, but by the affordability of travel relative to people’s incomes and budget – and this is improving in many places even if exchange rates move adversely. Other things like AirBnB can make accommodation more affordable. The pool of prospective tourists is increasing.
It is getting easier to travel for a whole variety of non-financial reasons, that likely vary by region, but things like booking technology, the internet, greater recognition of tourism as an economic opportunity, bilaterial tourist agreements, proliferation of major travel businesses like Expedia, Flight Centre, and so on, make the decision to travel easier and more attainable. Financial impact aside, it is getting easier to travel and this also increases the pool of prospective tourists.
Population growth (more people = more tourists)
Wage / economic growth (more money = more tourism)
Changes in migrant populations (e.g. there are more Chinese living here than there were 5 years ago – so there are likely more inbound/outbound Chinese visitors due to friends & family visiting etc)
Political disruption is often correlated with currency disruption (which again makes it harder to discern that the effect is really due to forex rates)
Credit availability – this isn’t a major contributor, especially not in many foreign countries, but on some level it is possible that the availability of credit (and credit cards) and/or the ability to pay for a trip on credit will have an impact in certain periods (bearing in mind that all credit does is bring consumption forwards).

The biggest reason of all however is simply that tourists are typically price insensitive and also that tourism is not a rational economic decision. If you’re going to spend the equivalent of $5000-$10000 to travel halfway around the world for a once-or-twice in a lifetime trip to see ~~the most miserable city in Australia~~ kangaroos and the Sydney Opera House, do you really mind if the AUD has fallen from $0.80 to $0.75 or vice versa? I would say almost definitely not.

At some level you would think that forex should have an impact. For example you need 30,000 Brasilian reais to get around A$10,200 (rate of $1 = r0.34), which will buy you a decent Australian holiday and return flights. However if the rate were to halve, then you need 60,000 reais to get the same holiday, which is a ridiculously large sum of money.

When the currency change is very significant then I would believe that there is an impact on tourism, primarily because the exchange rate and the differences in the relative cost of living can make travel to a certain destination infeasible. However such currency moves are rare and I would conclude that most of the time the rate of exchange is almost irrelevant to the decision to travel.

Playing with the Tourism Australia website I came across an interesting example with Brasil. It’s a small sample but you can clearly see a possible political impact on tourist numbers due to the impeachment of their President around this time.

data from Tourism Australia and xe.com on 07.07.2018. Click to enlarge.

It is difficult to prove my point either way, because the currency also dipped severely at this point, I just found this an interesting example.

Lag time between decision and travel

One other item of note is that there is a lag time between planning a trip and currency movements. Trips don’t usually occur until 6-12 months after the decision to travel is made so there is an interesting element of consumer psychology to consider.

Let’s say for example that a currency declines and you decide to travel because a destination is cheap. You typically won’t travel for 6 -12 months after the decision is made and flights are booked. Are you going to cancel your trip if the currency moves adversely in that time? Almost definitely not, and not just because of sunk costs.

Additionally, nobody is thinking about things like cost of bottled water or food when they travel. What they’re thinking about is the cost of accommodation, transport, or the cost of the events that they are doing. Most of the events will be tourist-style events where the customer is price insensitive. What is the difference between paying $60 or $100 (or the equivalent difference due to a change in exchange rates) for a ticket to Australia Zoo? If you can afford to come all the way to Australia and you want to see kangaroos and crocodiles, you would probably be happy to pay either price.

Having said that, I am a wealthy (relative to the rest of the world) and privileged Australian so it is quite likely that I have a different attitude towards travel than many foreigners do. This is something to keep in mind and it is a place where unconscious bias could easily trip you up.

Tourism is not a straightforward tradeoff between pleasure and money. Rather it seems to be typically primarily a pleasure- or novelty- driven decision until or unless the prospective financial cost becomes too punitive. There is substantial flexibility in the willingness of the average tourist to pay, but only up to a point.

There are likely a large number of inbound arrivals that aren’t conventional tourists and are instead here on business or visiting family. Those situations may have different responses to exchange rates or the drivers of their travel may be different.

The bottom line

It’s really really hard, in my opinion, to prove any kind of strong relationship between currency movements and tourist numbers, either in the short term or over a longer period. I’m not convinced that there is a correlation, and I doubt if there’s much causation either.

My sense is that currency movements are not hugely important for tourism businesses. This is especially true if you use a really simplistic pairing like AUD/USD as a proxy for the affordability of tourism (especially given that >90% of Australian tourists come from outside the USA). Many other currencies like the Yuan, Euro, Pound etc have not moved significantly in the past couple of years.

I have thought about this and related issues a lot as I hold a (undisclosed) tourism stock. All else being equal, a low currency probably doesn’t hurt, but I think it is almost irrelevant when it comes to analysing or valuing tourism businesses, especially since there are so many different sources of tourists using many currencies.

A far more important concern is what are the underlying drivers of tourist numbers and in what situations would tourist numbers decline sharply?

One observation that arises from this post is that Chinese tourists are driving a large part of Australian tourism growth. Why? Despite the popular meme, it is likely not due to the emerging Chinese middle class – their wages simply aren’t high enough. So what are the mechanics of this? In what circumstances does it slow, stop, or reverse? War is an obvious one, and of course trees don’t grow to the sky. That’s a bit off topic and probably deserves a post of its own in the future.

These are all questions that I don’t think have been adequately answered publicly (that I’ve seen), and could use a lot more work from the prospective tourism investor. I would be interested in recommendations for answers to these questions if you know of any good reports or articles.

I have no financial position in any company mentioned. I own shares in an undisclosed Australian tourism company. This is a disclosure and not a recommendation.

Ethical Investing: Some thoughts on ESG funds

Sat, 23 Jun 2018 05:07:26 GMT

I am suspicious of much modern ESG investing. It’s great that investors want to invest in bona fide ESG funds for the purposes of conscious capitalism, saving the planet and all that. From a “positive use of your wealth” as well as a “making more $$ by not holding miners” perspective, this is sensible.

However, I do wonder how much of the ESG approach stands up under the microscope. ESG funds often claim to deliver outperformance relative to ‘vanilla’ funds, due to their ESG framework. This doesn’t make sense to me.

I wonder – what do ESG funds do that your garden variety fund doesn’t? Is it that parts of the ESG approach add value, or is it that non-ESG funds (i.e., the comparative sample) are not doing their job to the kind of minimum standard that an investor should expect?

I know that there is real demand for genuine ESG funds. I think they are a beneficial addition to the investment universe and may actually deliver some social good. There still seems to be a disconnect between their advertising and what is actually being delivered. Consider these factors:

Environment – miners/oilers, cleanup, environmental risks (spills etc), waste products (slag/tailings, chemicals), electricity/water requirements, relationships with locals (Exxon Valdez, Samarco), hacking/ data security

Social – sweatshops in China, child labourers in African cobalt mines, abusive business models (e.g. gambling), predatory lending, poor treatment of employees (e.g. illegal underpayment) & I would argue things like franchisee abuse also fall into this category

Governance – are the board & mgmt aligned with shareholders or feathering their own nest? Are incentives and other governance issues (e.g. trust accounts, related parties, etc) in order? Is the asset manager willing to vote ‘no’ and/or potentially advocate for changes in problematic areas?

It is my amateur view that analysts/managers that do not form a view of these issues when buying a company, are literally not doing their job. While there are of course differences between funds, it should not be possible for ESG funds to achieve a sustainable performance advantage simply by analysing these types of issues and avoiding the worst risks.

As a result, the ESG claim of outperformance does not intuitively make sense to me. While the evidence of outperformance itself is convincing, I do not believe that it is due specifically to ESG factors. I would guess that the claimed outperformance comes as a side effect of the ESG approach, via a couple of factors:

Avoiding many weak/cyclical business models (miners, oilers, subprime lenders)
Selecting firms with better governance (research suggests that better governed firms perform better)
Running a genuinely active approach (in combination with #1, above) relative to index hugging funds
Being measured against a relatively lame sample of non-ESG funds

ESG firms are also a smaller part of the market relative to the ‘vanilla’ funds that they are being compared against, which makes me wonder if there is a size effect to consider.

It is hard however to make a concrete judgement either way because the data I have seen is not ideal. Definitions of ESG funds vary and of course ESG investment strategies differ widely. Some research measures “responsible” funds relative to the average large cap equity fund. I have read a number of articles/ reports like this from Canstar and RIAA over time, but if someone could send me a convincing report of decent length, I would appreciate it. This chart from RIAA shows ‘Responsible‘ fund performance vs regular ‘Large-Cap’ funds:

Fork me with a hot poker, being a responsible manager of investor capital achieves better returns! How could we have known? (amazing…)

With ESG I very strongly doubt that a criteria like gender equality, for example, is a material contributor to investment returns, yet it is a metric on which some funds can measure companies/ management teams/ boards. I’d love to see more women on boards, because successful women are a powerful social good (Rowena Orr, amiright?), but, investing in companies with more equal representation should not deliver 2.5%p.a. extra performance over 10 years.

I know that that is only one metric, but it just doesn’t make sense. Investing in companies with a great culture that achieve equal representation as a by-product of a great culture for example, makes a lot of sense when it comes to achieving higher investment returns. But that is very different to using a static criteria – and notably, non-ESG funds should be able to identify a great culture just as easily.

I think in certain circumstances, another common criteria like a mandated number of independent directors could be damaging to performance. Ben Kerry recently shared this letter from Constellation which gives a decent explanation as to why. I’m sure there is no shortage of companies that need better boards, more female reps, and more independent directors – but putting warm bodies on the board so that they can meet criteria is an exercise in box ticking. The real situation is likely far more nuanced and requires a case-by-case evaluation, and this is something that an ordinary manager should be able to do just as well as an ESG fund.

My point is that much of the ESG approach, such as selecting for better governance and avoiding poor business models, is already available to and utilised by non-ESG funds. As to some other ESG metrics, I am not convinced that they, in and of themselves, deliver greater investment returns.

Having said that, there are elements of the ESG approach that I believe do add performance value. A company focus on treating employees well, for example, is not a make-or-break investment criteria for most of the investment managers that I read. Still, there are enough examples of treating employees well (Costco) and poorly (Amazon, Walmart) that I can believe this part of the ESG approach adds value.

If there were 1000 Amazons, and 500 of them treated employees well and 500 treated them as the current Amazon does, for example, I would bet that there is a robust statistical difference in performance between the two groups over time. In any one situation, like the current Amazon, employees don’t need to be that happy for a company to deliver great performance. Over time & repeat iterations however, things like regulatory risk and unionisation may catch up. I think this part of ESG may add genuine value.

On another front, given that many ESG firms are boutiques, I don’t think it is easy to say that the ESG approach itself generates outperformance when the comparison field is large cap retail managers like Perpetual. A more appropriate comparison (when determining if the ESG approach itself delivers outperformance) would surely be boutique non-ESG managers. Look at the above chart – the comparison large cap managers haven’t even matched the index over the last 10 years. It’s not exactly a strong comparison sample.

I see it this way – in reality ESG funds (and many other funds) may tend to outperform the average large cap retail fund. But in a perfect world, comparing a large sample of pound-for-pound identical funds with the only difference between them being the ESG vs non-ESG strategy, it is my view that much of the claimed performance benefit of ESG would disappear.

I am sure that there will be howls of protest, but I think that much of the claimed performance benefit of ESG funds is likely down to a) a better pool of candidate companies, b) selecting for better governance, and c) being compared to a bunch of mediocre closet indexers, rather than ESG criteria in and of itself being a driver of greater performance.

I consider ESG factors when I invest and, all else being equal, I would far prefer to put $ into ethical and sustainable companies. But ESG is quickly becoming a buzzword, and I think it is crucial for would-be ESG fund members to consider why the claimed benefits of ESG are actually being delivered.

I have no financial position in any company mentioned. I am not employed by and do not have any financial relationship with any asset management firm or ESG firm whatsoever.

I disclaim that this is a general article. I am aware that not all ESG firms are smaller boutiques, and that not all large cap managers lag the index. There is clear potential for sampling error and bias in every claim I have mentioned above. I still think I make a fair point that is worthy of discussion.

A Presentation to the Management of Oliver’s Real Foods

Fri, 18 May 2018 09:39:46 GMT

Last Friday I sent this presentation to Investor Relations at Oliver’s Real Foods with a request that it be brought to the attention of senior management. I wanted to give Oliver’s some advance warning and give them the opportunity to comment or correct me, if they chose. I did not receive a response from Oliver’s, so I have published the presentation. (Oliver’s has subsequently advised me that they had read the presentation.)

Here it is:

I am writing an open letter to Oliver’s Real Foods (ASX: OLI) to make some suggestions for several simple ways in which I think the company could improve its offering.

The short version:

It is my belief that:

Oliver’s can improve the quality and commercial productivity of its social media several-fold via a change in social media strategy and a more directly commercial focus.
Oliver’s should develop a brand voice, which I think will contribute to the productivity of the social media accounts and responsivity of viewers.
Once social media is sharpened up, Oliver’s should begin running very modest promotional campaigns on Twitter and Facebook, evaluate the response, and use these to inform its future marketing and promotion.
Oliver’s has several opportunities to improve per-customer spend via upselling, creating food ‘combos’, as well via promotion and growing customer familiarity with the products (e.g. via social media).
The promotions and social media should feed off each other, helping generate extra interest in the Oliver’s business.

The long version – Social Media:

I have mentioned previously that I am somewhat concerned about the Oliver’s Real Foods (ASX: OLI) social media accounts. There are a few issues with responses to reviews that I highlight in that linked post, but overall I think the company could use its social media accounts much more effectively.

I’m going to focus on a couple of recent posts here. I know that they are not representative of every post Oliver’s has ever made, but the problems with them highlight some weaknesses in Oliver’s social media strategy that I think should be fairly straightforward to improve.

For example, consider this post (which has since been deleted):

And this one:

Here is a general overview of Oliver’s recent tweets (as of ~16 April, when I began writing this piece):

I have four key criticisms. I believe that:

The first two posts are a) manipulative and b) set up a combative us-vs-them dichotomy (meat eaters / non meat eaters for e.g.). I have a sense of humour, but it’s not hard to imagine a customer looking at that and saying “hey who is Oliver’s to tell me that I should be a vegetarian?” Given that carnivores are >90% of prospective customers, Olivers has to be cautious here – note the customer comment on the meat eating post. Anyone that’s worked in retail will tell you truthfully that customers are ~~arseholes~~ prone to actively seeking out reasons to become offended. As a result, it is risky for any brand to stick its head above the parapet with these types of posts. Afterpay was stung by public backlash to a similar thing recently.
Oliver’s risks alienating customers. Last I checked Oliver’s sells chicken dishes, and the vast majority of the population still eats meat, so why is Oliver’s posting anti-meat eating propaganda? Oliver’s services highway rest stops and must cater to a wide range of potential customers in this niche. Perhaps Oliver’s has data on differences in spending habits (e.g. vegetarians might spend more) in which case it would make sense to market to vegetarians, but this is not marketing.
Oliver’s is missing a significant opportunity to promote its products and brands. Recently I have not seen a single recommendation for an Oliver’s product/ meal on Twitter (see the third image above) . For e.g. this would be a natural pairing with some of the pro vegetarian posts. Oliver’s Facebook account is higher quality and does promote some products (FB being a more populous platform also) but I think there is a dearth of product promotion on there too.
Oliver’s mission statement/ purpose is “To empower our customers to live a healthier and happier life.” It is my view that these tweets (among others) are not consistent with the mission statement because they a) are alienating customers (meat eaters/ fluoride drinkers), and b) are not empowering. The above meat/fluoride posts are propaganda, not a peer reviewed scientific publication or equivalent responsible – balanced – media article that might let a reader educate themselves. I would prefer to see Oliver’s share information from primary sources. I know that management have already put a stop to antivax comments, and I would like to see them place a similar moratorium on these anti-fluoride / anti-meat posts also.

Facebook posts are harder to present in this blog because of their larger size, but here is a summary of Oliver’s recent posts as of 5 May 2018, with a tick representing whether my view on whether that post could generate a direct commercial benefit for Oliver’s:

Oliver’s Shepparton now open ✔
Oliver’s CEO Madigan meeting Shepparton Council
Oliver’s Shepparton now open ✔
Updated cover photo showing OLI moveable feast (I think)
Are you a bean lover? (marketing Oliver’s fresh green beans) ✔
Pic of new Oliver’s bumper stickers
Pic of ladies from Oliver’s Real Food cycling team
Video of construction of Oliver’s Coomera
Oliver’s bumper stickers
Oliver’s greek Yoghurt ad ✔
Sharing a positive review
Sharing a positive review
Sharing a positive review
Oliver’s Shepparton team in training
Oliver’s Shepparton under construction

Facebook is definitely better than the Twitter feed, but there is an overall lack of posts that could lead to a commercial benefit for Oliver’s. I don’t want to seem too critical as I felt that a lot of the posts like the bumper stickers, the cycling team, and the positive reviews, were on-brand and enjoyable even if not directly commercial. Still, I think there are missed opportunities to convey product or brand information to Oliver’s customers. There are also opportunities to sharpen up the customer-facing voice a little:

“You can’t produce quality for cheap… idiot.”

I am concerned that Oliver’s is potentially alienating its customers. Oliver’s has a growing brand, its stores are gorgeous, and it risks damaging its strong initial impression with some of its social media activity. The social media accounts are a major part of the ‘face’ of the company. This face needs to be selected and curated carefully.

With regards to the lack of product advertising on social media, compare Oliver’s accounts to Subway and KFC. The Subway Australia Twitter is seemingly dormant since mid 2017 (previously it was more like Oliver’s than like KFC) but even it contained advertisements for its products. Here is Subway USA:

Here’s KFC Australia:

Oliver’s doesn’t need to be like Subway or KFC – it just needs to use its social media more effectively, which will deliver benefits at virtually zero extra cost. Please don’t hire a social media team – just put about thirty seconds worth of thought and planning into each post. Set commercial goals for social media posts (e.g. growing product recognition, click-throughs to the OLI website, retweets/shares etc), and if the prospective post is not likely to contribute to those goals, then do not post it.

At this early stage in Oliver’s life, my view is the social media goals should be primarily commercial and product/brand recognition in nature – NOT healthcare related. If Oliver’s gets itself set up to a point where it can count on being here for the next 10-15 years (like KFC), then it can look at influencing the national healthcare discussion. However, at this stage my view is that the brand and commercial performance are the overwhelming priority – the company needs to assure it has a commercial future – which implies a need to focus on product recognition and sales.

As a result I call on Oliver’s to sharpen up its social media. I have a list of straightforward, and high ROI suggestions for improvement:

Type out all posts again on Twitter. Do not just post a link to Facebook posts. All posts need to be fully self-contained on each platform because some people have Twitter and not Facebook, and vice versa. Posts like this are not good for attracting traffic, because people cannot see the content and thus don’t know if the post contains anything interesting: https://twitter.com/oliversrealfood/status/987582537944858624 . As an outsider I suspect that the impact of this tweet on sales and branding is zero, and thus entirely wasted.
Do not reply to people by tweeting at them. This clutters the OLI feed which should be solely for brand purposes. If Oliver’s must tweet to people, do it by REPLYING to their post, not creating a new tweet for them. E.g. this tweet contains two sins in one: https://twitter.com/oliversrealfood/status/985685003697774593
Set criteria on what Oliver’s want to achieve with its social media and then cull prospective posts that do not conform to this. Oliver’s shouldn’t use a corporate Twitter account to push a certain view of healthcare on people. What Oliver’s can do is – in a light hearted way – encourage people to be more healthy and provide them with scientific, high quality resources to learn for themselves if they so wish. That said – why read journals about how to be healthy when you can just eat Oliver’s? Additionally, several of Oliver’s products are still high in sugar etc. By posting too much about health, Oliver’s are inviting critical comments from customers or media on the apparent hypocrisy. Please convince customers to eat at Oliver’s and promote the ‘feed your good’ concept without holding the brand up as a paragon of wellbeing. Conceptually speaking, if Oliver’s food is healthy, then convincing people to eat it is a public service – no education required.
Consider the Oliver’s social media account ‘voice’. For example take this Facebook post:
Oliver’s CEO (right) and Project Director with John Mackey of WFM.

Consider whether it is ideal for Oliver’s to post in the “CEO Voice”. I think it’s great that OLI staff are meeting people that can inspire or improve the brand. That part isn’t a concern – the concern is that Oliver’s cannot expect 24 million people in Australia to relate to its CEO. A brand voice (Oliver’s) can have more penetration and pull when it comes to targeting customers – specifically because a brand voice takes the humanity out of the equation and simply targets human needs: Do you like fresh delicious food and feeling healthy? Then you’ll like Oliver’s. Contrast this with “Do you like Jason Gunn telling you about fresh delicious food and feeling healthy?” The emotional proposition for a potential customer in the second example is clearly more complex.

I would generally argue that a simpler proposition is almost always more effective, and intuitively I would assume that fewer people can relate to Jason Gunn than can relate to eating well and feeling healthy. That’s not a criticism of Mr Gunn in any way – just a reflection that Australia is diverse and so, presumably, is the clientele at highway rest stops.

Oliver’s doesn’t have to remove the CEO from the advertising – instead the two could work in concert. Some customers like a personal touch, and may respond better to Jason’s more personal approach and ‘championing’ of the healthy lifestyle, while others may find the more generic, overarching Oliver’s brand-voice approach to be more appealing. This way Oliver’s gets two marketing approaches for the price of one, rather than combining the CEO voice and the Oliver’s voice, which is what happens currently. It is my view that the ‘CEO voice’ on the social media feed results in the social media not working as well as it could or should. Plus, now that there is a new CEO – who will tweet? Does the brand identity have to change to reflect the new CEO? You can see the concerns, and this is why I think Oliver’s needs to develop a brand voice for its social media.
Promote the company in a way that generates specific interest in Oliver’s products. A food company should post about its food. Customers don’t buy; they get sold to. Oliver’s has ample room to start promoting its deals and prices to customers, which is important for making these products part of the consumer psyche. Oliver’s needs to get people thinking specifically about eating Oliver’s, much in the same way as I am thinking about a KFC large popcorn chicken combo with a 600ml Pepsi Max for $14.90 at the moment.
Use social media to generate general interest in Oliver’s. This is a separate point from promoting specific meals or deals, above. Consider this – name me five Oliver’s Real Food products. Then name me five Subway, McDonald’s, or KFC products. I would bet that Subway recognition > Oliver’s recognition in the wider population. This is a concern because the prospective customer can’t think “gee I’d love to have an Oliver’s pita pocket with a lemongrass lime and bitters Red Dragon Organic”, if the customer doesn’t know that these products exist. Social media is a literally zero cost way to promote the product list, so this channel really needs to be leveraged. Oliver’s also has the option to reach a reasonable number of new customers via paid promotions on Twitter and Facebook.
Consider using paid social media campaigns to promote Oliver’s, once social media is sharpened up.
Oliver’s may be doing this already (I haven’t been able to see any campaigns) so apologies if this is something that is already in the works. Once social media is sharpened up and commercial posts seem to be working, consider using small paid campaigns to build OLI product awareness. It’s possible to run a decent campaign for minimal cost – a friend of mine that uses Facebook advertising for business recently obtained the following rough quote for me: “a 5-day campaign targeting men aged 35-65 around Australia would get between 12,000-60,000 impressions (appearances in the Facebook feed) per day and cost $1000 total.” There’s plenty of room to fine-tune the targeting to specifically promote new restaurants or new products/deals etc. Shareholders will never notice the cost of a modest social media campaign, but the benefits are potentially sizeable. Oliver’s is only just entering the consciousness of many customers for the first time. A little effort can have a disproportionate benefit if a positive first impression for new customers can be generated.

Given that a very large number of prospective customers probably haven’t encountered Oliver’s yet, it is my view that the company’s public face, advertising, and social media accounts are even more important than they sound on paper.

I have a couple of other suggestions that were borne out of my thoughts on the Oliver’s social media account and my recent store visit.

Oliver’s should develop a signature dish or two if it has not already. Zinger Burger, Rippa Sub, Big Mac. What is Oliver’s specialty? The beans? Given that I keep a close eye on the Oliver’s Twitter and Facebook feed, I should know what the signature dish/es are – but I don’t.
Develop meal/ deal promotions and use these to feed the promotional machine at Oliver’s social media. I could not see any ‘combos’ or ‘deals’ in a recent store visit. What should I drink with my toast? As a new customer – and most Oliver’s customers are new ish – it is hard to know what goes well with a meal, if the restaurant doesn’t tell you. This also ties into the idea of whether Oliver’s is a QSR or a Café, which I’ll discuss below. QSR’s are all about meals or combos, whereas cafés appear to have a different modus operandi.
Use promotions or ‘meals’ to up-sell or cross-sell products with the commercial goal of lifting transaction volumes or spend $ per customer. What are the natural pairings with Oliver’s foods? Oliver’s could create ‘meals’ or ‘combos’ – add a coffee for $4, add an ice cream for $3, etc. By upselling existing customers, Oliver’s avoids incurring the Customer Acquisition Cost (CAC) that it ordinarily would if it had to attract a new customer to sell that item to. This means that each new product that an existing customer buys can make the restaurant incrementally more profitable. I expect it would also be possible to increase sales of slower moving or higher margin items via this method.
Consider developing and testing a store layout over the next year or two, with a view to minimising staff walking distance and improving the speed of service, and eventually standardising this format across multiple stores. Look at Subway, which delegates each part of the meal (initial customer greeting & bread selection, fillings & sauce, cookies & drinks) to different servers, reducing ‘transit’ time. KFC has the vertically stacked heated trays accessible from both sides (kitchen at back, customers at front). Oliver’s can’t necessarily do that but I think there will be meaningful gains to be made in time from standardising the store plan and making it more efficient. All proper fast food restaurants typically split staff between customer service and food production, resulting in faster service. Oliver’s seems more of a ‘café’ setup to me, with the open serving area and the same staff both serving and making food. This is something that management should be aware of, especially if trying to market Oliver’s as more of a quick-service restaurant proposition. I have previously made some comments on potential speed of service issues here.
Consider the way the business is positioned/presented to customers. Is Oliver’s a QSR like KFC or Subway, or is it more of a café like Gloria Jeans? I have no strong opinion on which would be best, but I think that crystallising the proposition – so that customers know exactly what they’re getting when they go there (QSR or Café?) – would add value over time.
Develop obsessive attention to detail and focus on small things, like what are the most popular dishes, do vegetarians spend more/less than carnivores, what food/drinks most commonly get paired together – don’t just focus on the store rollout. The board should strongly consider whether adding in some alternative, qualitative metrics in exec compensation such as growth in # of transactions, customer satisfaction, efficiency of marketing spend, would generate better outcomes than just incentivising store openings or hitting earnings targets.
Clarify the drivers of same store sales (SSS) growth both internally and in market presentations. So far it is unclear as to whether Oliver’s SSS growth is due to higher foot traffic/transaction #s, or higher spend per customer, or price increases, or growing restaurant maturity. I suspect that after price increases and restaurant maturity, transaction numbers are effectively flat. If Oliver’s improves its social media and advertising, it needs to be able to have metrics available to measure its success – e.g. by rising foot traffic, higher average transaction value (higher spend per customer) etc.
Consider simplifying the menu if necessary to ease supply chain pressure/risk. Oliver’s has a fairly big menu and the logistics of supplying this must be complex – and will likely get worse due to the centralised kitchen as the store network expands. I am not sure where I would start to simplify it, but it is my view that the larger the menu, the harder it is to supply fresh food to a growing number of stores and ensure that food is always fresh when customers ask for it. I would like to see Oliver’s at least consider whether a menu simplification would be beneficial, and/or consider (and explain to the market) if upgrading the central kitchen and distribution capabilities will be necessary. Either way, I feel that the supply chain is crucial to this fresh food business. I would like to ask that Oliver’s present additional, detailed information on its supply chain and kitchen facilities in a future presentation quite soon.

On a separate note, with Oliver’s not being a franchise, I have wondered if there is an internal bias that prevents Oliver’s from aiming to lower its prices. Franchises are always motivated to lower their prices, as this can increase customer #s and grow revenues, despite lower prices. This means lower prices are a winner for the franchise owner because, when revenue rises, the franchise owner (who gets paid a % of revenue) takes a larger cut from the franchisee. Thus a franchise owner is almost always structurally incentivised to lower prices. This is something to consider vis-à-vis Oliver’s competitive position over time. Can Oliver’s withstand competitors continually lowering prices? More pointedly – is a healthy food proposition strong enough to resist competitors continually lowering prices? I have no real view on this either way, and it is not an immediate concern, but something to think about.

One last comment:

I believe that if the above opportunities are apparent to me, a person of no real expertise in the QSR industry, then there are likely several other potentially beneficial ideas lurking in the wings for an industry expert to uncover. Oliver’s has a noted QSR private equity investor on its board, and IOOF Holdings (Perennial) recently took a reasonable stake in Oliver’s. Oliver’s should get in touch with IOOF’s (and other funds) analysts and ask them to visit stores and contribute ideas for lifting foot traffic, speed of service, spend per customer, and all the other things that make a commercial restaurant. A large OLI shareholder would also most likely share their research with management for free if asked. I think this could potentially be a gold mine for identifying good ideas and customer pain points, especially if the analyst is a QSR/café expert.

I think that Oliver’s has a lot of room to sharpen its offering, in a variety of ways, over the coming weeks and years. I think the suggestions that I have made above could add meaningful value at relatively little cost, and I would like to ask that management and the board consider implementing them.

Thank you for your time.

I own shares in Oliver’s Real Foods. This is a disclosure and not a recommendation. I was not remunerated for this presentation in any way, although I do stand to benefit from any increase in the value of the Oliver’s shares that I hold. Full details of my entire Oliver’s holding are at the bottom of this article here.

I gave Oliver’s management the opportunity to review this post before publication. I did not receive a response and thus have not made any changes. The invitation remains open so if Oliver’s wishes to make a response, I will publish that at a later date. This version of the presentation is very slightly different to the one I sent to Oliver’s. I have made some small changes and added a couple of sentences for clarity. Otherwise it is identical.

Big Trouble In Big Un

Sat, 24 Feb 2018 05:03:07 GMT

I am totally staggered by this BIG situation, but I’m late to this story. Although I thought the Tipsly transaction was unusual, I didn’t pick any problems with BIG and in fact I had a hard look at its books late last year and I couldn’t see any obvious warning signs. So I did not tip off AFR, I do not have and have never had any kind of investment position in BIG, long or short.

I wrote last month that I thought Getswift (ASX: GSW) was in deep shit with the regulators. I know that several people reported them and their adviser firms to ASIC for possible breaches of the Corporations Act. At the time I thought Getswift and it’s onetime $700m market cap were pretty ‘special’. I didn’t think I’d see anything like it again for quite some time.

Then along came Big Un Limited (ASX: BIG) which has totally blown Getswift out of the water. If Getswift was in deep shit, I think BIG is totally fucked. Totally. I think it is a zero and I think it never trades again. The latter statement is based on this little hint from the ASX:

And ASIC:

I’ve seen maybe 30-40 suspensions at ASX’s pleasure (listing rule 17.3) but I’ve never seen those two little words. That’s the biggest clue that this is serious. You didn’t see those two words in the Getswift 17.3 suspension. Yet ASIC is inquiring here.

Overview

Even if you are still a believer in BIG, the simple fact that so much of this stuff was seemingly not released until the ASX forced them to is a huge red flag in itself, in my opinion.

Here is an abbreviated list of problems I spotted in yesterday’s announcement:

Response #5: Customer substitution

It appears that First Class Capital (FCC) advances cash to BRTV to fund a video. If the customer is unhappy and doesn’t pay, BRTV can substitute another customer in without penalty. This is bizarre because this (and a couple of other things, below) says to me that FCC is not incentivized to care about the credit quality of the people they sponsor. This is because BRTV appears to carry all the risk of the customer defaulting:

Response #29: At any time that a Default Event continues (and has not been remedied by BRTV) ….FC may: …c) demand and recover any or all of the Secured Money from BRTV.

Response #30: If a Default Event occurs, BRTV must indemnify FC against any loss resulting directly from an Offer Amount…

Although, that doesn’t completely make sense because Response #27 says “As such, BRTV does not guarantee the repayment obligations of the Customers.”

I understand that to mean that BRTV doesn’t have to repay the 12 x $1000 monthly payments for customers – it just has to repay the Offer Amount ($12000). Which isn’t much of a difference.

Response #34 says: “where BRTV simply stops using the Sponsorship Pool, FC agrees that BRTV has no further obligations in relation to contracts with customers which have been the subject of Final Acceptance by the Customer.”

Do these obligations include BRTV’s obligation to indemnify losses? Where does the ultimate liability lie?

My confusion may be due to the pre- and post- acceptance phase from the customer. After the customer agrees to pay for the video, then collecting that seems to be FC Capital’s responsibility. Before that however, it appears to be BRTV’s issue. This is still a concern given most customers are in the pre-acceptance phase (more on this below).

So it is not certain what role FC Capital even plays – if BRTV carries all the risk, it should just extend credit to customers directly. However, that would have made its cash flows look really bad – paying the cost of creating the video up front and then only taking repayment over 12 months. BIG would also not have been able to grow revenues and cash receipts nearly so quickly.

As BRTV seems to be on the hook for repaying FC Capital, FC Capital has no real incentive to control its lending in my opinion – it can issue as much as it wants (up to $20m, subject to covenants) because BRTV will repay it and FC gets huge fees. In my opinion this is a very circular arrangement:

There has been some confusion (on my part also) whether this is a representative diagram. Here is an alternative explanation via website HotCopper that could also make sense.

I think BRTV carries virtually all of the risk, given the security over its assets as well as the fact that most customers (for which cash has been advanced) are still in the pre-approval phase. FC Capital can refuse any customers it wants (cherry picking the risks) and if that happens BIG has to either come up with another customer or refund the Offer Amount plus a 24% commission.

In my opinion this is not a sponsorship, but an extremely expensive working capital loan. There is an additional concern about this arrangement:

No business willingly gives away a 24%(!) commission to their financier while simultaneously indemnifying their financier against losses. This to me signifies that BIG is desperate and that most of the power in the arrangement rests with FC Capital. I also think this means that the BRTV business is lower quality than was otherwise apparent, because it implies an inability to seek alternative sources of finance.

It is staggering that the payment terms have not been disclosed previously (as far as I know). In this light, I think BIG’s Response #15 “SME financing is broadly used and well understood in the market” appears disingenuous. It’s factually true, but I doubt SME financing on BRTV’s precise terms is widely used, if at all.

Given that FC Capital has security over all of BRTV’s property, it looks as though BRTV is basically borrowing against its assets (at 24%p.a.) in order to extend money to customers that then comes back through the front door as revenue and cash flow. FC Capital holds onto 65% of all monies and BRTV is apparently obligated to indemnify them, so FC Capital appears pretty unlikely to have to bear any losses.

In my opinion this is a concerning arrangement and smacks of desperation. Notably this is not recorded as a loan on the balance sheet, and I think that that has the general effect of overstating BIG’s financial position, the quality of earnings, and the amount of growth that has occurred.

It also seems unusual that FC Capital is only financing 35% of receivables, since it keeps 41% as security. Many debtor finance programs will offer 50%-80% of receivables or more. In the ASX announcement (p.39, Q25 (b) ), BIG said that $19.8 million is held as Security Deposits. This compares to ‘approximately $19 million’ of the Sponsorship pool that has been used. It is not clear why ~104% of the Sponsorship Pool is held as security, given the security deposit is supposed to be only 41%. I’m not sure if I understand this correctly, but why is BIG paying 24% per annum for an arrangement where its financier appears to have more than 100% collateral?

On a different topic, hypothetically speaking, if BRTV had no real customers using the FC Capital arrangement (and I am not saying that it doesn’t) then this would be a scheme to inflate revenues and cash flow. That is why some of the media reports of customers not being aware that they have open accounts are concerning.

Description of the First Class Capital deal:

In the original announcement in Dec 2015, the wording of the FC Capital deal doesn’t really explain the true nature of the arrangement, in my opinion. It indirectly hints at debtor finance, but it doesn’t even explicitly state that it is a debtor finance arrangement (where FC Capital extends credit to BRTV based on BRTV’s receivables from customers).

The use of the word ‘sponsorship’ of customers I think is materially misleading, especially in context of the terms which make the arrangement look a lot more like a working capital loan – not debtor finance – since FC Capital appears to advance cash before a paying customer is secured (more on this below).

To me this is another big red flag as the wording has (whether intentionally or unintentionally) significantly clouded the true nature of the arrangement, in my opinion.

Response #8: Videos add value to BIG even when customers don’t pay for them.

Even when customers don’t pay for their BIG videos, these videos have ‘material long term value’ because they populate the video review platform and content library. They make BIG’s platform look ‘lived in’, I get that. But how is BIG going to “develop strategies for using these assets to generate revenue” ? If the customer doesn’t like the video, they wont use it. In my opinion, it is hard to see who is going to subscribe to advertising videos of random restaurants.

Plus, given that the customer already paid for their videos, is BIG really going to ask them to pay some sort of annuity revenue for its continued use as well? Doubt it. Videos have a limited shelf life even when used in advertising. In my opinion, they are consumed and then after a while they are old.

Response #54, and #60 (Q.1-3): BIG did not correctly disclose the arrangement to issue discounted shares to FC Capital.

I think this is a red flag, administrative error or not. Given the terms of the financing I describe above, the subsequent decision to issue shares to FC Capital without proper disclosure is concerning, especially given it took a year to execute the agreement (during which time the value of the shares rose manyfold).

Tipsly:

I thought the Tipsly acquisition was pretty concerning.

Tipsly website registered in February 2017
Deal negotiated in May 2017
Tipsly LLC wasn’t registered until five months later on 20 October 2017 (to Tyler & Ryan O’Rear)
Tipsly was acquired for 3m BIG shares at $0.60 plus another $2.4m in cash and scrip
An additional 1.8 million (valued at over $3m at time of issue) BIG shares were paid to Thirty Three Affiliated Holdings, (of which Doug, Cydney, Tyler, & Ryan O’Rear are directors) in return for ‘services’. It’s not clear what this was for, nor what services were provided that weren’t already included in the Tipsly transaction.
Until very recently there were videos on Youtube (via Brandon Evertz’ YouTube account) that showed Doug O’Rear at social events with (presumably?) the BIG CEO, suggesting a social connection:

Here is the first link and the second link (videos have been removed).

The above videos were already hidden on YouTube. They were apparently embedded on the Big Review TV website using YouTube and you had to have the exact link to watch them. (They are now completely taken down).

I’ve been told that Big Un’s explanation for the timing of the LLC creation was that Tipsly was not set up for acquisition, but something about that does not sit right with me. I can’t think of a good reason why Tipsly would not already have its own LLC, especially since it was supposedly just about to launch when BIG offered them a deal.

Others have pointed out issues with the seeming quality of Tipsly’s tech:

The first tranche of Tipsly was bought by $BIG for its tech prowess. https://t.co/Xjm0LCVCgA is built on Shopify using a third party template : https://t.co/N8Tw6j8Pch pic.twitter.com/AMVF1mayPh

— Fred McBill (@fmcbill) February 12, 2018

And:

The first tranche of Tipsly was bought by $BIG for its sophisticated app. Tipsly app images are from iOS template Routes by Beans UI Goods in Sweden. https://t.co/oDvxdzVEUW pic.twitter.com/jP9WhqzpEk

— Fred McBill (@fmcbill) February 12, 2018

Also:

Who were the recipients of 3M $BIG shares issued on 22/01/18 for the acquisition of the “Tipsly Mobile Application Technology”? Market value at time of issue: $10m.

Tipsly app images are from a template available for $38.

No escrow according to 3B. Have they been sold already? pic.twitter.com/X6WXYQpOic

— Fred McBill (@fmcbill) February 20, 2018

If you look around the Tipsly site there’s certainly not much there. I have been checking for a while and I haven’t been able to find the app in either the Android or Apple store. (I don’t have an Apple or an Android device though, so if you check today and that has changed, please let me know).

Questions from the Second Aware Letter

This part appears to show a considerable amount of churn at BRTV’s customers. There are apparently minimum conversion ratios (that didn’t seem to be specified) to prevent BIG holding on to finance forever, but they do not appear to be a high threshold.

If I understand correctly, seemingly only around 1 in 5 customers (791 out of 3,518) that is presented with a video actually accepts it (accepts the agreement to pay FC Capital):

That suggests that BRTV has to do a lot of sales activity to win replacement customers, whatever they say about their pipeline. This part is even worse:

So $18 million of last quarter’s cash flows came from FC Capital for POTENTIAL CUSTOMERS. These are customers that have “not yet accepted a video but have not been declined…”. As we saw in the above table it looks as though only around 1 in 5 Potential Customers go on to become an Accepted Customer. This implies a significant contingent liability for BRTV in the event that it cannot find customers to replace them. To put it another way, if BRTV for some reason cannot replace customers, I think its cash flows could be something like 80% overstated (possibly even more, given that all cancellations seem to require full repayment, plus the 24% commission to FC Capital).

Another concern in my opinion is that the other $2.3 million cash receipts came from ‘pilot sponsorship programs’ in the USA. Remember how I said the FC Capital sponsorship program looks like an expensive working capital facility? I wonder if these two US sponsorship programs are established on similar terms.

If so, that would be a concern, in my opinion, because it could suggest that basically 90% of BIG’s cash receipts last quarter (There was a further $2m from general advertising) were from entities that are financing BRTV customers via BRTV basically borrowing against itself. Also, just under two thirds of BIG’s reported cash at bank is actually held in security by FC Capital.

I think it would be a grave cognitive error for an investor to attempt to rationalise or explain away this situation. If you are not concerned about the recent disclosures then, in my humble opinion, you really, really should be.

P.S. and if you got to the end of all that and you’re either a) asking WTF is going on or b) thinking that 10foot is an outrageous downramper with no grasp of what a good business looks like, ask yourself this simple question:

Why does BRTV have to borrow at 24% per annum to grow its business?

I have no, and have never had, any financial position whatsoever in any company mentioned, listed or unlisted. This is a disclosure and not a recommendation.

Getswift: Data Talks, Bullshit Walks

Sun, 04 Feb 2018 09:59:12 GMT

The title of this piece comes from an interview with Getswift (ASX:GSW) executive chairman Bane Hunter. He’s spot on:

Hunter has a clear message for all startup founders seeking US investment:

“Data talks, bullshit walks,” he says.

He advises founders to “be conservative and over deliver” when speaking to investors, because “everything you say is going to be recorded and measured”.

“When you come back 6-12 months later everything can and will be used against you when you raise,” Hunter says.

I’m looking at Getswift’s latest quarterly. At first glance there’s a fair bit of ‘walking’ going on. Or to quote another prominent elder statesman figure, Marshall Mathers:

“It’s quicker to count the things that ain’t wrong with you, than to count the things that are.”

Cash flows lag revenue and the difference has blown out this quarter
Cash flows fell despite ‘geometric’ revenue growth
Interest payments don’t correlate with cash balance. (Getswift paid $15k in interest expense despite having no debt and $26m in the bank.)

I can think of 4 possible explanations, and I’m going to throw around a few ideas:

Getswift could be booking revenue on free trials that goes unpaid when clients discontinue. This could explain revenues running ahead of cash flow but does not explain interest expense.
Getswift could be recording revenue at its ‘headline’ delivery fee (26-29 cents per delivery) but only getting paid cash at the fee rate it’s negotiated with clients (much lower than the headline rate – ~13 cents or so). This matches the below table, and could explain revenue and cash flow but not the interest expense.
Getswift could be running free trials, recording revenue and financing the subsequent receivables (via debtor finance) to show cash flow. This could explain the revenue/cash flow difference (lenders won’t finance 100% of receivables) as well as the unusual interest expense.
Getswift could be counting the interest on its cash balance as ‘receipts from customers’. That would be pretty unconventional but the numbers roughly fit. That could explain cash receipts but not the interest expense.

Sure, that’s just speculation on my part, but there are some meaningful discrepancies here – and how would you know otherwise? Company disclosure is less than zero.

Quarterly revenue vs cash flow:

Quarter	Revenue	Cash receipts from customers	Delivery #s	Fee per delivery (revenue basis)	Fee per delivery (cash basis)	Net cash difference (compared to prior quarter revenue)*	Cumulative cash difference LTM
Q218	$321,000	$160,000	~1.2m	$0.27	$0.13	-$95k	-$70K (8% of Getswift’s LTM revenue hasn’t turned into cash)
Q118	$255,000	$175,000	~0.996m	$0.26	$0.18	+$23k
Q417	$152,000	$128,000	~0.73m	$0.21	$0.18	+$11k
Q317	$117,000	$54,000	~0.5m	$0.23	$0.11	-$8k
Q217 (IPO 9 Dec)	$62,850	not stated	~0.34m	$0.18	not stated

(note that figures above have been rounded off and are not precisely correct)

*To see if there was a payment lag I subtracted cash flow from revenue in the prior quarter. For example Q218 cash receipts are $160k, vs Q118 revenues of $255k. Even if actual cash payment falls through into the following quarter, there is still a huge hole not being filled.

A more concerning implication is that, if you assume that 100% of the revenues booked lead to cash flow, up to ~$80k of this quarter’s receipts from customers could be due to last quarter’s revenue. Last quarter, Getswift had $255k revenue but only $175k receipts, i.e., $80k was unpaid. If that $80k got paid through in this quarter instead, then Getswift only earned $80k in receipts from customers in Q218. Overall cash flow also declined vs last quarter. I can only guess that Getswift is accruing revenue that it does not earn.

Getswift is reporting ‘geometric’ revenue growth but cash flows persistently fall short. This is surprising because Getswift’s revenue recognition policy from the 2017 annual report states:

“For contracted customers, the revenue is recognised on a monthly basis, when the group is able to reliably estimate the underlying value of service provided for the period. This is determined based on the number of task deliveries and SMS values tracked.”

However “For pay as you go customers, the revenue is recognised at the point when the cash payment is received from the customer.”

Under the PAYG model, there should be virtually zero mismatch between cash flow and revenue. Ergo most or all customers must be ‘contracted’. However, Getswift confused the issue in its ASX announcement last week. The company said:

“Regardless of any POC (proof of concept) period, because the contracts are pay as you go, clients that wish to no longer use the platform simply cease using it and this is then reflected in our periodic reporting of delivery transactions and revenue.”

This does. not. make. sense. If the contracts are pay as you go, Getswift should record the revenue when the cash comes in and there should be zero mismatch with revenue. Is it contracted or not? I cannot be sure what to conclude from this, but to me it looks like a yellow flag from a company that is rapidly becoming a byword for poor disclosure and overly optimistic statements.

Getswift turns Chinese

$26.5 million cash at bank at the start of the quarter (the big capital raise came right at the end of December and so likely did not contribute anything). Zero debt. $0 interest income. A net interest expense of $15,000. Getswift is Chinese, apparently.

Where’s the cash? Where’s the interest income going? 2.5% interest on $26.5m = $663k per year. Divide by 4 to get a quarterly figure = $166k. Getswift’s receipts from customers for this quarter was $160k. Coincidence that those numbers are so similar? You tell me. Surely they wouldn’t record interest income as receipts from customers? Surely they wouldn’t keep all their cash in a business account earning 0% when the interest income is so significant relative to receipts? Surely..

Last quarter Getswift recorded $64k in interest which is about a 1% interest rate, but roughly makes sense in context of its cash balance and the timing post- capital raise. I cannot reconcile this quarter’s figure at all.

Where it at?

Also worthy of scorn is Getswift’s raising of $75 million to “advance new product development initiatives and general working capital purposes.” Forecast R&D cash outflow next month is $1m. Forecast staff expense is $1.3m. This company has $96 million in the bank.

And working capital? At a software company? Wot?

Ohhhhh wait, yeah if you know your revenues are gonna run well ahead of cash flow, and you’re gonna spend money and not make any, then you need a lot of working capital. Perhaps that explains it.

This company does not make sense. When revenue runs ahead of cash receipts, cash receipts are declining, and the interest income on $26m in cash ($96m, now) suddenly goes AWOL, those are some pretty glaring warning signs. With zero transparency and numerous unexplained issues – not to mention those undisclosed material facts I keep mentioning – in my opinion Getswift is worth no more than its cash backing per share, 50 cents or so. Not only that, I think it’s totally uninvestable.

One thing I would dearly like to ask management and Getswift’s corporate advisors is “at what point does this transition from poor disclosure and optimistic forecasts into a legal and regulatory issue? Cos I’m pretty sure you’re about to find out where the line is.”

With a totally non-independent board, I think that’s a question that needs to get some serious internal airtime.

I have no investment position in Getswift, and will not be taking any investment position. I have no relationship with Getswift, its management, staff, or corporate advisors whatsoever. This is a disclosure and not a recommendation.

Getswift: The gift that keeps on giving

Thu, 25 Jan 2018 04:37:12 GMT

There was a pearler of an announcement from the Getswift (ASX: GSW) this morning. I paraphrase:

The share price didn’t move after we first announced the contract, therefore our Fruit Box contract was not material
When Fruit Box was cancelled, we hadn’t completely finalised our contract with Commbank, but we were sure hoping to, because if we did, then we wouldn’t have to report the loss of Fruit Box
We signed the contract with Commbank shortly after and, given that it would take 12+ months to show revenues, this very large and so far non-contributing contract definitely means that Fruit Box is immaterial

ASX: ‘Has Commbank agreed to use the Getswift software?’

We see no reason why they wouldn’t
Because we see no reason why they wouldn’t, this means that we, unfortunately, don’t have to respond to your request that we justify our statements “revenue will commence in mid-2018” and that we will get “257,400,000 deliveries”. Sorry about that!

ASX: ‘You’re suspended.’

There is an issue of credibility when these things happen. Getswift could have, narratively, been a new company, understaffed, run off their feet, bit too optimistic in the forecasts – whatever – and got caught up in some problems with the ASX. Now they realise “hang on, we’re in trouble here” and they take a step back, make extensive disclosures, share price does whatever, and Getswift lifts its game from here.

In my view, that was most definitely not the case with today’s announcement. Getswift ducked all the substantive issues and gave an unconventional explanation to justify why its contracts were not material. Share price movements are far from the only test of materiality.

Just because the share price didn’t rise on news of winning the contract, that does not mean that it would not fall on news of losing it so soon after. I think this is a strange argument because Getswift didn’t disclose the loss at the time, so there is no way to know if shares would have moved, and thus no way to determine the materiality of the announcement based on share price movements – which is the criteria Getswift used to judge materiality! As a result I don’t think the company can argue it was not material based on the share price alone.

I believe that the Fruit Box contract was almost certainly material in the context of the ASX’s continuous disclosure rules and I showed why in this post.

Then there was this:

A contract, or a contract?

“Regardless of any POC period, because the contracts are pay as you go; clients that no longer want to use the platform simply cease using it and this is then reflected in our periodic reporting of delivery transactions and revenue.”

What is the point of calling it a contract? Sure, there is an agreement on fees and payment terms. However this looks like a pretty soft contract that doesn’t reflect the locked-in revenues that the market has been assuming for Getswift. Getswift has been implying that there are locked in revenues and switching costs by forecasting a full 5 years’ worth of deliveries, even though their customers can stop at any time.

If you look at the prospectus there is another questionable bit relating to these ‘contracts’:

“Discounts are applied to larger clients using a tiered fee structure, based on the client’s monthly transactional volume and the length of contract commitment.”

Why offer a discount for a longer contract if your client can quit at any time? In my view this does not make a lot of business sense. Volume discounts, sure. But why offer a discount for length of commitment if your client is not bound by that commitment? You are literally giving money away for free to any shyster who knows how to negotiate.

Getswift has forecast hundreds of millions of transactions from deals that apparently

a) won’t earn revenue for ~12+ months (Commbank) and,

b) have no switching costs and that,

c) clients can quit at any time.

How much hubris do you need to have to go out there and say that our new software solution with no switching costs, no exit fees, and currently in a pre-pilot phase will, fo shizzle, “result in over 257,400,000 deliveries on its platform over the next five years, with an estimated aggregate transaction value of $9 billion.”

What a fucking shambles.

Getswift earns 10foot’s highest accolade:

Speaks for itself, really.

I have no position in any company mentioned. This is a disclosure and not a recommendation.

What is a material fact?

Mon, 22 Jan 2018 10:17:48 GMT

Not being a hotcopper member myself, I ask that people send me good stuff they see on there. I got this hilarious one overnight:

from hotcopper via the 10foot inbox

I don’t assert that there is anything wrong with Fantastic Furniture or AFR here, but there is a certain humour in having to source a quote from a known fraud (Fantastic’s parent company is Steinhoff) for use in reporting on another company.

Whatever, does Getswift really have a problem or not?

I opined ‘yes’ in Getswift Gets Swifted over the weekend. After some double checking I think it is pretty obvious that Getswift has failed to reveal material facts to the market.

I have taken the following information straight from ASX listing rules Chapter 3: Continous Disclosure, and the Guidance Note 8 which assists Chapter 3. Stick with me, the story comes after the legal treacle.

What do the listing rules say?

3.1: Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information.

That’s straightforward. How do you define ‘material’?

What is material?

Section 677 of the Corporations Act defines material effect on price or value. As at 1 May 2013 it said for the purpose of sections 674 and 675 a reasonable person would be taken to expect information to have a material effect on the price or value of securities if the information would, or would be likely to, influence persons who commonly invest in securities in deciding whether or not to subscribe for, or buy or sell, the securities.

It should be noted that the test in section 677 is an objective one and even if company officers honestly believe the information is not market sensitive, it will not avoid a breach of Listing Rule 3.1 if that view is ultimately found to be incorrect.

The key word here is ‘influence’. According to Guidance Note 8, the information must be likely to play a material role in an investor’s decision to buy or sell a security (i.e., Getswift shares). Day traders are excluded from the definition of ‘investors’.

Material information can include (among other things):

The entry into, variation, or termination of a material agreement
The fact that the entities earnings will be materially different from market expectations

The ASX would suggest that entities apply the guidance on materiality in Australian Accounting and International Finance Reporting Standards, that is:

Treat an expected variation in earnings compared to its published guidance equal to or greater than 10% as material… (..unless there is evidence or convincing argument to the contrary).

Getswift doesn’t do formal published guidance, however I would argue that the forecast delivery numbers combined with indicative $ per delivery amount to the same thing. You can form your own opinion on that. Some examples in Guidance Note 8 suggest that a company needs to provide an update for a material change in earnings, and also that a material change in analyst consensus estimates even if a company does not provide guidance may need to be reported.

An example:

I am going to use the Fruit Box contract here because it is quantifiable, but remember that there are problems with several of Getswift’s contracts according to AFR.

On 24 Feb 2017, Getswift signed a contract for 7m deliveries over 3 years with Fruit Box. This works out to be about 2.3m deliveries per year. At the time, management was talking generally (not in this specific announcement) about getting $0.29 per delivery.

Even using figures of $0.25 and $0.13 per delivery, to account for a wide range of possible prices, the contract is still clearly material in my opinion.

7m deliveries @ $0.25 / $0.13 per delivery = the total value of the contract is around $1.75m / $0.91 million.

Divide by 3 to get a single year’s contribution = $0.58m / $0.3m in expected revenues per year.

Getswift’s annualised revenues at the March 2017 quarter were not disclosed, but annualised receipts from customers were $0.2m, and annualised delivery numbers were 2m. (I multiply actual figures by 4 to get annualised figures).

Getswift’s annualised revenues at the October 2017 quarter (the most recent quarterly) were $1.02m, and annualised deliveries were 4m.

Getswift lost somewhere around half a year to one year’s worth of then-current revenues with this contract. Fruit Box’s estimated contribution of ~$0.3m-$0.6m/year and 2.3m deliveries per year is huge in context of Getswift’s sales and delivery numbers at the time. According to AFR, which quoted Getswift managing director Joel MacDonald:

“In relation to The Fruit Box Group, Mr Macdonald said “it’s not material now“, after saying the contract had been pulled immediately after GetSwift made the statement to the market.“

In my opinion the contract cancellation at the time was very clearly material, and is still material today.

Compare GSW with OLI

Compare Getswift’s behaviour with today’s announcement from Oliver’s Real Foods (ASX: OLI). Oliver’s sold its Maryborough site for $0.2m less than it had previously forecast to the market, and it put out a market sensitive release about it. Oliver’s has $30m in annualised revenue.

Oliver’s is only one tenth the size of Getswift’s market capitalisation, but it is doing 30x Getswift’s annual sales and it thought a $0.2m change was material. I actually think that the OLI announcement was probably not market sensitive, but it definitely shows up Getswift by contrast.

Even if you disagree, these questions (which draw on the Chapter 3 criteria) are also fairly indicative. If the answer to any of the following question is ‘yes’, then the information could be material:

Was Fruit Box material?

If Getswift had announced a big contract (relative to then-current sales) with Fruit Box, and then announced very shortly after that the contract was cancelled and had not progressed beyond a trial, would this have changed your degree of conviction in your investment?
Would the loss of this Fruit Box contract and its ~$1m a year in revenue have resulted in a meaningful change to a change in your valuation of Getswift shares at the time?
Would analysts following Getswift have had to make material changes to their valuation models following the loss of the Fruit Box contract, and would this lead to a change in consensus valuation for Getswift?
Does the news change your current view of the company’s prospects or reduce your degree of confidence/ materially increase your uncertainty regarding its other contracts?
Will the entity’s earnings in the period likely be materially different from market expectations?
Would you have participated in either of the capital raisings if the company had disclosed that this contract was withdrawn?

I would submit that the answers are yes, yes, maybe, yes, yes, and ‘while it might not change the decision, it would definitely change our risk reward tradeoff and would be something serious we would have to factor in’ (and therefore be material).

Alternatively, here is a question matrix straight from ASX (page 3) which also makes it quite clear:

While there might be arguments to the contrary, and companies are allowed to argue exceptions to the rule, by these standards Getswift still appears to have at least one undisclosed, material piece of information on its hands. If Getswift had disclosed this in February last year, it might have interrupted the hype machine, but it wasn’t disclosed and the company has raised capital twice since then.

Was Commbank material?

Getswift also appears to have pulled a swiftie with the Commbank contract, when it first said in April 2017 that it would have a full national deployment in place in 2017. Then in December 2017 (after raising capital twice) Getswift said that both organisations would start marketing it in February 2018 and revenues would commence in mid-2018.

The AFR said that that was incorrect, with Commbank not approving of that announcement and the arrangement actually being in a pre-pilot stage.

Breach of the listing rules

In my opinion, Fruit Box definitely and Commbank possibly looks like a breach of the company’s continuous disclosure obligations. However so far, this situation only deals with the ASX listing rules. These are breached all the time. Breaches are serious but rarely have consequences.

The real concern is if the information that was withheld from the market might have had a material impact on the decision of ordinary shareholders to buy Getswift, and institutional investors to subscribe for a cool $99m worth of new shares in Getswift. In both circumstances, people have handed over very large sums of money into a situation where they may not have been fully informed. That could bring serious legal and regulatory ramifications, not just a slap & tickle from the market operator.

If you are one of those insto shareholders, or a Getswift shareholder that bought in post Fruit Box/Commbank, I imagine that you are chewing nails and spitting tacks right now. If you’re a class action lawyer, you’re probably sharpening your knives and/or rubbing your hands together with glee. And if you’re ASIC, I imagine you’re laying there wondering whether it’s time to get up off the couch.

As I said in my Getswift post on the weekend, much hinges on the materiality (or otherwise) of those contracts to Getswift. I also said that I think Getswift is in deep shit, and it’s not hard to see why.

Like many, I can’t wait to see what the company comes back with tomorrow.

I own shares in Oliver’s Real Foods. I have no investment position in Getswift. I do not intend to take an investment position of any kind in Getswift. This is a disclosure and not a recommendation.

Getswift Gets Swifted: AFR-style

Sat, 20 Jan 2018 02:57:08 GMT

Can you still be a genius if your viewpoint is the same as everybody else in the market? Asking for a friend.

You will know that I wrote about Getswift previously. In that post I focused a lot on the company’s deal with Amazon. I made the silly mistake of assuming that the company’s other contracts were real. According to AFR, they are not.

You should read that AFR article. Go buy the AFR. Buy two. It’s a pretty damning piece of journalism, and it plays my favourite game, He Said She Said.

What Getswift said:

Fantastic Furniture: “Getswift…. is pleased to announce that it has signed exclusive commercial multi-year agreements with BETTA Home Living and Fantastic Furniture.”

Fruit Box Group: “The Fruit Box Group…signs up to an exclusive 3 year contract with GetSwift’s last-mile delivery services solution… Exclusive contract projected at more than 7,000,000+ total aggregate deliveries.“

Commbank: “GetSwift estimates the deal will result in over 257,400,000 deliveries… Rollouts will commence shortly to selected markets with a full national deployment expected to be in place in 2017.”

What AFR says actually happened:

Fantastic Furniture: “They came and presented their software and we did a 30-day trial. But at the end of the trial we said thanks, but no thanks.”

The Fruit Box Group: “We tested the product and it didn’t go beyond the pilot stage.” Whoops, 7m deliveries gone.

Commbank: “The GetSwift application is not yet in pilot phase, so until we are comfortable with the performance of the solution we are unable to comment any further. The update made by GetSwift to the market on 18 December was not approved by Commonwealth Bank,” a company spokesman said, adding it had signed a contract with the company.”

These are all contracts that Getswift had said that it had won. (I recently criticised the December 18 announcement for how long it would take to show revenues.)

At the very least this involves incredibly poor communication to the market, especially the apparent non-existence of the Fruit Box contract. AFR is especially juicy:

“In relation to The Fruit Box Group, Mr Macdonald said “it’s not material now”, after saying the contract had been pulled immediately after GetSwift made the statement to the market.”

I strenuously disagree. 7m deliveries is extremely material to a company with the revenues of Getswift and it was even more material at the time of the original announcement in February 2017. This surely invites a class action from shareholders and possibly legal redress actions from those who participated in both of the capital raisings. Regulatory attention from ASIC is virtually guaranteed.

(I explain the ‘materiality’ of the Fruit Box contract more in this post. I think it is almost 100% certain that this contract was material.)

Seriously, what is it with Fidelity? (Adapted from the original on Hedgeye.)

Rule #1 of the capital markets textbook says:

You cannot raise capital from people if you have not disclosed material facts about your business.

For Getswift, much hinges on the ‘materiality’ of that contract, as well as the possibility of other exaggerations that may be lurking.

In my opinion, the AFR article calls into question literally every other deal Getswift has ever announced, especially since some customers could not be reached or declined to comment on their contracts. Amazon is the elephant in the room here, but there’s Yum! Brands, NA Williams, Takeaway.com, and all the rest. It all comes down to trust and if you cannot trust a company to disclose appropriately, especially when it has a titanic market capitalisation relative to sales, it’s uninvestible.

There are also several implications for Getswift’s business model that jumped out at me.

The business model

I hypothesised about this a fair bit in my previous piece and today’s AFR article appears to provide partial confirmation. Getswift has so far seemingly failed to land contracts with the big logistics businesses (Fruit Box, Fantastic Furniture) etc. It has however been popular among franchisees and smaller businesses that lack the resources to develop their own platform. Red Rooster restaurants and Tuckerfox spoke favourably of the software and use it regularly.

Extrapolating this I am extremely doubtful that Getswift has a substantive contract as a serious logistics service provider for Amazon. Probability-wise – remembering there is no way of knowing for sure due to the company’s limited disclosure – I think it is more likely that it will be some sort of arrangement to offer Getswift’s software to third party customers who can’t develop their own software. Maybe it’s a deal to run the Amazon smoko trucks like I suggested? That’s assuming that the Amazon contract announcement didn’t ‘get swifted’ and get released before it entered the pilot stage.

Heck, maybe the Amazon contract has been withdrawn and it’s not material so it doesn’t have to be disclosed! Remember, “…due to the terms of the agreement the number of deliveries this agreement may generate is currently not determinable.”

I mean, fuck.

Acquisitions

The mention of acquisitions in that AFR article is another glaring red flag in my opinion. Getswift is supposed to be getting ‘geometric’ revenue growth growing at 50% per quarter. Rapidly growing, successful software companies do not typically need to make acquisitions. Rather they typically pour all of their cash back into R&D, marketing, support systems. Typically the infrastructure to support future growth has to be built out well in advance of that future growth, so heavy cash outflows proportional to revenue are common.

This also means that conserving the cash pile is quite important and growing SaaS companies can have fairly limited visibility of when they might actually become cashflow positive (usually it’s some nebulous X years in the future). As others have noted previously, Getswift has virtually zero R&D and support infrastructure – this is what the $75m capital raising was for – and so I would expect their expenditure to be very heavy and their visibility of CF break-even very low. As a result, acquisitions seem risky, given the typical SaaS company likely has no idea of when it will become profitable.

The company’s public narrative is that Getswift is a very successful junior SaaS product growing rapidly, with great customer reviews and a huge untapped market. This type of company should not need to be acquiring anything, especially not so early in its journey when management should be ruthlessly focused on the core business. Frankly, Getswift has so little infrastructure (although it has been hiring actively recently) that I would expect management to be run off their feet.

That’s even before you get into the boilerplate risks of acquisitions. Sure the industry might be fragmented, but if the valuation of Getswift is anything to go by, it’s not exactly full of bargains. A small acquisition (<$20m) might make sense, but if Getswift makes, say, a ~$100m acquisition, that will be a screaming red siren in my opinion – especially if acquired revenues are multiples of their own.

Personally I think you can forget trying to do proper analysis here. To my mind, the other concerns with lack of disclosure and the disturbing report from AFR today outweigh literally everything else positive about Getswift.

I’ll wrap it up there, but first, a nod to the myriad other people who were quick to call out problems with Getswift. Seaforth Ben, Steve Johnson at Forager, Totus Capital, and one individual who asked not to be named but as far as I know was the very first to point out that the emperor had no clothes.

I think Getswift is in deep shit. The AFR has scented blood and so have the short sellers. Do journalists become more savage if their publication has previously posted glowing reviews of a company? I look forward to seeing how it plays out.

I have no position in any companies mentioned in this post. I do not intend to take an investment position of any kind in Getswift. I have no relationship whatsoever with the AFR or anybody employed by, or consulting to, Getswift. This is a disclosure and not a recommendation.

The risks in Trimantium Growthops

Sat, 09 Dec 2017 04:07:30 GMT

I came across the Trimantium Growthops upcoming IPO recently. It is a consulting business whose listing process reminds me of National Vet Care (ASX: NVL) and Automotive Solutions Group (ASX: 4WD) in that it involves getting agreements from a list of business owners, raising the funds for IPO, and then using the IPO funds to acquire the businesses from these business owners.

Trimantium Growthops, or TGO for short, will be acquiring 8 businesses, half in cash and half in convertible shares (“CRPS”) that will vest over three years. The founders + vendors of the businesses are also migrating to the TGO brand and will continue to run their individual businesses. If their businesses grow profits sufficiently the vendors stand to double the number of shares they are awarded, while if the businesses underperform badly enough they will receive zero shares. I have a number of thoughts about this IPO.

In short my opinion is that:

It is potentially overpriced, given the lack of forward revenue visibility, change of control provisions, and dilution from the CRPS. See my comments below about ‘the consulting business’ and ‘retainer fees’.
There is some uncertainty over related party transactions with major shareholder, Trimantium Capital. See comments about ‘related party transactions’.
There is significant uncertainty regarding the licensing terms of the Trimantium brand name. See comment on ‘The Trimantium GrowthOps brand name.’
It is not clear why existing shareholders should keep >20% of the combined company, as their financial contribution appears to be less than this. See comment on ‘existing shareholders’.

The consulting business

TGO’s businesses do a grab-bag of executive coaching, app development, digital media and things like creative content and marketing. The idea is to bring the businesses under the one brand umbrella and use them to cross-sell each others’ offerings. There will apparently be limited cost-saving synergies, but the cross-selling opportunities are expected to be significant. The list of clients is respectable:

click to enlarge.

In general I’d agree that this is a growing market and that Trimantium Growthops has a well thought out pitch. I also am a fan of the way they will increasingly look to align with customers, e.g. via equity-like remuneration arrangements. Still, the risk and complexity involved in integrating 8 different businesses under a single banner is quite high – Automotive Solutions Group (ASX: 4WD) made a colossal mess of an almost identical IPO 12mths ago and was recently bought out 65% below its IPO price.

Additionally, the consulting business as a whole is cyclical. That’s hard to see at the moment because consultants like McKinsey are bringing in the $$$ and have been for years. However in downturns, companies bring in-house the functions that they should have had in-house the entire time, with obvious implications for consultant demand. I’d struggle to determine the risk/reward tradeoff between a growing change-consulting market and the possibility of declining overall consulting budgets, because the demand for tech + change solutions appears unlikely to abate.

Consultant demand is booming and there appears to be a shortage of candidates – I know that because I have recently been researching MBAs and the job market.

Still, I think the fundamental question for prospective shareholders is “Is this a semi-cyclical business with limited forward revenue visibility, being sold close to the top of the cycle at a price that is above average?” I don’t know the answer but in my opinion, given what I point out below, it’s something that should be considered.

The Trimantium Growthops consulting business

In my opinion there are a number of key risks with Trimantium Growthops consulting business specifically. First is the limits to the visibility of future revenue. From the prospectus, I have underlined relevant sections:

5.2.3 SHORT SALES HORIZON AND DIFFICULT TO PREDICT REVENUE: GrowthOps’ forecast revenue consists of a portion of revenue arising from existing contracts with clients, a portion of revenue which is expected to arise based on historical trends and track records with existing clients and a portion of revenue arising from the conversion of pipeline opportunities. In addition, certain of GrowthOps’ existing contracts include retainer or monthly service fees and can be terminated on relatively short notice. While some clients have annual plans for technology spend which give some visibility to expected spend, many projects or contracts which the GrowthOps Businesses have with clients arise on an ad hoc basis and are around 3 to 6 months in length. In addition, a number of the existing contracts that GrowthOps has with clients rely on the issue of specific statements of work which specify the product to be supplied or the services to be rendered on a particular project. These contracts typically do not guarantee minimum levels of work and there is a risk that the level of work requested by clients through statements of work or purchase orders may decrease or cease entirely. As discussed further below, a number of the contracts GrowthOps has with clients are terminable on short notice or will be up for renewal during the Forecast Period, which means these contracts may be terminated or not renewed for unexpected reasons.

Second is the change of control provisions. While these are not unusual, they appear an extra risk in a company that already lacks locked-in revenues (relevant parts underlined again):

(from section 5.2.8 CHANGE OF CONTROL FOR COMMERCIAL CONTRACTS): A number of contracts to which a GrowthOps Business is a party (including client contracts and premises leases) contain change of control provisions. The change of control provisions in these contacts may be triggered on completion of the Acquisitions. For certain of the relevant contracts, GrowthOps has sought the consent of the counterparty to the change of control arising from the relevant Acquisition as it considers commercially appropriate. In a number of cases, the Company has made the commercial decision to not request consent for change of control. To the extent that the required consent is not obtained (in all circumstances including where the company has not sought consent), GrowthOps may be in breach of the contract in question, which may entitle the counterparty to terminate the contract. In addition, in providing a consent (consent to a change of control) the relevant counterparty may seek to renegotiate the relevant contract on terms which are less favourable to GrowthOps. Any such termination or renegotiation may adversely affect the operations, performance and position of GrowthOps.

This is normal in most consulting businesses. Short contracts and limited forward visibility is a key risk of the consulting business model, which is why I also pointed out the cyclicality of the industry above. However it’s worth bearing in mind that the change of control provisions, lack of consent from some clients, and possibility of renegotiation, are additional risks for the company. It is tough to determine if TGO is a good investment without knowing which customers are going to quit or renegotiate and the impact of this.

Trimantium Growthops will have a fully diluted market capitalisation of $142.6m to $166.4m when listed. It has a proforma forecast NPAT of $8 million (loss of $16.2m on statutory basis). This prices the company at 17.8x proforma NPAT at its lowest market capitalisation. The multiple is about 13x if you exclude the CRPS. I do not think it is prudent to exclude the CRPS because there appears to be no real mechanism for which they get cancelled (unless the acquired business badly underperforms). As a result I would be inclined to consider these part of the market capitalisation.

While this multiple does not seem expensive, it could prove extremely expensive in context of the additional risks created by the change of control provisions as well as the short forward visibility of the consulting business model. Any lost or renegotiated contracts would be felt keenly, in my opinion.

There is also an additional risk and/or benefit – I couldn’t decide which, probably both – in TGO’s retainer fees.

Retainer fees and high margins

When I first looked at Trimantium Growthops I was surprised by the margins it was getting for its consultancy work, which is typically people-intensive and low-margin. The company’s EBITDA and NPATA margins have been 15.9%/18.2%/22.8%/23.3% and 10.7%/11.8%/15.8%/16% respectively over the past 4 years from FY15/FY16/FY17/ to forecast FY18. A 16% NPATA margin is staunch for a consultancy firm; in general I would expect around 10% margins. Historical NPAT margins have also been around 14%-17% over the last 3 years (lower on a proforma basis once corporate overheads are accounted for). I believe that the key ingredient to these high margins could be the retainer fees. Look at this chart:

source: TGO prospectus

36% of all revenues come just from retainer fees. The retainer fees sound like they are primarily associated with the advertising business, where AJF partnership (creative agency) has the client accounts of companies like Officeworks and so on. I’m just guessing but I imagine they get a fixed retainer as long as they have the account, plus more conventional fees each time they run a campaign.

I’m not certain of the level of service and ongoing cost involved in a retainer arrangement, as it was not clearly explained. Still, the cost of providing a retainer could be quite low (because the customer has already been acquired and agreed to stick around on retainer) and it may be a highly profitable revenue stream.

If this is the case, then margins on actual consulting work may be lower, and retainer fees could be key to Trimantium Growthops’ higher levels of profitability. At least some of these retainers are locked in via multi-year contracts, but some can be terminated at short notice, and the ongoing viability of the retainer fee model may be crucial to understanding whether Growthops will generate value for shareholders.

“Client concentration is particularly prevalent in relation to retainer-based revenue streams, which generally arise out of fixed term contracts. Upon the expiry of the relevant retainer term, the renewal of the contract is not assured and is not within the unilateral control of the applicable GrowthOps Business. It is difficult to quickly replace revenue from large retainer-based contracts which are not renewed or are terminated with new business as there are relatively few contracts of that type available.”

If retainers are a more profitable revenue stream, which is hard to evaluate given that there was limited data on the individual businesses, then this places extra importance on their continuation (esp. in context of change of control provisions, reliance on KMP, and so on).

If retainers are not likely to continue, TGO could simultaneously be looking at less work and lower margins, which would be a double-whammy for the value of the company.

The Trimantium GrowthOps brand name:

Trimantium GrowthOps has an arrangement with its backer, Trimantium Capital, that I think will prove troublesome (relevant parts underlined):

3.6 TRIMANTIUM GROWTHOPS BRAND
GrowthOps is a party to a co-existence agreement with Trimantium Capital under which Trimantium Capital grants GrowthOps rights to use the TRIMANTIUM brand. GrowthOps is required to use the TRIMANTIUM brand in the form TRIMANTIUM GROWTHOPS, such that the word “GROWTHOPS” is given equal prominence to the word “TRIMANTIUM”. Trimantium Capital consents to the use and registration of GrowthOps’ trade mark application for TRIMANTIUM GROWTHOPS as well as any business names, company names, domain names, social media names and other trading names containing the brand TRIMANTIUM GROWTHOPS. In addition, each party may, with the other party’s written consent (not to be unreasonably withheld), use or apply for registration of a trade mark, business name, company name, domain name or otherwise, which contains the TRIMANTIUM brand

This is a concern for several reasons.

First, it muddies the Growthops brand name by making Trimantium the first word. In my opinion if you are an investor you’re going to be calling TGO ‘Trimantium’ for short. This has obvious implications for brand recognition etc especially in light of my second concern:

Second, if Trimantium Capital or its majority shareholder Phillip Kingston (who will also be the managing director of TGO) separate from TGO on bad terms for whatever reason, what happens to the TGO company name? It is not hard to imagine having to rebrand the whole company from ‘Trimantium Growthops’ to ‘Growthops’. Much was made in the prospectus of the importance of brand, reputation etc for the consulting business. A change of name could result in reduced name/brand recognition and reduced contracting work. Alternatively, TGO could have to pay a fee to keep the brand name and this gives Trimantium Capital significant bargaining power. If this latter outcome occurs, it could result in TGO paying basically a perpetual licensing fee to Trimantium Capital. Phillip Kingston sounds quite entrepreneurial according to media reports, so it is not hard to imagine him leaving for new opportunities in a few years, which would bring this uncertainty to the fore.

Third, it’s unclear on what terms the Trimantium name is licensed to Growthops. I could not determine if there were fees for this or what the terms of ‘separation’ were, if Trimantium Capital/TGO wished to part ways. Given the importance of the brand name to the company, this seems a big omission from the prospectus.

For contrast, look at Oliver’s Real Foods (ASX: OLI), a 10foot holding. In the OLI IPO, the founders sold the Oliver’s brand to Oliver’s the company in return for shares in the company. Now even if these individuals are fired, the brand (which underpins the entirety of the company) is secure.

Related party transactions:

One thing I liked about TGO was that management will retain significant shareholdings, and salaries for the managing director are quite low at just $15,000 a year (yes, fifteen thousand). However, some of the transactions between related parties I did not fully understand.

First is the purchase of Unit Co by TGO. Unit was previously considering an IPO that was subsequently abandoned earlier this year. From the prospectus (key things underlined):

GrowthOps intends to acquire The Unit Co Pty Ltd for $1 and the assumption of its outstanding liabilities. The Unit Co Pty Ltd, a controlled entity of Trimantium Capital, has loans outstanding of $5.0 million to Trimantium Capital and associated parties which relate to costs incurred in preparation for and the development of the current GrowthOps IPO, which will be repaid from the proceeds of the IPO. These costs comprise $2.1m of pre-IPO costs paid to advisers which form part of the transaction costs of this Offer, and $2.9 million incurred in developing the GrowthOps opportunity and its associated knowledge base.

It’s not explained clearly in the prospectus exactly how the $2.9m was spent to ‘develop the Growthops opportunity’. Growthops is buying established businesses and, while there are due diligence concerns, the fees for these were identified and are included in the listing costs. I would have thought there was relatively little to do in terms of establishing the Growthops ‘opportunity’ and it is not clear how this $2.9m (4% of raised capital) was used.

source: TGO prospectus

I also have some thoughts on the holdings of existing shareholders:

Existing shareholders

At the midpoint of the offer ($1.085 per share), there will be 98.5 million shares on issue. 33.9 million of these will be owned/held in trust for existing shareholders (management and Trimantium Capital). The remaining 64.6 million shares will be owned by those who apply for the IPO. This is a fair split; at the midpoint, IPO investors contribute ~45% of the fully diluted market cap and will own 45% of the company.

However, it looks as though IPO investors are funding the entire business (the acquisitions) while existing shareholders still get 33.9m shares that are worth $37m, and they get all of their costs refunded. This is important because TGO doesn’t appear to have much of a business until it raises cash to acquire the 8 new businesses – Trimantium Growthops was only incorporated in August 2017.

It is hard to tell from the prospectus, but it looks as though existing shareholders may not have invested much $$ in the company at all.

So Trimantium Growthops was only incorporated 5mths ago, major shareholders did a bit of work preparing for IPO (~$5.1m in costs, which will be refunded), convinced a bunch of investors to hand over $70m, buy a bunch of businesses, and hey presto, now the whole company is worth $150m and the original shareholders of TGO are worth $37m on paper.

I may be missing something, but I really don’t like the way that this looks.

To my mind this also raises the question of whether a $150m market capitalisation is justified, if the businesses can be acquired for less than $70m. It appears as though TGO is attempting a private-public multiple arbitrage + roll-up business, only this one looks riskier than most.

As a result, my opinion is that Trimantium Growthops appears overpriced and risky, and I will be avoiding it.

I have no financial interest in Trimantium Growthops, any related company, or any company providing services to it (e.g. its broker). I will not be taking a position during or after the IPO. I own shares in Oliver’s Real Foods. This is a disclosure and not a recommendation.

**edit** Unbeknownst to me, my work was lucky enough to feature in specialist media outlet Mumbrella’s coverage of the Trimantium IPO. If this is something you are interested in, Mumbrella fills in a lot of background info – and if you look closely, you can see me in there.

***final note: Trimantium Growthops later fell a lot in price, and was delisted by its Board of Directors.***

Getswift and Amazon

Sat, 02 Dec 2017 00:34:31 GMT

Topical subject. Getswift Ltd (ASX: GSW) put out a barebones release announcing a deal with Amazon ($AMZN) on Friday morning, before being suspended by the ASX and instructed to prepare a more informative update – probably because shares were up over 100% at one point. The subsequent more informative update was emphatically not more informative, but I’ll get to that.

The market is divided into two camps on Getswift. One camp thinks that VC missed the greatest investment since Facebook, and the other camp thinks that Getswift investors are going to get stiffed one way or another. It is a known fact that opposition only strengthens strong beliefs, so I do not see people revising their position in a hurry.

Some have suggested similarities between Getswift and 1-Page, a previously hot software company that also struck a much-touted deal with Amazon.

In the original version of this post I wrote that I thought that Aesir Capital may have also advised 1-Page. That was incorrect, it was Cygnet Capital that was involved with both Getswift and 1-Page, not Aesir. I apologise for the honest mistake.

So far it has been difficult to get a purchase on the Getswift business model as it works in practice. If Getswift gets anything like the number of transactions it is predicting, and at the prices it says it charges, then it will still do well from here. Now, there are a large number of yellow flags in my opinion including low R&D spend, director departures, low staff costs, limited tech support + sales staff infrastructure, and so on. Getswift is totally unsuitable for the 10foot portfolio because of these things.

If you don’t get the business model, how can you value Getswift?

Even putting those concerns aside, in my opinion, there are so many questions regarding these forecast transactions that I think Getswift watchers currently do not have any way of proving if the company is capable of doing what it says. Despite signing many deals, it is unarguable that the company has not yet demonstrated that deals lead to revenues. The next few quarters will be critical here I would think.

Additionally, with such limited disclosure – the company announces a huge-sounding deal with Amazon but doesn’t disclose the slightest information about it – mug punters like myself must resort to rampant speculation. And, since there are no details being released about the deals, in my opinion it is impossible to determine what they are worth with any accuracy. Which of course makes it very difficult to value Getswift.

I can’t tell you what the company is worth, because I don’t know. But to justify today’s market capitalisation, I think Getswift needs to hit $75m in revenue within the next 3 years, at high gross margins, and with further rapid growth still occurring. The company has a fully diluted market capitalisation of ~$765m including shares on issue, shares in escrow, in-the-money options (no OOTM options as far as I could see) and performance rights. $75m in revenue would price the company at ~10x sales, which is ‘fair’ for a software company with high margins (and strong customer retention and switching costs) that is growing rapidly. I’m not certain Getswift fits that criteria but I’ll get to that.

How do you determine the lifetime value of a Getswift deal?

Here are a few things I’ve been thinking about:

For example, is the contract ‘binding’ in any way? Are customers legally bound to use Getswift, are there switching costs, are there penalties if the customer chooses not to use Getswift? Is there anything to prevent clients shopping around for a better deal? Why don’t customers develop their own solution if they’re going to be spending $100m plus on deliveries? Can Getswift generate a lifetime value from customers greater than the cost of acquiring the customer? For that matter, what is the cost of acquiring and onboarding a customer? How much investment will be required in sales, support, + R&D infrastructure in the future and what will margins look like after that? In software especially, I think the ‘stay-in-business’ expenditure is much higher than you might think, because if a company is not developing rapidly, it’s actually going backwards.

Getswift’s deals so far mostly seem to be struck with customers on a more individual basis, not a whole-of-organisation deal. This may prove more attractive, for example as individual customers (e.g. franchise owners) lack the ability to develop and maintain their own delivery software. This could see GSW maintain higher margins and build some sort of switching costs in, if it becomes essential to the customers’s business. It does however suggest more difficult growth (time consuming to convince 10m individual businesses to sign up with you) and a more fragmented customer base, which could be good or bad. It’s also important to question how much Getswift is giving away to its enablers like NA Williams who is introducing GSW software to its customers. How much does NA Williams get paid and how much % of the value in these future GSW customers does NA Williams capture for itself?

On the other hand, Getswift has also been striking deals with big companies like Yum! Brands and Amazon, and shareholders are about to find out if GSW has pricing power. For example, Yum!’s competitive position depends at least partly on its cost-competitiveness vs McDonalds and so on. If you think that an average takeaway restaurant might have around 8% NPAT margins, that is $4 profit on a $50 order (excluding delivery costs). If 25.5 cents of this goes to Getswift for the delivery, that’s something like a ~4% reduction in pre-tax profit. Amazon’s margins are much lower. It is hard to see Yum or Amazon giving over a huge share of its profits to their delivery software provider. Customers also hate delivery fees so I do not see those making a comeback to cover the cost.

The Facebook of Logistics

It’s difficult to get a grip on all of these questions and that’s why I think so many people are responding harshly to Getswift, at worst suggesting it is a scam. Some of the comments on the company in the market are not helping, for example calling it the ‘Facebook of Logistics’, a ridiculous title as there are not many similarities between the two in my opinion. Facebook provides a highly functional, multipurpose platform which leeches off user activity and has extraordinary network effects and switching costs. Getswift is a discrete, single-purpose piece of software and, as I just said, it is difficult to determine if it has any of those features.

Be that as it may, the company’s been in my too-hard basket until yesterday when the Amazon announcement came out. And I now think Getswift could be about to run headlong into a brick wall. It’s the classic an irresistible force meets an immovable object parable, only in reality there are no irresistibles, and we will see if it’s Amazon or Getswift that gets moved.

Getswift meets Amazon

I have no idea what Getswift’s deal with Amazon is. It’s a ‘Master Services Agreement’ so Getswift provides a service of some sort and in return Amazon (or someone) pays Getswift. Since we are rampantly speculating, I’d say the deal is perhaps offering Getswift software to Amazon 3rd-party resellers in order to let them do their own deliveries if they choose. If I’m right, this may let Getswift retain acceptable margins and $ per delivery, for the reasons I highlighted above (lack of customer ability to develop own solution, possibly hard to switch etc).

Course, maybe Getswift just provides the software for the food truck that sells smoko to Amazon warehouse workers. I wouldn’t get out of bed for a deal like that, but how would you know?

Still, unlike previous deals including the NA Williams deal, a Master Services Agreement (MSA) with Amazon implies a pricing contract as well as limited pricing power for Getswift. Getswift renders a service to Amazon and Amazon decides if it is worthwhile on an ongoing basis (every couple of years, or whatever, but of course the terms of the contract are not disclosed). Getswift would not appear to have much pricing power under this arrangement – just look at Vita Group (ASX: VTG)’s MSA with Telstra (ASX: TLS). Telstra keeps walking back Vita’s remuneration and Vita says ‘thank you sir’.

If however I’m wrong and the deal is with Amazon itself, providing software for last-mile delivery, which is what the market currently seems to think, then I have appropriated a few thoughts from the Twitterati:

and:

For this kind of deal, in my opinion you can draw a lot of assumptions even without having the first skerrick of information about the contract:

Getswift needs Amazon a lot more than Amazon needs Getswift.
Getswift is replaceable. Amazon has logistics expertise, tech expertise, a massive budget, and can build whatever it wants:
As a result, Getswift (like all of Amazon’s suppliers) likely has minimal pricing or negotiating power.
Amazon is ruthless with its suppliers, grinding their margins down to zero. Do you want to sell serious volumes? You need to be on Amazon. Amazon is going to make you pay for the privilege, capturing most of your historical margins for itself.
Amazon is ruthless with 3rd party operators on its platform. It actively bids its products a few cents cheaper than competitors, for example. If Getswift supplies 3rd party operators with its software via Amazon, it may actually find Amazon competing with it to sell delivery software in the future.

Getswift’s payments per delivery have been around 25.5 cents as of the most recent quarter on a reported revenue basis ($255k revenue, $175k in cash receipts, 1m deliveries). The NA Williams deal implies around 13 cents ($138m revenue divided by ‘over 1bn deliveries’). With Amazon, in my opinion, I would not be surprised to see Getswift getting as little as 5 cents per delivery or less, and that declining over time as Amazon renegotiates. That’s if Amazon is the end customer and not 3rd party resellers.

You do not know which is the case, and neither do I. I quote:

“Due to the terms and conditions of the agreement and the highly sensitive nature, no further information will be provided by the company other than to comply with regulatory requirements for disclosure.”

Highly sensitive for who?

“Due to the terms of the agreement (with Amazon) the number of deliveries this agreement may generate is currently not determinable.”

So ultimately there is a significant degree of uncertainty regarding Getswift’s value and I think it is near enough impossible (for me, at least) to determine the company’s intrinsic value with any accuracy. I could forecast x transactions at this price or that price, but I don’t know how much tech support staff, sales staff, R&D, marketing, and so on will be required to build and maintain Getswift’s position. This is a not a value investment. The only way Getswift actually makes any serious money for investors – And we’re talking about a 10x sales multiple being ‘fair value'(GSW currently priced at ~750x annualised sales) – is if it builds a system from which it can grow rapidly and persistently extract returns well above the cost of capital over the next decade or more.

I labour over this point because it is very easy to forecast revenues to the sky based on the numbers that Getswift has put in its recent presentations. However GSW’s ability to a) deliver on its promises and b) maintain its margins in the face of customers with much greater pricing power are great unknowns.

Getswift needs to suck value out of other players’ pockets, but it does not look like it is currently in a position to do that. I also don’t think the information publicly exists yet that would let an investor determine that unequivocally either way, but the company’s market capitalisation is seemingly already pricing it in.

But hey at least they love their work. Look at how enthusiastic they are to be returning to trade on Monday:

source: LinkedIn

You can’t put a price on passion.

I have no financial interest in any company mentioned (including the US-listed and unlisted ones). This is a disclosure and not a recommendation.

A qualitative look at Oliver’s Real Foods

Sun, 15 Oct 2017 04:17:59 GMT

I recently had a look at healthy food company Oliver’s Real Foods (ASX: OLI). Oliver’s operates fast-food outlets that sell only healthy and organic food. You can read my purchase thesis here but in my view it is the qualitative factors here that will prove make-or-break for this young brand.

These are three key premises (‘beliefs’) that I have for this investment:

Oliver’s has a semi-moat due to its differentiated offering to McDonalds/KFC, as well as difficulty for new chains to find available leases to compete with Oliver’s
A meaningful chunk of Oliver’s customers are probably willing to pay a little more for the healthy food compared to McDonalds
Thus Oliver’s does not need to be ‘the next McDonalds/KFC’ it just needs to provide a ‘viable’ alternative to junk food (by which I mean right price, good service, easy to access, etc)

I did an analysis of each Oliver’s location with a view to determining what kind of obstacles a customer might encounter.

Analysis of site locations

Oliver’s has 21 stores and 2 that it recently acquired and is converting. I looked at all 23 stores including the recent acquisitions using Google Maps. This is a fairly idiosyncratic system and the individual ratings are up for dispute, but I believe the overall picture is accurate:

11 stores are metro/12 are rural (refers to proximity to built up areas, but is idiosyncratic. Rural might simply mean 50km out of Melbourne, if there’s not much nearby. Equally some genuinely rural areas got classed as ‘metro’ due to being right next to a town.)
All 23 are located on a main road
13 are on a primary highway (e.g. Melb-Syd) , 9 on a ‘secondary’ (e.g. Syd-Wagga), and 2 I thought weren’t on a highway at all
6 restaurants have 0 or 1 competitors close by. 11 stores have 2 competitors, 4 have 3-4, and 2 have 6 or more competitors (average of ~2.04 competitors for every Oliver’s store)
Competitors are overwhelmingly KFC or McDonalds (more than 90%), very few cafes or Subways nearby, and no Zambreros/sushi restaurants etc
21 stores have easy entry/exit access and a spacious carpark, while 1 was mediocre and 1 I thought was poor
19 locations have no nearby ‘clusters’ (rival service stations) of competitors. 4 locations have 1 nearby cluster competitor (this is separate from the # of restaurant competitors above).
17 restaurants are ‘integrated’ with a servo cluster, i.e., right next door to the servo. 4 are ‘separate’ from the servo building but still within the same parking area. 2 restaurants are not close to a servo. (‘not close’ in both these situations means like, ~1km away).

Management also has a solid criteria for restaurant location and I believe they have a good grasp of this part of the business:

source: Company presentation

There are a couple of restaurants that look like ‘experiments’ e.g. with no service station nearby, or in hugely competitive areas, but on balance, Olivers’ knows how to pick a restaurant location.

Here is an example of one idiosyncratic rating to show the possible flaws in my above methodology. This is the Oliver’s at 1-3 Sowerby Street Goulburn:

I put it as having 6 competitors due to the number of nearby choices (even though not immediately adjacent to Oliver’s) and the relatively easy access to them all. I also listed it as having 1 competing fuel station cluster competitor (Caltex Woolworths, above). This restaurant I classed as ‘not close’ to a servo even though you can see the distance is relatively short.

I also classed it as not being on a highway at all, because it can’t be directly accessed from the main street. However there are other Oliver’s restaurants (in less dense surroundings) that also do not have a direct entry from the highway, that I have still classed as being ‘on’ a highway because they appear much easier to access.

I fully expect that there would be significant disagreement on a number of my individual judgements, however I think the overall picture (competition overwhelmingly McDonalds/KFC, most sites are generally good quality) is highly accurate.

Restaurant reception/reviews

This section contains one of the major risks of the thesis, although I could not verify my research enough to be confident that it is creditable. I have recent anecdotal reports from several of the troublesome restaurants mentioned below that suggest that the negative reviews were overblown or are no longer relevant. This is why I was comfortable enough to invest, although I think this is a crucial area and one to watch closely over the next few years.

I read every review I could get my hands on from the past 12-18mths of Oliver’s operations. However, there were not nearly enough to form an authoritative sample of the whole business, and many restaurants had no reviews at all. This means that this whole section is far from authoritative and is probably pretty close to pure speculation.

So I present this info as is, and you can make of it what you will.

The key driver of Oliver’s as an investment, in my opinion, is the value that the business adds for customers/ how much the customers like it. For example, if Oliver’s has a winning business, it could become much larger over time. If, however, the business model itself (healthy food at Oliver’s prices at highway rest stops) is likely to be unsuccessful (e.g. for reasons of price, lack of demand, poor reputation etc), then a low share price affords scant safety.

Unfortunately only 5 stores had a list of reviews long enough to consider representative (reviews were from TripAdvisor and Zomato). On a scale of 1-5, Terrible to Outstanding, Oliver’s restaurants in Officer and Ferry Park generally cluster around a 3 – Average, although not all Officer reviews were scored. Geelong and Gundagai were skewed towards the Outstanding end of the scale, while Wyong looks terrible.

(another weakness in the data: It’s unclear if the reviews refer to the southbound or the northbound version of these locations. It is also important to remember that reviews can tend to be skewed to the negative, because happy customers have no real reason to write one.)

However, there are persistent complaints even in the positive ratings – coffee is too expensive, food portions are expensive/too small, food is ‘limp’ (old veggies etc), service is slow. There were also a few comments made on general uncleanliness of the restrooms, a concern given that the restrooms are a key attraction in a business like this (on the highway).

It’s possible to argue that management bought back its franchises to enhance control and improve cleanliness and implement coherent staff training and so on. However, the average to poor rated stores above were not franchises (I think), except for Wyong. Management states that it bought back the franchises because they were the most attractive businesses, but if franchise stores perform way better than corporate stores, one has to ask if it’s the ‘corporate’ part that’s a problem.

Were they the most attractive because they were franchised, or because of their location? My research suggests at least part is due to location, and at least one store (Wyong) I would expect to perform better with some love + attention from management, at least if the reviews are a fair judge. Still, if food businesses are being criticised for lack of cleanliness and poor service, that is a risk. I have formed no concrete opinion on this either way. There is plenty of anecdotal evidence to suggest that people love Oliver’s.

I currently think Oliver’s offering + service is good enough to be investable. I just mention this so that you can see my thought process and the things that I have considered and looked at.

As an aside, note that the CEO below also comments on the supply chain challenges of running a fresh food restaurant, which I touched on in my thesis and remain a key risk as the business expands.

Thoughts on food prices

CEO Gunn has a solid rebuttal to food price complaints in this interview, courtesy of The IPO Review’s interview with him here:

“Good question, but realistically no, (prices) wont come down. In fact I do not believe that we are expensive, it just seems that way to some people. It seems that way to some people because we have all been conditioned to think that food is cheap, when it is not. What is cheap, is highly processed food that is full of artificial colouring, flavourings, and preservatives. This is not actually food. We should stop asking why REAL FOOD is so expensive, and start asking, “How can this cheap food be so cheap?” I think it is also worth mentioning, that being the worlds first certified organic fast food chain, we face many challenges around supply chain management that traditional fast food business’s do not have to overcome.”

Be that as it may, it is a good point. In fact a key part of my thesis is that Oliver’s will benefit from price elasticity if it is able to expand in a way so that its only competitors are KFC/McDonalds. Put this way, if you are health conscious either voluntarily or forced (e.g. you are gluten intolerant), would you pay $14 for a popcorn chicken combo, or $16 for a gluten-free chicken salad/sushi? Chicken salad is the likely answer and many people will happily pay that bit extra. The real question then is, ‘how elastic are prices?’ and the answer also is “probably not that elastic”. You might pay $16 or even $18 for a chicken salad, but $21 (50% more than competitors) might be a tough sell. These are not Oliver’s prices, I am just talking in general terms. Likewise people may pay more for a ‘real’ coffee (i.e., not McDonalds) coffee, but how much more?

Conceptually, I have thought of the Olivers’ demographic something like this:

25% (ish) of customers might typically prefer a healthy restaurant if available

25% (ish) of customers probably won’t eat healthy at all either for preference or reasons of price

The remaining 50% can probably afford to eat either or, and will likely make a idiosyncratic choice based on a composite of preferred food/brand, service, taste, etc.

The numbers are just conceptual but I believe Olivers’ likely has a fairly reliable but small core demographic of chia-seed munching Melbournians, and a larger opportunity in the market that will need to be convinced, which means price and service will be key.

Based on this picture (and other similar pictures) of the menu from Google, Olivers’ food does not appear overly expensive:

source: Google

However, this is offset by reviews like:

“Not cheap, $34 for two coffees, a beef pocket and chicken pocket and some soybeans or edamame.”

“The pumpkin soup at $12.90 was very bland and EXTREMELY overpriced for soup, the minestrone was similar as well. “

(there are numerous comments like this, I have not cherry picked the only two negative ones)

Just negative reviews? Or fair criticism? I don’t drink coffee, and I am a KFC popcorn chicken chomper from way back. Plus I don’t have an Olivers’ near me (yet) to go and sus it out, so I don’t have a personal judgement of its premise yet. There is also plenty of positive anecdotal evidence in favour of Oliver’s.

That is what I think of Oliver’s so far. If you have some additional input or disagree with the way I view Oliver’s (and I’m particularly keen to get some anecdotal reviews if you visit their restaurants in Wyong or NSW) please leave a comment so other people may benefit from your thoughts also.

I own shares in Oliver’s Real Food. This is a disclosure and not a recommendation.

Strong narratives: A source of competitive advantage?

Sat, 07 Oct 2017 11:25:38 GMT

One of the best things about investing is that you will draw on virtually all of your skills, knowledge, and experience at one point or another.

I studied narratives at school, formally, as an academic pursuit. It sounds dry, and it kinda was, but it’s proven to be valuable in highly unusual ways. Try deconstructing a modern political narrative and see what core themes you come up with, you’ll be surprised (or maybe not…). Anyway, the human brain continually strives to explain and grant significance to its experience and I believe my understanding of narrative has, by extension, made me a better investor.

Say what?

Typically, the vast majority of investors have equal access to the facts (excluding the minority with the most in-depth research and/or best access to management). Each investor is presented with a series of facts and essentially strings them together into an investment thesis that says ‘Buy’ or ‘Sell’. You can draw entirely opposite conclusions depending on what narrative you actually use to tie them all together.

I suppose a classic (simplified) example of narrative would be something like Fisher & Paykel Healthcare (ASX/NZX: FPH). Obesity and lung cancer; two big killers and a huge driver of demand for FPH’s oxygen masks and related devices. People are getting fatter, living longer (especially Americans, FPH’s biggest market), and finding it harder to breathe, and they’ll need more of Fisher & Paykel’s devices in the future. The company is switching manufacturing from New Zealand to Mexico and along the way it’s expected to generate big increases in its profit margins. It already has great ROE and ROIC and it is a world class company on these metrics.

The flip side of this is that a meaningful % of profit is going to lawsuits defending its patents as FPH has been accused of patent infringement by ResMed (ASX: RMD), a major player in the space. Fisher Paykel is well and truly going up against the incumbent here, it is priced to the moon, and it potentially stands to lose the ability to sell its primary products (worst case scenario; it might also have to pay restitution) in the USA. Depending on the outcome, shares could conceivably either be worth double in 5 years or fall 70% in the same time. Virtually nothing will change in terms of its expertise and the appeal of its products, however. Depending on which narrative you choose – and both appear equally consistent at first glance – you come up with diametrically opposed outcomes. This is a case where the numbers alone will not save you – you also need to create, investigate, and follow a coherent narrative.

(‘Meta’ strategies around position sizing, through-the-cycle view, avoiding potential for loss/binary outcomes etc can also be quite valuable here.)

How to read a narrative

I recently stumbled across this post about cracking the narrative from a random blogger which, in my opinion, hits the nail on the head. It’s great to read a narrative for entertainment or excitement. I love hearing about how a company is going to change the world. But the real investing work starts when you use the narrative as a jumping point for asking questions and seeking inconsistencies.

Why does Jason Bourne in The Bourne Identity (30yo) look like he’s about 12, despite his life being filled with brutalization and violence?

Why is Marie, despite the wastrel’s idle life that she lived, suddenly so adaptable to a life on the run?

Every narrative has its own internal logic, and I’m not just talking about the ‘introduction, problem, resolution, conclusion’ story structure that you learned in primary school. Even unconventional narratives (narratives with no coherent story structure) are conventional, because they make sense to somebody. I’ve heard it said that life without meaning (action without purpose) is the definition of insanity. I prefer to believe that people who are insane have an unusual view of reality and the things that they do make sense to them. Whichever way you cut it, a coherent narrative is key to almost all of life’s ventures and the absence of one is always a warning.

I suppose I’m not exactly delivering earth-shattering insight here, but if the narrative in an investment changes, that’s an instant sign to be wary. Narratives change all the time. But the fact that they have changed is a sign that you must look to either positively vet and/or attempt to falsify the new narrative.

And if you can’t find a narrative, then you either have a bad business (it is unfocused) OR if you can generate your own narrative from the company’s actions (perhaps the execs are poor communicators or the market misunderstands the company), then you have a source of potential competitive advantage.

Note that the narrative is never ‘we have an awesome product that is going to change the world.’ That’s garbage – that’s not a story. A real narrative is something like Greencross Limited (ASX: GXL), which also fills in the empty space:

In the course of growing by acquiring new vet clinics, we realised that pet retail is a perfect complement. So we entered a new market by acquiring pet retailers, then we realised that we could add a substantial kicker by installing vets in our retail stores. This would let us establish new vets for a lower cost, letting us grow the vet biz faster, while also allowing us to cross-sell products, boosting our retail sales. Because of our big initial foray into pet retail, we incurred a lot of debt. Our expansion is now at a point where we are funding ourselves from our own cash flow, and as we pay down debt and roll out our in-store clinics and grooming salons, growth could remain strong for several years. (this is just a summary in my own words)

I don’t hold Greencross. I’m pretty bearish on it. I think if you look at its Western Australian sales recently you get a real good taste of what happens to the company in a downturn – but it’s got a very well-defined narrative. In my opinion, very few ASX companies have a narrative that is this well defined.

(The speccy small caps like to kid themselves that they have a narrative, but typically the story is light on detail and heavy on fluff and optimism.)

Anyway like all good stories, Greencross’ narrative writes its own questions in the mind of the reader. If you come across a story like the above, you can generate your own questions (you must be skeptical), answer them all, and the investment thesis practically writes itself. Brief sample:

How much better is this co-located vet thing? What do the numbers say, how much faster could the company grow compared to acquiring externally?
How is this a source of competitive advantage?
What’s the possible market size on vet clinics and pet retailers?
Why would vets, skilled medical professionals, want to work in a retail store and be expected to cross-sell dog food? (actually, I dunno why, but I suspect incentives are the answer)

Importantly, you also now have a number of checkpoints to follow over the course of your investment. What’s the maximum possible # of in-store clinics and how far from that goal are they? You can literally follow the narrative over a few years and watch if each of the events in your ‘story’ comes true. And you will get a very clear idea of whether your investment is kicking goals or not.

Narratives. I’m tellin’ ya. You gotta use em. There are also situations in which a narrative doesn’t work, such as if an investment is attractive on a risk-reward basis but the result clearly depends on a binary outcome (e.g. a successful lawsuit or clinical trial). Narratives are not binary, and typically investing is not binary either, which is why narratives are useful most of the time.

Sometimes, you can find investments that are likely to be winners almost regardless of the narrative and its coherency or lack of – Forager Funds is a good example, but they follow a ‘meta narrative’ – no less valid – around the flow of capital and the business cycle.

Bashing the narrative

It has become favourable in recent times to bash companies that emphasise their story, and rightfully so, because many companies are in the business of selling a story, not a business. Yet I think that a strong narrative can equally be a signal of a focused and driven business. Those that understand how to compare reality to the narrative, find narratives quite useful.

A preference for narratives

Anyone that follows a narrative alone is a sucker – but the same can be said for those who use numbers (e.g. valuation) alone. Even the investors that think they are purely probability or valuation-focused, what they’re really doing is testing hypotheses (a.k.a narratives) and evaluating likely outcomes. An investing narrative (jointly the ‘why’ and the ‘how’) is at least as important as the numbers (the ‘what’ and the ‘how’).

If I have an edge as an investor, I’d say it’s 100% my understanding of narrative.

Edit: After writing this post, I stumbled across another great blog post on narratives, and ironically, it references the same ‘cracking the narrative’ blog post I linked earlier! Clearly my competitive edge is under threat.

I don’t have any financial interest in any of the companies mentioned. This is a disclosure and not a recommendation.

What is a synthetic subprime CDO?

Mon, 25 Sep 2017 11:36:01 GMT

Six months ago I was asked to explain what a synthetic CDO was. Well pal, the sky is blue because bankers in Wall Street…. I sort of did my best and drew a few diagrams and we got about halfway there and came to a halt. I understand roughly how a synthetic CDO works, I think, but the problems implied in such a thing are not easily imparted to someone who does not follow finance. Another one of my friends asked me the same question and I thought maybe I could gin up a couple of diagrams that other people might find useful as well.

The trouble with descriptions on paper is that it is hard to build a mental model in your head. I have had a go at doing so below.

I have built these based on what I’ve read in books like The Big Short (Michael Lewis) and The End of Wall Street (Roger Lowenstein). I am not directly familiar with CDOs and have never read a CDO prospectus. I have taken some liberties with the structure of mortgage bonds, simple interest, etc to simplify everything as much as possible. This is a super simplified diagram that I hope will prove useful.

An illustration of the steps that lead to the creation of synthetic CDOs:

Step 1: Get mortgages

Banks lend money to people to buy houses. Some loans are more risky than others. Not all loans get paid back. ‘Sub-prime’ loans, the primary cause of the crisis, are riskier loans to less reliable borrowers.

When you repay a loan, you must repay principal (the loan sum, e.g. $500,000) and interest (the interest, e.g. at 3% per annum, that accrues on the principal. I.e., you pay 3% of $500,000 per year in interest).

If a loan is not repaid, the bank takes the house and sells it to get payment for the loan. Sometimes the house does not sell for a high enough price for the bank to get its money back, and the bank takesx a loss.

Step 2: Make mortgage bonds

Once a mortgage has been written, if you are a bank and no longer want to take the risk of that loan not being repaid, it is very hard to ‘sell’ a mortgage to another bank or investor. If you package up (say) 1000 mortgages into a mortgage bond, however, they can now be sold and a bank can rid itself of the risk by selling the mortgage bond to someone else. The bank gets some money, and those other investor/s who bought the mortgage bond, earn interest on the mortgages and take the risk of not being repaid their principal.

Mortgages in a bond are ranked from highest (AAA) to lowest (BBB-). Investors at the top get the lowest rate of interest, but also take the lowest risk and have the highest likelihood of being repaid, for reasons I’ll explain in a moment. A bond could be worth $100m or more, so one investor does not own the whole thing. Little pieces of the bond are owned by dozens of investors. Some investors will hold only AAA, while others will hold BBB-, for example. This is a sample mortgage bond, with just 5 ‘tranches’, or levels.

Simplified mortgage bond. Actual mortgage bonds could have up to 13+(?) tranches.

Note the 7% figure in the BBB- level. This is the level of losses required before the BBB- holders will be wiped out. Now, imagine that this bond contains 1000 mortgages. 10 of those mortgages (1% of 1000) fail and the mortgages are so bad that once the house is sold the investors in the bond recover no money. Investors in the BBB- tranche of the mortgage bond take 1% losses. However, because the BBB- tranche becomes worthless with just 7% losses, BBB- investors have actually lost 1/7th, or ~14% of their investment.

Many finance books use a ‘waterfall’ analogy, with the ‘waterfall’ (cash; mortgage + interest repayments) falling on AAA holders first, before excess spills down to AA, and then A holders, and so on.

Ratings agencies decided which parts of a bond were how risky, e.g. did a tranche have a AAA or BBB- level of risk?

Step 3: Package multiple mortgage bonds into a Collateralised Debt Obligation, or CDO

In order to sell more mortgage bonds of crappy mortgages, Wall Street packaged parts of numerous mortgage bonds (100 or more) into a kind of ‘super bond’ called a CDO.

Due to flaws in the rating agencies (S&P, Moody’s, Fitch), Wall Street was able to ‘game’ the ratings agencies models and get many BBB- securities re-rated as AAA. See the below diagram:

BBB- magically becomes AAA.

In this diagram, the BBB- tranches from 5 mortgage bonds (top) are piled into a CDO (bottom left). The ratings agencies would then re-rate as much as 80% of this BBB- debt to AAA (bottom right).

CDO creators were able to convince ratings agencies that BBB, or lower rated debts, were somehow not BBB at all when they were piled into a CDO. Quoting Michael Lewis in the Big Short, up to 80% of low-grade debt could be subsequently re-rated as AAA, or highest quality.

So you have a CDO composed of junk (BBB-) being sold as gold (AAA). AAA debt was more highly priced so banks made a lot of money via this practice.

Now in the original mortgage bond, the BBB- tranche takes losses first. Once the first, say, 7% of losses (people not repaying their mortgages) are taken, the bottom BBB- tranche is wiped out. However the re-rating of the debts in the CDOs created an illusion.

In this image, a regular mortgage bond takes 4% losses, wiping out just over half of the BBB- layer:

This is what 4% losses in a regular mortgage bond might look like, if the BBB- tranche becomes worthless at 7% losses. (not to scale; bonds could have up to 10 ‘tranches’ [layers] or more.)

In the above diagram. We’re assuming that the BBB- tranche is wiped out with 7% losses. So 4% losses (40 mortgages out of 1000) wipe out most – 4/7ths – of the triple B tranche, as intended. However, since so much of the higher-rated tranches in CDOs were actually disguised triple B tranches from mortgage bonds, 4% losses in a CDO might look more like this:

This is what losses on a subprime CDO (which was actually all BBB- that got re-rated) might look like.

Instead of losing just 4% of the bottom tranche, a CDO might lose 4% from all or most tranches, because they were all disguised BBB-. If there were 13 tranches and all were BBB-, 4% losses in the original mortgage bonds could be a 52% loss to the CDO. Quoting Michael Lewis again, 4% losses in mortgage bonds happen in good times.

Due to the way they were structured, very small losses could hurt higher tier investors also.

This is just for illustration. In reality CDOs were far more complex. Next up, is the ‘synthetic’ CDO.

Step 4: You can’t get enough mortgages to feed the demand for CDOs. Enter the ‘Synthetic’ CDO.

There weren’t enough mortgages to go around to feed the creation of CDOs. So Wall Street started creating ‘synthetic CDOs’ from the payments from investors betting against CDOs. To keep this short I assume you know what a credit default swap is, but I am going to use an ‘insurance policy’ analogy to describe them.

Situation 1: This is how ‘The Big Shorters’ (Mike Burry et al) and the CDO market originally worked. Investors bought ‘insurance’ (credit default swaps) against a regular CDO defaulting. Companies like AIG Insurance sold these types of ‘insurance’ products:

The regular CDO and investors betting against them. (click to enlarge)

The typical interest payment to CDO owners (orange) might have been something like ‘2% above LIBOR’ (London interbank offer rate) but I have just called it 3% for simplicity.

Scenario 2:

At one point, AIG FP stopped writing insurance. Now Wall Street banks and other investors started writing the ‘insurance’ risk, and Wall Street used the ‘insurance’ payments to create synthetic CDOs to feed demand:

Synthetic CDOs were just somebody elses insurance payments, packaged up to look like a bond. (click to enlarge)

Read the diagram. Unlike a normal CDO, there is no property or mortgages underlying these ‘synthetic’ CDOs. This has a few implications. If the investors buying the insurance policy (credit default swaps) go bankrupt, CDO investors lose everything. Additionally, in this situation there is no property that can be sold to recover the losses, because there are no mortgages.

I couldn’t tell you if that was fraud, as I am not a lawyer. But it looks pretty outrageous.

The greatest concern is actually a bit more abstract – with synthetic CDOs and credit default swaps, there is no limit to the risk (defined as total maximum amount of loss) that can be placed in the financial system. For example, no matter how bad the loans in the USA got, there is always a certain maximum amount of risk. For example say the population is 300 million people. There is a vague, but fairly firm, limit to the number of mortgages you can write for this many people. Just for illustration, there couldn’t be more than, just say, 400 million homes and, say, 800 million home loans. If each loan is $300,000 on average, the total maximum amount of money that can be lost on the loans is something like $240 trillion, plus interest. Admittedly this is an outrageous sum, and far more than was lost in the GFC. But at least with a mortgage you know the upper limit on your risk, and there is a property that can be sold to reduce some of the losses.

However, with synthetic CDOs you can create as much risk as you like because the number of homes and borrowers is not a constraint. This is why many crisis commentators and post-crisis books take an apocalyptic tone – because the world really could have been looking at financial Armageddon.

I hope you found the diagrams useful.

I have no financial interest whatsoever in any of the above mentioned products or companies, directly mentioned or implied. This is a disclosure and not a recommendation.

This is a very rough description of how they worked and I know that it glosses over several important aspects. This post is more about writing something that would explain how a CDO works (to someone with no financial background), than it is trying to be a definitive treatise on CDOs.

If you know more about CDOs and think I have misconstrued something or missed an important point, I would be glad to hear from you.

The things that move share prices

Wed, 06 Sep 2017 09:59:44 GMT

I have recently been reading through well-known investing blogs like Bronte Capital (John Hempton) and Bristlemouth (Forager/Steve Johnson) from their beginnings in 2008 or so. They are very good. I read Hempton’s in its entirety a few years ago and I would recommend his earlier posts as an excellent crash course in how the truck banking actually ‘works’ when the rubber hits the road (i.e., when the liabilities hit the shareholders).

If you know some other good Australian investing blogs, I’m compiling a list, so please leave suggestions in the comments.

In the course of reading both blogs I have come to an insight that I think is often overlooked in investing. Most professional investors make specific use of this piece of knowledge but I haven’t seen it mentioned explicitly.

I am not entirely sure what to call it (I am sure that there is a CFA term for it, if you know it feel free to jump in) but for the time being I will call it:

‘Factor-driven investing’

It’s fairly obvious. I think most investors use it implicitly but I’m finding that stating things explicitly in the blog is helping my process a lot. More relevantly, all of the 10foot companies so far are businesses that require, in one way or another, a re-rating of their value. I have been thinking about various aspects of re-rating at some length.

Anyway, so ‘factor-driven investing’ (please give me a better name) is where you’re looking at a factor in your investment, such as the value of a company. But that factor does not line up with the primary factor that is driving the value of the investment. I.e., the value of your investment is being driven by something other than what you think is driving it.

Say you’re looking at company XYZ, and it looks really cheap. But because of the structure of the debt or whatever, the earnings/growth of the company is not what’s driving this company’s value. Which is weird, because don’t earnings drive company value?

RNY Property Trust (ASX: RNY) is a perfect example. The company was in breach of its debt covenants, but it was marketing its properties for sale to see if they could pay off the debt. On the face of it, the properties were worth a lot more than the debt. In that situation, I think it very unlikely that a lender would put the screws to the company. If they foreclosed on the loan, the company goes into administration, then you have to appoint administrators, pay bulk fees, and sell the assets anyway (usually for a poor price) to figure out what they’re worth. Losses are almost always more severe in this situation. The lender might as well wait a few months and see if RNY can pull it off. That’s exactly what happened, although unfortunately RNY didn’t pull it off.

However, in that situation, the value of the properties is not the driving factor of the investment. The ‘thing’ that drives the investment in the near term is the breached debt, or more specifically the patience of the lender and the likelihood of them tipping the company into administration. More importantly, if the lender is not patient, you are setting yourself up for a fall regardless of what the properties are ‘worth’.

So if you’re looking at the value of the properties and going ‘wow this investment is really cheap, I should buy it’ your process is wrong. What you were actually doing with RNY was making two bets – one on the value of the properties, and another – more important – bet on the patience of your banker. Which is perverse, because who wants to invest based on the patience of their banker? This is something that had to be identified and addressed before investing otherwise you were exposed to significant risk.

RNY was fairly straightforward. Most investors look at debt and maturation dates and so on when they research a company. Still I think it is important for investors to identify the factors that are actually driving the valuation.

That’s probably blatantly self-evident. I find it useful to spell out these things specifically because once a theory is laid out, it can be manipulated. E.g. one can ask ‘in what circumstances is this theory wrong?‘ etc., but that’s a story for another day/possibly never.

A current example: NGE Capital

One thing I think I will do for future investment theses is try to prioritise the ‘factors’ that are driving a company’s value and their expected timeframe. For example with NGE Capital (ASX: NGE) which I just purchased, the primary driver of the company’s value is the way that people are pricing the LIC.

That is the most over-riding concern in the near term. One week early in August, NGE shares fell 8% and the gap between share price and NTA widened by close to 10% despite no announcements from its major holdings. In fact, NGE’s net tangible assets grew measurably, yet its share price went down:

See NGE (blue line) vs the share price of its 3 largest positions (these account for 51% of NTA, plus NGE has 26% in cash) source: Google.

So the primary driver of my investment’s value is however the hell people decide to price NGE this week (the same can be said for every company). However, the second most ‘powerful’ factor, in terms of ability to influence LIC share price, but the most likely to cause lasting change (in my opinion), is the value of the underlying companies. I have come up with a preliminary list of factors in order of their ‘power’, which I define as ability and likelihood of influencing SP:

The 4 factors that have the biggest impact on NGE’s share price and their time frame

The way that people price shares in the LIC (phases of the moon, motivation of buyers/sellers etc). Applies daily.
The value of the underlying assets. Share price should generally track these quite well – approximately, and on average – over 6mth-1yr periods and longer.
The success of the manager at making good investments. This is where you start talking about multiple ‘cycles’ of investments (selling winners/losers and searching for more purchases) and the presence or lack of a repeatable process. Applies over multi-year periods.
The long-term reputation of the manager. This is like a ‘meta’ factor because it is semi-independent of a company’s assets. Forager LIC (ASX: FOR) is no more likely to outperform now than it was a year ago, but its units trade at a 20% premium to NTA – compared to previously when you could invest in the fund at a price equal to NAV. Arguably this is due to scarcity of units. If it’s the rep of the manager however, you’d expect the premium to NAV to remain fairly constant over the long term, just like with Wilson’s WAM Capital (ASX: WAM). Reputation influences share prices across the spectrum from daily to multi-year timeframes.

Over a 1-3-year time frame, the value of the underlying shares NGE holds should well and truly be the underpinning driver, especially since NGE is publicly traded and the manager appears to have a shorter-term timeframe (i.e., realises value more regularly). However, if for example, there’s no-one interested in buying or selling the LIC/ the manager doesn’t get a good rep/ doesn’t have a repeatable process etc, it will be difficult for NGE to re-rate. So there are a few different factors to keep an eye on.

In the future, hopefully I’ll find a situation where I can swing for the fences based on a factor mismatch that’s clearly in my favour. A further plunge in NGE’s share price, despite positive news flow at all its companies, might fall into that category.

I own shares in NGE Capital. I used to own shares in RNY Property Trust but recently sold the whole position. I have no financial interest in any of the other funds mentioned like Wilson, Forager, or Bronte. This is a disclosure and not a recommendation. You can follow 10foot on Twitter @10footinvestor.

Investing lessons from the scrapyard

Fri, 05 May 2017 03:25:12 GMT

In another lifetime, I was a labourer at a scrap metal yard. And when I was there, I met a bloke we’ll call ‘Dave’. I’ve always wanted to write about him but have never quite had the platform or the context. Now I do, and a little piece of Dave will be immortal forever. He was a real character.

Enter…Dave

Dave had left school at grade 6 and worked a lifetime of backbreaking manual labour, marrying an Aboriginal woman along the way and raising a bunch of kids. Dave’s marriage came during the White Australia Policy era, making it what we might call an “extremely non-consensus” approach – to say the least! Nearly 60, he was spry and fit, and could outwork anyone I’d ever met – but not surprisingly, he wasn’t book smart.

Although embarrassed about it, he’d tell you quietly, with disarming frankness, that he was dumb. To his everlasting credit, he was quick to get help with things he couldn’t do, like addition or multiplication (e.g. of incoming scrap volumes). A lesser man might have tried to hide it, with negative consequences for everyone.

44-gallon drums were the main storage medium at the scrapyard. We used to get excess drums full of oil products, chemicals, industrial solvents, you name it (ask me about the time I spilled flocculant on the concrete). Dave loved cutting open mostly-empty drums of old diesel with an oxytorch (for the uninitiated: they explode when you do this). I was once working about two metres away from Dave – wearing earmuffs! – when there was a massive explosion – the drum he was cutting had more diesel left in it than was usual. The difference between a 95% empty and a 93% empty drum is hard to tell from touch alone, but it makes a significant difference to the size of the detonation…

Believe you me, it was not a mild “bang” type explosion – think “FUCKING BOOOOOOOOOOOMMMMMMMM”. The explosion occurred so quickly that I almost didn’t “hear” it – I heard the ringing in my ears before becoming aware of the noise from the explosion, which “arrived” a few seconds later (despite the noise definitely preceding the ringing sound, I experienced them in the reverse order). Everything moved in slow motion and signals from my body became disrupted. I distinctly remember tilting my head to understand why my vision was suddenly weird while my body sent signals that weren’t being processed. It’s hard to explain but I remember looking down at my hands and not recognising the object I was holding (I was disassembling a water meter at the time). I received the sensory information like reading a morse code signal, it came in intermittently over the course of a couple of seconds:

IS MY VISION BLURRY
EVERYTHING IS SLOW MOTION
I FEEL WEIRD (disorientation, ringing sound)
DID SOMETHING TOUCH ME (the building shook)
LOUD BOOMING SOUND
??????? (thinking for a few seconds)
……….
AH, DAVE WAS CUTTING A DRUM

Cutting open drums of fuel with a three-thousand-degree flame spoke volumes to Dave’s intelligence, although the fact that he’d reached the age of 60 with such a dangerous hobby might suggest he was smarter than he let on.

Lesson #1: On knowing your boundaries

I said to him one day as he walked into the shed ‘Whaddaya know, Dave?’, this being a common greeting at the shop, roughly equivalent to ‘how is your day going?’ or ‘what’s new with you?’.

“Mate,” he announced, “I know fuck all about fuck all. I know what I know.”

Which is a typical piece of Australian double talk that tells you fuck all about fuck all and won’t make sense to a student of traditional English, but conveys a surprising amount of information to those familiar with the lingo.

What Dave meant was that he was good at the things he knew how to do, and not so good at the other things.

This is the first of two crucial lessons about life I learned from Dave. So much has been said about acknowledging your weaknesses and having a ‘too hard basket’ that I won’t go over it again. Suffice to say that he taught me not only that it was OK to say that you don’t know, but there are benefits for everybody when you are strong enough to acknowledge your weaknesses and seek assistance to compensate for them.

Lesson #2: On the value of experience

The second lesson was even better; it was a vivid demonstration of the value of experience.

Contrary to what he believed about himself, Dave had a very high IQ, which is largely a separate construct from the ability to read or count. I had at the time a substantial amount of experience with intelligence tests, and a fellow labourer was a psychologist by trade, so we knew the signs. And we agreed; Dave was one switched-on fella.

If I am reasonably good at some things, like pattern recognition, believe me when I say that Dave was light years ahead, especially when it came to spatial awareness.

He would blow my mind on a daily basis when we were storing scrap output. This is not rocket science – you stack it so that it is accessible via forklift for loading onto a truck, and try to do it in a way that requires minimal space. The dimensions of the storage bins are fixed (many were old 44-gallon drums; see Dave’s hobby above), so the room for exercising ‘skill’ here is limited – or so you might think.

It is a boring and simple job and not very interesting. So you can imagine how special Dave’s skills must have been to generate awe in people who watched him work. Even if he wasn’t directly involved, he would often just wander past and rattle off half a dozen suggestions.

‘What about if you do X, Y, Z, put B there, take A out, put Q in that spot and put C on top.’

Uhh…what?

And then he would come and show you what he meant, since I and co-workers typically couldn’t see it. And blow me down if we didn’t routinely end up with 40% more space than we would have had if left to our own devices. Literally, 40%. And it would take 50% less time to load on the truck. I know that because I was so impressed that I measured it. Simplistically, there are two variables. First is simply the size of the containers (height, width, depth, weight) and optimising those for space. Second is the complexity of the containers, as some items were stored loose (e.g. crushed hot water systems).

So you had to balance 3d space & weight as well as the complexity of storing (loose items slide off each other & can take up more space, plus you don’t want your load moving around during transportation). When you break it down there is a fair bit involved; you are definitely working across more than four dimensions.

Dave’s pattern matching abilities were off the charts. How do you stack 6 medium sized cubes, 12 irregularly shaped rhomboids and 9 large cylinders in a space-saving way? It takes some thought to figure it out, but once you’ve done it there is an easily recognisable “right way” that Dave absolutely nailed.

A lifetime of labouring, most of it at the same workplace, had made him phenomenally, mind-blowingly good at the things he knew how to do. It was not just skill. His brain had shaped itself to increasingly specialise in and support his well-practiced skills. Normal people physically could not see the things that Dave could see, until he showed them.

To repurpose an Isaac Asimov quote; ‘highly advanced skills, to outsiders, are almost impossible to distinguish from magic.‘

That was Dave to a T. And after he finished helping and went back to his own tasks, the people that were around would shake their head in amazement and go ‘geez he’s good.’

But back to investing lessons. How well adapted do you think Warren Buffett’s brain must be after a lifetime of looking for moats and not reacting to negative news?

(See the 10,000 hour theory of excellence, and then figure out how many thousands of hours you can squeeze into a 60-year investing career – or a 40-year labouring one.)

Yeah but…what’s the second lesson?

Point is, it’s not just what you can see that is important in investing. You have to consider the things that you can’t see. It’s often the unseen risk that bites you on the buttocks. And by definition, if you can’t see it and don’t know it exists, you can’t compensate for it.

You need to seek out people with a different opinion to you, find out why their opinion is different and if you can, get them to justify it. This is hard in finance because people are at least partly incentivised (to ensure access to hidden opportunities and to avoid looking like an idiot if proven wrong) not to share their thoughts. That’s one of the reasons I started this blog. Hopefully you, dear readers, will be able to share your thoughts on some of my investments and help me see the light if I’m in the dark.

But for now I’ll leave you with a Dave-ism, which like many of his sayings, took on a life of its own:

“E’s a fucken deviant cunt….Good bloke though”

And next time you meet a bloke like Dave, consider there’s probably more to him than meets the eye.

Infinite Nuance

Ubisoft: Peak Uncertainty

Case Study: Simply Wall St Dashboard Feed

Case Study: iApply Loan Application Flow

The End of Henry Morgan

How it started:

How I knew:

The rest of the story:

Litigation

The Takeovers Panel

The ousting:

The liquidation:

Liquidated

Lessons learned:

Final note:

Halo Technologies IPO (ASX:HAL): Some Thoughts On Risk

The Setup

The concerns:

1. The incentive structure is poor

2. The bulk of Halo’s revenue comes from AAIG’s own clients

3. Halo has not demonstrated a talent for acquisitive growth

4. Halo appears overpriced

5. Halo Technologies’ management team does not have a track record of operating a financially sustainable business

6. There is the potential for significant governance risk

Hiring contractors as key management personnel?

The bottom line

Remote Work: Not As Simple As It Seems

First, some qualifiers:

Second, some exceptions:

Understanding Remote Work vs In-Office

Do Tasks

Seek Outcomes / Solve Problems

Task-focused roles: Remote

Outcome-focused roles: In-Office

Shared resources vs cross-functional teams vs siloed teams

Why the in-office vs remote work debate is ultimately meaningless

Closing Thoughts:

Metro Bank: Peak Uncertainty

Scale

Strategy

Progress So Far

The Path Forwards

Outlook

The bottom line:

Changing the shape of the playing field: Content and the attention economy

The Internet Changed Everything

The signal

The audience

The Hero

The message

The capability

The attention economy

The Rebrandening: 10footinvestor and Infinite Nuance

10footinvestor has changed.

Infinite Nuance

The New Site

A moment’s silence for 10footinvestor

Infinite Nuance, which sounded a lot better than 51 Shades Of Grey

Incremental, iterative decisionmaking

Which and when and where and how much?

Technical CEOs, transitions, and growing organisations

Sezzle’s Precipice

Management: Infinite Nuance

Process versus Outcome

Paradoxical Management

Conclusion

Interactive Brokers: A Stock Pitch

How IBKR adds value:

What I think will happen:

Brokerage as a Destination (BaaD):

Customer acquisition:

Risks:

The bottom line:

Blue Ocean Strategy: A Review

How to conduct a performance review

What the ideal performance review looks like

How to introduce a performance review process

Conduct a practice performance review

Before the review:

Holding the actual performance review