Markets

Firstly, I do not believe the market is in bubble territory. Are some assets overvalued? Most certainly yes (looking at you Afterpay and Tesla), but overall, the market discounts the future, and with the level of central bank interference as well as fiscal stimulus means that we can pretend the main-street economy will, at some point, catch up to the markets.

Furthermore, and to the point, it has become common knowledge that the market is in “bubble-territory”. I would hazard a guess that if it is common knowledge that we are still questioning if it really is frothy then we still will see markets grind up. We saw mania in late Jan early Feb, but on the whole, it has been linked to certain names and not to the markets as a whole.

There is probably a second post to be said on what is happening in the crypto/NFT/bitcoin space though. My quick thoughts are, perhaps bitcoin and other tokens are acting as a release valve for traidtional markets.

An interesting counterpoint to bring out is that Jeremy Grantham thinks we are overvalued, but instead of institutional bagginess we are seeing bagginess in retail speculation. Something that is quite different from 2000 and 2008 (link). Jeremy Grantham has called the top more than once. But calling it early is almost indistinguishable from being wrong.

Furthermore, the dry powder that private equity has and other insto’s have, is enough to really move the markets (example) not just grind them up. We are seeing bond yields come up, and equities slowly fall. Meaning that money must be sitting on the sidelines for a larger pullback. Timing is notoriously difficult, and any movements by the central banks will be a signal to those with cash. Those moving to cash are making the guess that the vaccine rollout will not be smooth and the economy will not catch up quick enough to asset prices.

Inflation

The biggest challenge that investors have at the moment is not the bubbliness of markets, but of inflation. I have been an inflation hawk for the majority of 2020 (proof). This is linked to rates which by bond vigilantes or whatever are somehow going up despite the best efforts of the RBA/ECB/The Fed.

There are many reasons to think that inflation is coming. I will list the reasons in terms of time horizon.

Short: in the short term the worry should be on how supply lines have been traumatised by COVID and those lucky to not be unemployed have saved money and now want to spend it. This is the best reason to expect short term inflation to go up. At one point though, economics 101 would expect things to reach an equilibrium. Consumers will get the products they want, and businesses will supply them. Overall, ceteris paribus, you could maybe expect inflation to go back to levels seen before COVID.

Medium: the current movement towards globalisation has ended. This should not be a surprise to anyone reading the news. The fractionalisation of supply chains and of technology will lead to higher prices as no longer will companies have the chance to go to the lowest bidder for labour. Labour costs have been kept down through globalisation, but it is unlikely that geo-politics will allow unfettered movements in the factors of production (the exception being capital). The blocs currently talked about are China, the EU, and the US.

Long term we have an aging world (data). An aging world means that savings will need to be spent on medical care and consuming. When we have fewer people working and more people consuming, we have inflation. A great book on this can be found at this link.

For the sake of completeness, the counterfactual does exist. The productivity gain by technology and a movement of workers to cheaper regions due to the work from home phenomenon may help keep inflation low over the short to medium term. Furthermore, where we have seen strained supply lines (semiconductors) the amount of money being spent to fix these issues would mean a glut of supply in the future. There is also Africa as a frontier to exploit in the production of goods to help solve the long-term aging issues (link), but you could expect at one point, like other advanced economies, for the continent to age.

Lastly, we are seeing inflation in commodity prices, house prices, and the expectation in yields. There is a good question there if it will show up in CPI data. Gold is down, but most industrial metals are up (YTD, Trading Economics data). Will those costs be passed on? In the short term, there may be reasons why suppliers can't pass on costs to consumers. It may actually be costly to firms to pass on any extra expenses (more here).

MMT

Is inflation always a monetary issue? No. It is a supply and demand issue, only sometimes it is easier to call it a monetary issue than address key causes in the underlying economy (labour, income, and amount of goods produced). A key worry in some corners of the markets is Modern Monetary Theory (MMT). Is MMT inflationary? Maybe. They seem to view government spending as having no end except through how resources are used. If resources are misallocated and inflation begins, then MMT-people would say that less government spending is needed. If inflation does not exist then the government can continue to spend. Ergo, MMT will only be inflationary if misused (link to a talk on this).

There is a good reason that MMT is being discussed seriously in some circles. There is political expediency to making sure the economy is humming along, and those zombie companies don't die. A second GFC type event has the ability to cause massive and irreparable harm to social structures. Asset prices are too important to be left alone.

Assets

This is all a long-winded way of saying, markets will probably come down slowly, rather than burst. In this case, as I have argued before, owning real assets is the key to getting ahead.

Markets can either be driven by narratives or by numbers, do we care about fundamentals or the stories? I strongly believe as the year goes on, numbers will start to matter more. That means investors will need to care about moats, brands, patents, land, and fixed assets.

Lots of food for thought.

"It is not a case of choosing those [faces] that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees." John Keynes

"The ultimate gift, in our digital age, is a CEO who has the storytelling talent to capture the imagination of the markets..." Scott Galloway

Since I last wrote an article, in May, the markets have been on a tear. There are plenty of good reasons for that (liquidity, vaccine, bored-markets hypothesis), but something that does not get mentioned is the brand some stocks have. Think the Nifty Fifty, WAAAX, FAANMGs, BATs, all include(d) brand name stocks, that created a narrative about ownership and the owner, that abstracted from their place in the economy and the wider world. The stocks that cause the indexes to rise are generally those brand name stocks, the largest ones.

As I think longer and longer about what makes a good investment, the more that I believe that brand is an essential characteristic of what makes a good investment. And I am not talking about corporate/product branding, but what I call investment branding or securities branding. This is when investor relations guru's, good marketing, key investor thematics combine into creating a brand around a stock or other investment.

A meme stock is a company that has brand value in the minds of investors. The brand is not entirely tied to the brand of the company, but becomes tied to the investment in the company itself. The word meme itself comes from Richard Dawkins. It describes how cultural units change and evolve, especially by imitation. A meme stock spreads by prophets and missionaries, and as people find out about it, the stock price increases.

This analysis is particularly pertinent towards the rise of retail trader/investor, something that occurs every few decades before they get burnt by the market. Professionals and institutions do get suckered into paying for the brand "nobody ever got fired for buying IBM," but do also tend to stick to more rationale fundamental analysis. What this post proposes is not a rejection of fundamental analysis per-se, but a way of discussing what may be happening when there is too much liquidity in the system, and prices/multiples no longer make sense. Investment branding is a cartoon of fundamental research, an abstraction; it helps to explain why good companies do not always make good investments or in the reverse, why bad companies make good investments. It also helps explain why some company fundamentals, their price and the real economy are so out of lockstep.

This was all written in December and January’s before the events with GME. I am still processing these events and how this framework can capture these market moves. This will be discussed below in further detail.

What is Branding and Investment Branding?

As Professor of marketing, Scott Galloway (known as Prof G), would say: a brand is the emotional and tangible touchpoints that surround a product. It is what distinguishes one product, or maker of said product from another in our mind. Businesses make their brand from packaging, advertising, logos, colours, choices of words etc., so to create an emotional response in the consumer.

"Brands are two things: promise and performance." Scott Galloway

For any brand, there are three branding touchpoints, prepurchase, purchase and post-purchase. For this post, we will treat them as the same, unless signalled otherwise.

Whilst we are comfortable in understanding that, we will need to look at how companies, and their missionaries, also create a brand within financial markets; their product is their equity. The ultimate goal of this is to drive up investor interest in the stock, decrease their cost of capital and make for easier exits. Creating an emotional story for investors helps CEOs sell this product. Investor relations is the job of managing the marketing and communication between a company and the financial community. They are the ones, in conjunction with others in the marketing department and the executive leadership team, in charge of informing market participants of the company. Further some investors themselves become missionaries of their investments and try to sell their ideas to others.

Returning to Prof G, we should look to his ideas on what makes a good investment and how that relates to investment branding. And then we can discuss how investor relations help guide the investment branding decisions in conjunction with others.

Prof G would say there are three characteristics for investors that are important: reoccurring revenues, high growth and increasing gross margins. But that is not enough to create a brand; the brand must be positioned in the mind of the consumer. All good investment brands want to position themselves in your mind and de-position their competitors against themselves. When I write "de-position" think of how Apple uses privacy to de-position Facebook and Android against iOS (see this article by Prog G on laddering).

The investor relation guru will talk to the investor in a language that shows, increased and reoccurring revenue, greater growth, and greater margins. Attributes that investors care about, such as distribution networks, logistics, addressable markets, and balance sheets etc. will be stressed if important. The positioning of the securities brand is always aligned with the product and corporate branding. Investor relations professionals know that there is a limited amount of money chasing too few stocks and therefore must position companies into investors minds.

"In a capitalist society, we mark life by our purchases." Scott Galloway

Many people think about the above quote in terms of material acquisitions, and also experiential acquisitions. But the truth is, nowadays saying you trade stocks, crypto, sneakers or anything else also marks the consumer out. To the retail trader, buying a dividend darling like BHP on Commsec says as much about the trader as buying NIO call options on Robinhood. Our ego is tied to what we invest in, as much as everything else. The good investor tries to act unemotionally, if they can.

To become a brand name stock, the company must be in a hot sector. No unloved sector can have a security that is branded. If you think of energy, for example, you may only think of one or two public companies, but I assure you they are not sexy companies. No one thinks of Exxon Mobile or AGL as sexy. But if you think of the renewables sector, suddenly you have Tesla. Now Tesla is a sexy company and a sexy security. If you own TSLA you own the future, you're helping the world, and it is exciting. One way to find the hottest sector is to see what type of ETFs and funds are being launched.

Securities that end up with a brand most likely also have good marketing and consumer brand visibility, meaning that consumer brand knowledge helps drives security branding. In Kumar, Sujit & Abdul's (2019) paper on brand value and firm value, they show in Table 1 how the literature supports the idea that marketing and brand associations drive higher market performance. In Frieder & Subrahmanyam (2004), they find there is "a preference for visible, brand name stocks in individuals' decisions to hold stocks, which supports the hypothesis that individual investors exhibit a propensity toward companies with easily recognizable products." A simple 2018 paper by Herciu shows "that market capitalization, enterprise value, brand value and corporate reputation are interconnected and leverage each other." It seems self-evident that well-known brands, for a multitude of reasons, have better financials and hence may have better share market returns. Brands are built by superior marketing, which is leveraged by investors as shortcuts in decision making.

The deliberate misspelling of the word "stocks" to “stonks” has come to mean a humorous company that you can bet and trade on, companies you can make concentrated bets on with a high likelihood of extreme tail events (left or right), in which the online trading community at Reddit will reward you for. Part of the reward is the feeling of community. That feel of the status of owning a security that this community care about, which goes back into how a brand is experiential for one that owns the product (the security.)

Putting this together we have the necessary parts of the framework:

1) Valuation narrative more important than numbers

- The narrative of the markets and the security itself means that rational financial analysis should not matter. Numbers become performative.

- This is liable to change depending on the markets regime. At one point we can expect valuations to matter more than narrative.

2) The company is a disrupter

- Only hot sector companies can create a brand. This also means that they have high growth potential.

- If the company is not a disrupter there must be potential for the company to be a disruptor in the near-term.

3) Superior brand equity vs peers

- Market participants have to know what the company is and its products.

4) The missionary

- There needs to be a CEO, or someone else like an hedge fund manager, with clout telling the companies story

- By buying stock from the promises of the missionary, we align our life with their goals and promise.

Some less essential but still important parts of the framework:

5) Recurring revenues

- Companies with stable and recurring revenues get higher multiples, all else equal.

- Companies with the hope of recurring revenue also works. Think TSLA and their taxi idea.

6) Expanding margins

- As above, ceteris paribus, expanding margins get higher multiples.

Implications

There are three main implications I think we can take away from meme stocks. The first is that they help explain why the market can stay irrational than shorters can stay solvent. That is, investors are sometimes buying an experience in buying certain securities, and they are buying a product that becomes part of their personality. This is mania, but not in the entire market, but in certain securities.

Another implication comes from the game theory idea of tactical voting. Sometimes the best trades we find are not the ones that are the best ideas but are the ones that others think are the best trades. In this case, I would be advocating for trend/momentum trading on the back of story companies. Perhaps my framework above can help you find those companies.

Lastly, the implication of a meme stock goes to the understanding of the narrative that management and other missionaries can create, and also the memes that get passes along due to that. A great book on candour and investing is Investing between the Lines by L.J. Rittenhouse. Understand that all investment-related material is a marketing and branding exercise.

On GME

I'll assume you have some understanding of what happened late January with Gamestop. Let us go through the framework I have espoused one by one, as simply as possible, and see how this works.

1) In the current market, with the discount rate so low, the NPV of a company approaches its future value which can be whatever you forecast.

2) Ryan Cohen's role on the board led many to think that there was a disruption that could come to the game store sector, possibly by a new and better online store to compete with Valve.

3) GME has over 60m people in its loyalty program, showing that there is a brand that people know and recognise.

4) Michael Burry, Kieth Gill (aka RoaringKitty), Elon Musk, Chamath Palihapitiya; all got in on this bandwagon.

5) See 2, the move to an online store will expand margins vs having a retail store and all the expenses that entails.

6) See point 2, the move to an online store and more touchpoints for the consumer would create more recurring revenues.

Limitations of this post

The biggest limitation of this analysis is the lack of quantitative rigour. This could be improved by identifying meme stocks and then regressing them on the factors above. There would be some issues with this, including how to easily identify brand value and how much clout a missionary has.

Even if this framework can find a meme stock ex-post as it becomes one, it may not find a meme stock ex-ante. The real value for any investment framework is in the ex-ante analysis, and that analysis is correct. Further, some bad actors will use frameworks like this, and their innate understanding of human behaviour to create artificial meme stocks for the wrong reasons.

There is also an issue of when does a meme stock revert to being a normal non-branded stock.

Further, the last big issue of this framework is that at one point valuations will have to matter. I can't say when this will happen, but the artificial capitalistic markets that we have built ex-GFC will need to be dismantled for the efficient allocation of capital. When this happens, I would imagine the number of meme stocks will decrease.

Conclusion

This is only a framework for looking at meme stocks. But I think it may hold some promise in finding the next ones. There are some implications for the investor to look out for falsehoods and to make sure that the investor relations department does not blind you to the real promises of the company. A further quantitative look is needed to see how useful this is.

More than that, from the ashes of Covid-19, there will be change. We are all MMT'ers now. Helicopter money, ZIRP/NIRP, possible monetisation of debt... It's safe to say that unconventional monetary policy is the new normal, "whatever it takes" round II, it is all the new normal.

The best we can do is not worry about the market moves and the significant volatility that we have now, we must look ahead. Forecasting is useless, but we can construct plausible narratives about what could be ahead, and use the insight combined with flexibility to make better decisions.

People are losing their jobs left right and centre due to this virus. To keep the money/credit markets working the Fed, ECB, RBA etc are announcing an alphabet soup of initiatives (here's a list). Fiscal policy is being created to help get the economy back, and keep people employed.

How we recover, and whether it will be in "V" shape remains to be seen. A lot of commentators are worried about deflation or inflation. But, I think, this puts the cart before the horse. Inflation is generally considered to come from wage increases. With unemployment increasing, businesses closing, the current regime is deflationary... For the short-term.

It can be argued that the extra money put into the system is inflationary. But at the moment that money is going towards groups that would either be out of cash or need access to cash for their borrowings — probably more of a net neutral to inflation. Inflation could begin rising (much) later.

But in Australia, there will probably be a period of semi-austerity and higher taxes (anything for the deficit) perhaps helping to keep a lid on it.

The issue that the I foresee, with low-probability but it is useful to think about, is stagflation. Once businesses start getting confident, with the extra stimulus and the world is no longer practising physical distancing, could we see all that extra money being inflationary? What if consumer confidence doesn't increase in-hand with that inflation? It's useful to think of a plan if we see a repeat of the 1970s, something probably not many investors remember.

What performs well in stagflation, commodities and real-estate. Put it in your toolbelt. Just in case.

Opthea

Opthea Ltd (OPT:ASX) is a drug development company that is trying to solve eye disease and in particular Diabetic Macular Edema (DME) and Wet Age-related Macular Edema (wAMD). Macular Edema is caused by a build-up of fluid in the back of the eye, this causes black spots in vision and can lead to blindness. Their drug-candidate is OPT-302.

What OPT-302 does is it blocks receptors that cause the build-up of the fluid. It does this by blocking VEGF-C and VEGF-D receptors in the eye. Interestingly the standard drugs for treating DME and wAMD targets the VEGF-A receptor in the eye. OPT-302 is intended as a combination therapy to be used in conjunction with a VEGF-A inhibitor.

Macular Edema (source: Opthea's May 2019 presentation)

Further and even more interestingly the drug makers that create the VEGF-A inhibitors are running out of their patent protection (see below). The other main drug used to treat wAMD and DME is Avastin (Bevacizumab, by Roche) which is used off-label. But these drugs have an efficacy and durability issue that seems to be lessened in combination with OPT-302.

Molecule Brand Name Indication Maker Patent Expiry Aflibercept Eylea DME Regeneron/Bayer 2020 ranibizumab Lucentis wAMD Genentech/Novartis 2020 (Source: here)

In August last year, Opthea announced positive results in a Phase IIb wAMD trial with 366 treatment-naive patients, soundly meeting its primary endpoints. The results were very interesting, as on the investor call it was stated that Lucentis scored the best it ever had in a trial increasing letters seen in an eye test by 10.8 but OPT-302 had done better with 14.2 letters (transcript of the call here & results from the announcement, p3). This was all with a similar safety profile as Lucentis.

ETDRS chart (Early Treatment Diabetic Retinopathy Study) used to estimate visual acuity

Almost immediately the stock went up ~148%. As of the 10 March 2020, the stock is up 204% since August 2019. At the peak, the share price had increased by more than 400%.

In December Opthea announced an AUD50 million placement to fund Phase III trials in wAMD with 660 patients in two concurrent trials. This was against the backdrop of an ongoing Phase IIa DME trial with readouts due early-to-mid 2020.

Knowing that the patent protection runs out for two of their competitors, it was interesting to see this placement. There are multiple ways to fund a trial and going at it alone is not the norm. In general, a lot of drug development companies prefer to partner with a bigger partner, this is to reward shareholders and to offload some financial risk. This is as drug trials can be very financially risky due to the expense. For example, Novartis is roughly ~200x larger than Opthea. Furthermore, Dr Megan Baldwin, the companies Managing Director and CEO, stated at an investor briefing the company had been in talks with global pharmaceutical companies.

So why do a placement?

In the Phase Ib DME study, Opthea showed that OPT-302 worked really well. Five out of nine patients in the study had DME in both eyes. They treated one eye but not the other and if you look at the results below, OPT-302 really seemed to work.

Phase Ib DME study (source: Opthea's Jan 2020 presentation)

Add in the information gleaned from the Phase IIb study in wAMD, the Opthea team may be confident that the drug-candidate works. The more positive information that Opthea gets on OPT-302 the more derisked the company is from an adverse result and the stronger the negotiating hand in any partnership deals or takeover deal.

For Novartis and Regeneron/Bayer, OPT-302 becomes an even more interesting molecule to get their hands on. As a combination therapy, OPT-302 could increase patent protection for their molecules to treat DME/wAMD.

A derisked drug-candidate commands a lower discount rate in evaluating its NPV, hence OPT-302 (and the company behind it) should have a higher value.

Furthermore, Novartis has tried to create an alternative to OPT-302 with Beovu, another VEGF-A inhibitor, but the drug has shown recent safety issues. This further raises the need for Novartis to plug an earnings gap when Lucentis comes out of patent protection. Other competition in the space all seem to use VEGF-A inhibitor drug-candidates. For example, Kodiak Sciences, listed on the Nasdaq (KOD:NASDAQ), has their drug KSI-301 already recruiting for Phase IIa. They are capitalised at USD2.53bn (as of 11 Mar 2020).

Again, to reiterate the point, OPT-302 is for use in combination with a VEGF-A inhibitor. These molecules pose little threat.

Information on Opthea Trials

DME Phase IIa (ongoing)

• 108 patients in two treatment groups (2:1 ratio)

• randomized, double-masked

• OPT-302 2.0mg with 2.0mg of Eylea compared to Eylea + sham

• 12 weeks trial

• Readout expected 2Q2020

wAMD Phase IIb (finished)

• 366 treatment-naive patients in three groups (1:1:1 ratio)

• randomised and quadruple-masked

• OPT-302 (0.5 mg and 2.0 mg) each in combination with Lucentis (0.5 mg) compared to ranibizumab (0.5 mg) + sham injection.

• 24 weeks trial

wAMD Phase III (planning stages)

• Two concurrent trials with 660 patients, 330 per arm

• Initiation of the trial expected 1H2021

• Readout expected 1H2023

M&A/Licensing Deals in Ophthalmology

• Xiidra which was sold by Takeda to Novartis in July 2019 for USD3.4 billion upfront and USD1.9 billion in milestones

• Nightstar Therapeutics acquired by Biogen for a pipeline of gene therapy candidates in ophthalmology for USD800 million in March 2019

• Aerie Pharmaceuticals acquired Avizorex Pharma for $10 million + milestones in late 2019

• Novartis spun out Alcon to shareholders in April 2019, 1 Alcon share for every five shares held in Novartis. At the time Novartis had a market capitalisation of USD190bn.

Conclusion

Before getting positive results in the Phase IIa DME and Phase III wAMD a pharmaceutical company may pay a lot less for licensing rights. If successful though, and results show that it may well be, the premium could increase. Add in the need for competing companies to want to increase their patent protection, there is a lot of shareholder value from taking the risk of the Phase III trial in wAMD.

Approved VEGF-A inhibitors have generated revenues in excess of USD10 billion in 2018, by showing that the investment community is interested in funding Opthea's trials only creates leverage with pharmaceutical companies in any negotiations, getting them a better deal.

Leverage is just another word for an informational edge in negotiations in this case.

Their competitors need a deal with Opthea to plug a revenue hole. That commands a premium. With Kodiak Sciences worth 5x more than Opthea, Opthea is a massive albeit risky opportunity.

Disclosure I own shares in OPT

Anyone who reads, or listens to Charlie Munger knows that he always focuses on incentives: show me the incentives and I will show you the outcome. If someone does x, what makes it in their interest to do so? Thinking philosophically, one could always point to the fact that we live in a Society of Control. As Gilles Deleuze would say we are controlled (incentivized) by non-stop observation, judgement and examination of society and/or the State. This though does feels incomplete. Rene Girad would say that we desire what others desire through the process of Mimetic Theory. Munger would tell us to use multiple models in analysing behaviour.

We

It seems everyone is talking about the We Company, how it is a failure of corporate governance, and how it is a bad investment for retail shareholders. What I think is more interesting is: how did we get here? What are the incentives that make an IPO this derided?

Obviously, we got here as the We Company needs money for growth, and for early VC backers to exit. But I want to focus on the founder and CEO, Adam Neumann and how he treats the company, and what it all means.

Greed is good.

— Gordon Gekko (Wall St, 1987)

The abstraction we call the corporation may well be one of the smartest imagined realities humans have ever made. The ability to create an entity out of thin air, and imbue it with its' own person-hood has made the modern world possible. Society allows the corporation to own and control property and thus individuals (shareholders) can pass off risk. Individuals do not need to risk their own bankruptcy, they can risk a non-entities, an imagined entities, bankruptcy. In many cases, owners of these entities are absent from the running of a business and they need managers for it.

That is a big issue though, between those that manage these entities and the owners who are invested in the company. How do the groups align incentive if management want a salary, prestige (status), and other benefits, and shareholders want a high ROIC? Even if there is no risk due to the debts being owned by the company not investors, they do not want a loss in their sunk cost of their own investment. Thus there are systems in place to keep shareholders and management interests aligned.

It's very, very important to create human systems that are hard to cheat. Otherwise, you're ruining civilisation because these big incentives will create incentive-caused bias and people will rationalise that bad behaviour is ok.

— Charlie Munger

Since the 1990's giving management equity has been the usual way to align interests, in fact there is even a Dummies article about it! Nowadays more and more start-ups are taking a lot of money and diluting the founders share of equity but through preference shares and different classes of shares they are retaining voting control of the company. Management may own less equity than other shareholders and be able to out vote them in meetings. This can be perverse if you have bad acting management.

Let's bring this all back to We Company.

Adam Neumann holds a lot of his wealth in We Company (about 30% of We’s equity), and in theory equity in a company can often thought of as a call option on the capital structure in incredibly levered companies. Neumann should in theory, have a lot of upside and limited downside, hence the creation of a company in the first place.

Once a founder has a company and is raising money, a founder generally should be incentivized to do what is best for the company. Especially as their ownership share gets more and more diluted by different funding rounds. As this happens hopefully their remaining equity is more valuable though. Now one should be paid for the work they do, especially if it creates wealth for the shareholders. And Adam does not draw a salary from We but gets paid through the loans from We, taking out loans from banks based on his equity in We, and through the valuation of We itself increasing.

This does not mean Adam has not acted in bad faith as management to other shareholders. By using $700m from We's backers to buy buildings that We leases and making it pay for a new trademark (he was paid in equity for this), giving family members jobs there, and the whole weird corporate structure shows that basic governance is lacking. Adam is acting like bad management. He knew that We would want the trademark he himself held, yet he sold it from himself to the company, giving money from shareholders to himself.

Further, the incentive to sell down his own holding ahead of the IPO is an awful sign. Why? Probably as he does not much believe in the companies prospects. And truthfully, why should he? The duration mismatch on assets to liabilities is huge. He is very obviously maximising his gains at the expense to others as he rightly should as an individual, but as a manager he probably should not do so as it decreases shareholders wealth due to negative perceptions.

Adam recently turned around and gave back the equity he got for the trademark (I started writing this post two weeks ago before I got too busy to finish this.) What is the incentive for this one may ask? It is all about making Adam money (again). If the negative perception of the IPO makes the listing valuation less, by holding the new piece of equity for the trademark, Adam takes a large loss on his remaining equity. The observation, judgement and examination by the wider investor community forced him to give it back.

What does this add up to: Adam is obviously extremely interested in enriching himself and probably not about trying to match asset and liability duration even as doing so would maximise shareholder value (will that raise consciousness though?) If we really want to see Adam caring about his company and other shareholders he should remove the classes of shares and have one class. One vote for one share, see how he acts then if he can be voted out of his management position.

One last thought

In October of last year pension funds and asset managers wanted exchanges to limit how long a public company could stay listed with dual class shares for governance reasons.The reason that individually they could not just refuse to include stocks with dual class in their funds themselves and called for regulation was that they needed their competition to exclude them too. If they did not, and the competition performed well (funds with dual listings) vs their fund (funds without dual listings) that would put their funds at risk of redemptions. This is emblematic of how powerful incentives can be. All needed to change or none would be able to. Causing an incentive to all complain together but not change their investment mandates individually.

Current market pricing and mentality: at the moment in the Australian rates market the sentiment

has become stronger and stronger that the RBA will drop rates due to slowing growth and household

leverage pressure.

The RBA has only now started to come to terms with a more dovish monetary stance in order to keep

Australia out of a recession.

This being said, the RBA does still seem hesitant to drop rates and have taken any excuse to hold it off.

An example of this was late 2017/ early 2018 when iron ore prices propped up depressed growth.

As a result of Australia’s poor current economic position, rates markets have priced in an aggressive

dovish prediction, with short term paper currently trading at 1.31%, 19 bps lower than the cash rate.

This not only offers a positive carry on a short position (assuming your account earns the overnight

cash rate), but is priced 6 bps away from a rate drop, and 19 away from remaining the same.

This offers a 3:1 payoff (simply put) for the trade, and has a positive carry.

The catalyst for Idea: what has changed, however, is the future amount of fiscal stimulus relative to

monetary. The Liberal party plan on decreasing corporate and income tax, which in the long term

may impact negatively, but in the short term will definitely be a positive. By having on average

~$1080 more on their tax returns, families will be able to spend more and feel less strain on their

mortgages (household leverage). As a result, this should, just like in late 2017, prop up the economic

data so that the RBA does not feel obligated to drop rates. Thus leading to a snack back of futures

back to the current overnight rate.

The catalyst for trade: The catalyst for the trade is simply the first economic set of economic data

that occurs after the implementation of the tax changes.

Details of trade: The time frame for this trade is less than 6 months. The expected profit for this trade

are +19 bps un-leverage (1.9%+ with leverage) and the expected downside is 6 bps

(0.60% with leverage).

This year we did much better than last year (we said we'd be back with vengeance) and had a much more comprehensive and cohesive story with what the global markets where up to at the start of April. We were lucky enough to be selected to represent Monash university and go to the national finals with our ideas and positions. Whilst we are in May now (sorry for the long time with no posts, we have been working hard at uni and in our respective jobs) we thought we should have a look at what we did. Commentary will be italics.

For those who do not know or remember what the competition is, we were asked to build a global portfolio across 5 asset classes (cash, bonds, equities, currencies and commodities), worth $500m USD, and at least 5% in each asset class and in the finals you can chose derivatives for three hedging strategies.

We had two main themes throughout the entirety of the rounds. One was asymmetry, looking for when the probability of a favorable payoff was high; and secondly 'pervasive uncertainty' in the market.

Our first major position was a large short on the Euro vs the USD at the time of the competition we believed that as we are currently at the end of QE, along with the relative strength of its' money supply relative to the euro that we would see a strengthening USD, this is what we also saw in 2013. The long USD also allowed us to allocate extra cash to other ideas.

A month on and we would have delivered a miniscule return. We still think this will pay off. The Italian economy, along with Brexit concerns is still a worry. Add in a return of Trump's tariffs comments, this position should pay off the rest of 2019.

In commodities, we had what we think is another asymmetric opportunity within iron ore and steel futures. As productivity around the world gets better and monetary policy is normalising, nearly all reasonably abundant resources have a downwards price trend due to mining methods becoming cheaper. Since iron ore is an industrial metal, we know that it is highly linked with global economic growth, at the time we thought a short on this is consistent with a slowing global economy. Steel was priced the opposite at the time with growth concerns. We thought therefore that iron ore could be asymmetrically hedged with a small long position on steel as it is currently priced too pessimistically as opposed to the positively priced iron ore.

This has also paid off in the last month. This position was almost like a classic oil spread trade but not quite. We had one judge say to us that they would be looking into doing it themselves. That level of feedback felt amazing.

Our equities position was pretty boring but consistent with a slowing world economy, FUD and monetary normalisation. We went long the world index and added extra weight to global infrastructure & utilities. One area in which we thought had a huge downside was corporate credit, not only are there an increasing amount triple B rated debt, but credit spreads are at an all time low, along with a large amount of 'cov-lite' loans. The issue was that to go short on this high yield debt proved to be extremely expensive, as we would have had to cover any coupon payments on the bonds and as a result that gives us an expected loss of roughly 5% on the trade. However, we believe we found a way to gain exposure to this high yield market without having to pay the premiums of going short on a bond. By shorting highly indebted, low quick ratio companies in the consumer cyclical sector we could make use of the distressed equity valuation method. This method suggests that distressed equities perform more like call options on their corporate structure than traditional valuation methods. As a result we think we have the wind in our back as we have an opportunity to bet against high yield debt by selling the most expensive call options on the market.

Unfortunately I do not have the pricing data, nor the time at week 11 at university to recreate the index we made and work out if we had made money. I suspect not. On page 26 of the presentation (the link to it is below) there is a link to the index we made. If anyone wants to have a look and tell me the results I would be more than pleased to update this.

For fixed income, we had a mix of slowing developed economies and growing emerging economy sovereign bonds. Initially, our fixed income positions did seem very inconsistent with our theme of monetary normalisation, until you account for our FX positions which has hedged a lot of our raw EM exposure. We thought at the time that the steep yield curve and high yields meant that before any additional capital gains, we had an expected return of roughly 8%. On top of this, we were already starting to see economic slowdowns in countries such as India, which have a lot more monetary policy headroom relative to inflation and growth compared to nearly all developed markets. Additionally, with our developed markets position, we think that this is a great opportunity to ride these bonds as their market participants mentality change from hawkish to dovish. We find our AU and CAD positions especially attractive given their fragile housing markets and UIP pricing shift.

Thus all up the portfolio we went into the national finals was:

• Long EM bonds, with fx swaps (35%)

• Long certain DM bonds (30%)

• Hedging with interest rate swaps

• Long utilities and infrastructure (15%)

• Short high yield bonds through our distressed equities index, hedged with a long futures position on the SPY and a variance swap (-15%)

• Spread trade with iron ore and steel (-5%)

• Long USD and short EUR in currency, with cheap options hedge (-50%)

Our main takeaway this year was that we needed to work on how to sell a portfolio. It's all well and good to have to good ideas, but no one will listen to you if your presentation does not look professional. Last year we were told that we had too many ideas and concepts, this year we pared that down, I would say that again, we need to pare it down and even more basic with how we can play the major global themes.

A big thanks to Citi for creating & hosting this event.

WJD & Jay

To see our full presentation link is through here.

Pinterest

Pinterest is a sort of free catalogue of ideas that allows users to create 'pins' with images and GIFs that they add to their boards (users can have multiple boards usually sorted thematically). I have spent some time using the platform to look for tattoo ideas, to me it comes off as an interesting Instagram/Flickr hybrid. Importantly it is paid for with promoted pins by companies. I have spent a lot of recent time talking about technology and advertising. After all free technology is only free as long as there is advertising paying for it.

With recent issues with online companies struggling to show that advertising is working or if the metrics are real Pinterest offers something that neither Google nor Facebook cannot at all times: users of Pinterest are proclaiming what they want. Facebook creates a profile of similar users like you; and what they seem to buy and when. Google does the exact same. What we see with Pinterest though is instead of finding similar users and what they may want or buy - users on Pinterest create boards with their wishlist. Usually the users creating the boards want to make something or have an idea of what they want, making for better, less intrusive personalised advertising. In an age where we are using adblocks and even tuning out of advertising this should be welcome to advertisers.

Some quick and important metrics: it's on pace for a $700m revenue for 2018, has over 250m users that on average spend 34 minutes a day on the platform, and lastly 55% of users use the platform to shop (here). The users also skew women, international and young a good target for advertisers. Even more importantly:

• 50% have made a purchase after seeing a promoted pin.

• 87% of pinners have purchased a product because of Pinterest.

• 72% of pinners use Pinterest to decide what to buy offline.

Some more metrics can be found here.

This is easily the most exciting IPO of 2019 I can think of off the top of my head. Here is a great 2014 Forbes article on why it should be an advertising machine.

Facebook

44% of Facebook American users between the ages of 18-29 have deleted the app off their phone. These are the users which marketers definitely want to catch. Whilst this is bad for Facebook and moreso for their advertiser partners, the truth is that those users are using Facebook's other services: Instagram and Whatsapp. I think you would find it hard pressed to find many people of that age who understands or even knows that Facebook owns either social media channel. As long as these teens think that they are not 'using' Facebook they will keep using Instagram & Whatsapp. Making Facebook money and creating an evermore comprehensive database on which to sell advertising to.

The bigger issue is the political response to the repeated Facebook privacy violations. Apart from allowing users more access and control of how their data is used; the government in America (which is FB's largest market; page 37) probably cannot break up Facebook or regulate them in such a way that would be palatable to their freedom of speech or liberal values. The users worried about privacy or how their data is used will have already left Facebook meaning even with an EU like GDPR in the US it is doubtful the bottom line will be too impacted. The platforms that Facebook has created mean that people do not want to leave them, and they are happy to pay for them with their data and ultimately with their attention. As long as advertisers do not leave in droves - which is doubtful - Facebook will be fine. I will leave a caveat; if the Facebooks metrics scandal getting worse would wreck my analysis due to advertisers leaving first, not the users.

To me they are approaching long term buy opportunity at these prices, I eagerly await their FY18 results as I want to know how revenue has been impacted over this years scandals. With a forward PE of 18 according to Reuters, it looks good for a tech company.

Apple

Apple's recent profit downgrade is the first one since 2002 or 2004. They partly blame it on China, which they think is a product of economic slowdown and the effect of the tariff war. Whilst I do not dispute this, I think it's overly simplistic. There are two other big reasons in China they have not pointed out. One their prices are too high, secondly Apple cannot differentiate itself properly in China - which is why their prices are too high. I will focus on the differentiation issue.

You probably read me say that Apple cannot differentiate itself in China and went 'what?'. So let me explain. Across the world there are multiple phone hardware OEMs and and a software for them (Android). There is also Apple which has its' own exclusive hardware and software. For most people that means if you are in the Apple or Android ecosystem you do not want to leave. Since China is the largest smartphone market it should have the perfect market for Apple as once you start using their services why would you leave? But there is a massive problem. Users in China do not live their life in their phone like they do in the West, rather they live their life through an app called Wechat which is owned by Tencent.

Wechat is a superapp which can do many things. You can obviously chat to people and use video call functions. But also "WeChat users in China can access services to hail a taxi, order food delivery, buy movie tickets, play casual games, check in for a flight, send money to friends, access fitness tracker data, book a doctor appointment, get banking statements, pay the water bill, find geo-targeted coupons, recognize music, search for a book at the local library, meet strangers around you, follow celebrity news, read magazine articles, and even donate to charity … all in a single, integrated app" (Sonal Chokshi, Anthony Horowitz, 2015).

The phone ecosystems are no longer Android or Apple in China; it's just Wechat. The best hardware for a price whether that is Apple, HTC, Xiaomi or OnePlus will be bought as they all have Wechat on their respective appstores. Apple needs to work out what that means and how to compete with some of the most innovative phone companies in that market.

Wechat is a way of life; Apple is just a lifestyle company.

A lot of the information and functionality of the internet is free. Do not believe me? Think cloud storage, email and browsing software. Apart from paying your internet service provider for the access, most things on the web is pretty much free in the Western world. For the Western world this is great because a functioning and healthy society needs news media and investigative journalism which they can get through the internet. I do not think that this is a particularly novel idea nor a contentious one. But living in the world right now, without universal basic income, means that we need to pay people to do that journalistic work. Something that costs money - payscale currently says that an average journalist wage is 53k. The problem is to have a news networks means that you need to pay the journalists, then the accountants, lawyers and all other support staff; this is expensive.

I probably started becoming aware of the wider world and issues through VICE magazine. Whilst I do not read it any more it does have some love from me due to the nostalgia value. Recently though they expanded too fast and now are struggling with growth, leading to layoffs. At the point I was into it, VICE media was a behemoth and the other new media plays (Vox, Mashable, BuzzFeed) were meant to take out the incumbents (NYT, Washington Post & Fox). This was by appealing to millenials and being fully digital they should have had lower overheads. But looking back on it, the incumbents have seemed to win (only with consolidation though).

The answer probably lies in reputation and how people expect news media on the internet to be free. Firstly on the idea of free: people do not want to pay for things on the internet. We do not pay for email, social media and YouTube: we do not pay for lots of games (Fortnite anyone?) and so why would we want to pay for news media? This is the issue that news media is having; people do not want to pay for it, and even if they do they do not trust it. Whilst part of the trust issue can easily be thought of by the lies and manipulation of the media, the other part of the trust issue comes from them needing to game the attention of people - to sell ads. Ads make the internet work and pay for the services on the internet. Make no mistake, the reason that Foxtel is having trouble in Australia right now is that Stan and Netflix their biggest competitors do not have an ads based model they are content and subscription only, they do not need to sell eyeballs - although that leads to their own problems. They also got into the demand based streaming service business model before Foxtel. Netflix needs subscribers, like Foxtel, only they do not sell ads. A look at Foxtel right now shows that they are limiting and stopping ads especially on their premium sports channels. We are now expecting a more premium service across all mediums on the internet - ads feel cheap.

Let us quickly think about BuzzFeed. They perfected the listicle and the "clickbait" article. The licticle being a journalist article presented in a list and clickbait being content made to create clicks and links to it - to sell ads. We do not trust BuzzFeed because of those two features but with them it helps to draw eyeballs and ultimately advertising. The Financial Times and the Wall Street Journal can create a paywall that people will want to pay for to cross, but can a site like BuzzFeed? Maybe. What makes them popular is what makes them a poor news site as they have become entertainment and clickbait outlets. So we need to think about the media again, how can a news media company on the internet make money when the internet makes information free? I am not so sure and it seems others are not sure either. So we see a trend in consolidation for the industry. The economics of digital media show that online ads are not worth as much as the ones in the physical newspaper and we know physical circulation for a number of publications is falling.

To think more about the payment issue it is useful to think of the one-click buy button that Amazon has. The Amazon one-click buy button is an amazing piece of technology, and was actually patented. Generally the movement in consumer technology has been the taking away of the abstractions to get to simplicity. That is why the one-click buy is great. It takes away all steps to buying something on the Amazon webstore. The more steps you have to buying an item the more likely at each step you will start to regret the purchase and not complete the purchase. But in comparison to news media, for entertainment media and for products that are shipped to us we are happy to pay for it. So we do not want to pay for news media except in our attention. It is generally easy and free to have access to the news. Why would I press the support buttons at the bottom of The Guardian articles and go through that process.

Wikipedia citing Thomas Davenport and J. C. Beck defines the concept of the attention economy as:

Attention is focused mental engagement on a particular item of information. Items come into our awareness, we attend to a particular item, and then we decide whether to act (2001).

This is how the internet of media has been made. Amazon, Google and Facebook all sell ads that take our attention. The saying goes: if it is free the consumer is the product (although this is not really as black and white as it is made out to be). These giants have made us - the consumer - the products and sell our attention to their clients. This is not new information. This is what DRIVES news media. The selling of ads to the eyeballs to their websites. But ads alone cannot sustain the news media. The rise in adblocking software is unrelenting. Google's new versions of their browser Chrome will now have their own built-in adblocking software. Bad quality adverts, malware and better user experience is driving this trend. This is another big issue for news media. If it sells access for information behind a paywall it needs a strong reputation but many people will not want to pay for it. Possibly one of the harshest catch-22 in the modern world.

But this shows us why the one-click button is so powerful. In a world where we do not want to pay for services online, where we want design and user experience to be simple and seamless our attention is limited. Therefore any removal of steps is important. The news is no longer a good that needs to be sent to us, nor is it entertainment (link). They sell us information and that is not tangible, it is commoditized and feels like a chore to read. We do not want to give it our attention. We do not want to pay for it. This issue is driving all online media at the moment, but mostly news media.

The takeaway: you cannot rely on attention if you sell a commodity. You must always try to create a brand that people will pay for.

The current strikes and protests in France end we need to think about what it means in a global context. The complaint that started it is that taxes for petrol are going up, and the common working class cannot afford these new taxes. The reason that the French State decided to change the tax structure around oil/gas was twofold: to increase tax revenue and to hit the CO2 emissions targets under the Paris accord.

If this is the reaction we have in France, what will be the reaction we have across the world as governments (hopefully) band together to mitigate climate change? Taxes on consumption of a good is one of the easiest ways to get a purchaser to internalise a negative externality - or so I was taught in my Introduction to Microeconomics subject at university. In non-jargon terms, a tax like the petrol tax makes people pay for the problems they cause through their consumption of a good/service, as otherwise it is too cheap to use the good in relation to the problems it can cause. It's also why we force miners to clean up their environmental mess when they leave a mine (usually to no effect & further reading).

For those of our species not in the developed countries they see our standard of living. They see how we live. Can you imagine for the sake of climate change they do not want to join the global middle class? The global middle class is the main cause of pollution and for many outside of that middle class it is their dream to live like the west - with our air conditioning and TV's. And worse of all emerging market countries are most exposed to the damages of climate change.The Paris Accords of 2015 means that in combating CO2 emissions we could be slowing down the rise of EM countries joining the DM countries in their standard of living. Again I ask, do we imagine that people will accept this slowing down of them catching up to the West?

The Economist had a good article that to understand EM bonds we have to understand how WILLING a country is to pay back its' debt holders. So let us tie it all together.

Climate Change is happening → we should probably try and mitigate its effects → people won't be happy with that political action → unhappy populations force politicians to make decisions that do not always favour EM bondholders.

Case in point - also pointed out in the Economist article - is that Mexico has elected a populist leader Andrés Manuel López Obrador other wise known as AMLO and one of the first policies he has enacted was the scrapping of a US$13bn airport that was paid for with debt. Sure, the airport was widely unpopular but giving into populism over the real need for the airport as well as the wishes of bondholders is not a great way to start a presidency (funny video on the topic).

At the moment we are seeing more populism, and as climate change changes the earth and we most likely get more fires, floods, droughts and etc; we could see more social unrest. That may not just be due to the disasters themselves, it could also be due to famine, drought, access to clean water, access to safe land for some other examples. The willingness for people to pay for climate change mitigation outside of leafy socialist enclaves is low. Especially when the standard of living can change.

As we make ever more contentious policy, and as populism spreads further we can expect to see the willingness question come up more often. And this is just one of the many opportunities/issues we have with the future of investing in the shadow of climate change. Other issues include scarcity of resources and the opportunities of renewables. Both of which may help drive alpha in longterm investors portfolio.

WJD

AI

Whether computer science grads like it or not, the use of artificial intelligence by itself is a commodity. Anyone can download Tensorflow and Keras and then use it to create an AI for their data set. After all AI is advanced pattern recognition (wiki). The reason for this is that most of the AI algorithm are open source and researchers do not always like doing proprietary work (exhibit B). Meaning that it is unlikely you will want to, or can invest in the algorithms itself.

How easy it is to use start using machine learning software That leaves two other interesting parts of AI around. Hardware and proprietary datasets. On the hardware sides of things Google and Nvidia have interesting specialised processors called TPU's, they speed up neural network learning, and Google is putting that into their cloud based computing software (so is Amazon's AWS & Microsoft's Azure). The appeal is obvious, the faster the machine learning the better. Although as I discussed last week, quantum computing will be quicker than the bits on these versions of TPU's.

Whilst I believe that AI is a commodity, what is not is data. Good data with commercial opportunity is where those who want to bet on the future of AI will go to. A good example of how important data is becoming is in the agricultural area. What is called precision ag(riculture). If you look at John Deere, the tractor and truck company, all their machines now comes with sensors. These sensors have over seen great improvements in production efficiency and field resolution times as well as a significant decrease in warranty expenses. By collecting data and letting the farmers understand it, they have a commercial opportunity.

This is why Facebook and Google have done so well. Large datasets with actionable data on the consumer allows the best targeted ads, which advertisers will pay for - obviously. These ads can nudge us (also see my last post on this blog) to do things we would not otherwise do, and the insights from the data, allows these companies to know us better than we know ourselves. Why else is Mastercard and Microsoft now working together to even better understand who is who, and what do they do online?

The takeaway is: novel datasets and the solutions and insights that they can give is where the money is at.

Farmland

I have been meaning to talk more about this for some time. So let us begin. In economics there is an idea that gets thrown around a bit, Knightian Uncertainty. That is that we do not know the true unknowns. Agriculture as a business has a number of variables in which we cannot control things like the weather, CO2 levels, soil health and the like. All of this and more affects the yield of any harvest, as well as the value of agricultural products and the farmland itself.

Investors dislike things that they cannot control. But what if I told you that we could lessen our exposure to the vagaries of the wind and broader weather issues make money on future of our species wanting to eat. After all everyone knows that that the population around the world is expanding and by 2025 the population will have gone from 7.2bn to 8.1bn mouths people.

That alone gives me great confidence in owning - for the longterm - farmland. This is rather than actually investing in, and being apart of the actual farming itself. One cannot hit back to us that increasing harvest yields and technology means that over time, even with inflation, the cost of grains have fallen (particularly good read here). They may say that farmers who do not own the land will not treat it right; but that is a risk in every endeavour where we limit skin in the game. And even as grain prices have fallen, farmland has a high correlation with inflation, meaning for those that are worried about a return to inflation; buy the land.

According to Nijs (2014) farmland has 6 main drivers (1) global population growth, (2) changing dietary habits, (3) agricultural productivity (which is both an issue and an opportunity), (4) changing climate patterns, (5) the rise of biofuels production and consumption, and (6) the increasingly limited availability of farmland. All great drivers for the longterm and patient investor.

There is more to it, but buying farmland is a smart move. The two REITs on the ASX (disclosure: I own both) have a yield of ~5% and ~8%. Both have land that has different types of crops & animals and are geographically spread out. One of them Rural Funds Group (RFF.asx) publishes this infographic below which I find particularly interesting for anyone interested in the area.

From: Rural Funds Group website (here)

There is a lot of nuance in this area, and truthfully I probably do not know enough about it. But I like the idea that I own something that will always be needed. It seems to be low risk and medium reward (also see Clarke et al 2012). And when someone asks about water, and about changes in soil composition I get to say that does not worry me. I am not the farmer merely the one that owns the land, I can collect rent and get a good capital gain from ownership. Smart management of farmland REITs will make sure to be geographically spread out, have different resource entitlements and not take big concentrated risks.

WJD

We had been discussing the Wesfarmers demerger of Coles, Data and the future of computing. So here it is:

William here, I was considering some of the points of we touched upon on Sunday and wanted to further expand on them as we left a lot unsaid. I will break it up into two main bits and reference it as much as possible so we can all have a bit more understanding of what was being said as it is very complicated.

Data and Flybuys:

As we discussed Wesfarmers did make sure to keep a 50% stake of Flybuys. The reason being is that the data they have collected since 1994 is includes nearly 50% of the population and 5.5m households (according to Wikipedia).

Recently the new Macbook Air came out which I was thinking of getting for university, and in less than a fortnight of it being out I got a targeted ad saying that for me it's 10% off if I buy now, semi scary until I realised I had looked at the price on the Apple store and compared it to the similar specced Surface Go. The more data that advertisers and store managers can get the more likely customers will remain interested, by the time I had got the advert I had forgot about buying the laptop as it was out of my price range, or really my need - it reminded me.

A good look at how we can use data to 'nudge' people can be seen in the Orwellian game-style Chinese point system to control the masses - points for being a citizen. The Chinese are merely taking a play out of what computer games have been designed to do. They keep us interested, we are addicted to the dopamine release when we play games or look at marketing (exhibit A & exhibit B), China won't just be using dopamine to create their in-game carrots. They have real life consequences to not being a good citizen.

Yuval Harari has stated that humans are an algorithm (we implement steps to go to a goal), and that we can be gamed by machine algorithms. Certainly a scary proposition but it looks to be true. Marketing is defined as the act of selling and promoting a product/service and what we are seeing is that marketing is now all done by data scientists. We are gaming humans into making decisions. That is why it is so important for Wesfarmers to keep Flybuys. If you're still not convinced: Qantas today has a market cap of $9.87bn, Credit Suisse says their Frequent Flyers Program is worth about $4bn.

AI & Quantum Computing

Computers at the moment are made up of bits, which are positioned as either on or off. That means with 20 bits you have 1,048,576 different positions (2^20). WIth a quantum computer the number of positions one may have are innumerable. The bits are now called qubits, although usually in practise at the moment they have either 2 or 4 positions (up down, spin up, spin down). These computers will be vastly more powerful what we do today. With 10 qubits we can have the same amount of positions as the 20 bits (4^10). The thing is these quantum computers are amongst us today and are not science-fiction. Finding primes will be much easier with quantum computing which is good for encryption. But also means that in the wrong hands hacking into systems would be much easier. Write a program to find all the bugs in a legacy computer. The first entities to own them will have a massive jump start on their potential.

Artificial Intelligence is having a renaissance at the moment too. Deep Learning using Neural Networks (20 minute video) that mimics our brain structure will be used in most applications. It has become prevalent and easy to use. One can download packages called Keras or SciKit and add it to your new app idea or any idea really. Whilst the commercial opportunities are boundless, they bring with them a host of issues. Humanism, or the idea that humans are the front and centre of the world is the dominant philosophy in the world. We can see that data is pervasive, and the AI to use it also, humans look to become obsolete soon; what will happen to humans? With commercial interests above the interests of society as a whole can we make sure we are making the right steps with this technology, or even, if we should. We could easily grant consciousness to a silicon wafer; if you believe a rock can be conscious.

Deep fakes and the rise in fake news will become even harder to spot and stop with AI and quantum computing. I heard a conspiracy theory that the governments and universities deliberately allowed the software to go on Github (where all open source software resides) so that when shit hits the fans and things go wrong, they can have plausible deniability with video evidence. Who knows.

On more positive notes, the technology is promising for the medical tech world, and performs better than most doctors in prognosis. Humans not driving and leaving it to AI should lead to a reduction in CO2 and deaths. And that is just scratching the surface.

Anyways, Hope you enjoyed this kind of content.

WJD

Bayan already owns the majority of shares (56%) due to a transaction with Kangaroo, where Kangaroo were given 9 mining projects in Indonesia. These are all located close to Bayan’s current mines and Bayan is the developer of these projects along with being the project manager.

There is one more party we need to introduce to this deal so one can understand what is happening. White Energy Company Ltd (WEC.asx) - an Australian coal-tech company.

Why does this opportunity exist? Usually when an opportunity likes this exists, getting into a risk arb opportunity this late to the party is almost impossible. But Bayan is involved in a lawsuit in which it (possibly) owes White Energy Company (WEC.asx) for repudiation and damages of a JV contract.

This was for a coal upgrading plant in which WEC supplied 51% of the funds and Bayan the rest of the funds and the coal. When coal prices rose, Bayan repudiated the contract and the supplying of the coal. The lawsuit is currently taking place in Singapore’s International Commercial Court (SICC) and the proceedings commenced in Dec 2011. Due to this in 2012 the Supreme Court of WA has frozen Bayan’s position in Kangaro.

Recently on the 25th of Sep 2018 WEC announced they would aim to stop Bayan transferring assets to Bayan or to a related entity. If Bayan loses in Singapore and do not pay up, WEC can use the frozen assets to pay back damages.

There are three tranches of the WEC v Bayan court case that need to be solved before that freezing order will be ended, assuming no out of court settlement. Tranche one was determining the scope of obligations under the JV contract. Tranche two is if there has been breaches, and three is if damages and how much should be awarded.

Currently tranche two is being fought out in the SICC, the last major question to be answered is could the project have been funded by WEC. Once that is answered we will get to the damages tranche. From what I can tell after spending hours reading the online court documents, there should be damages. It seems like a clear breach of the contract was made.

From there we now need to return to the acquisition. What happens now? We can assume the WA court will allow for the freeze to be furthered - in wait for the SICC decisions and possible appeals. We can also assume that Bayan knows this, after all this is their only Australian assets that can expropriated if Bayan refuses to pay the potential fines.

Bayan has the money and ability to finance the acquisition and pay damages to WEC. So my best guess is that they will. Why would they not? The Indonesian projects are close to their current operations, they already effectively run the KRL projects and there is massive synergies in owning outright the mining projects.

I think this is a pretty riskless arbitrage. Bayan has been involved in the legal dispute since 2011 and has known about their share freeze in KRL. Thus they are likely to be working out to either settle with WEC or just pay any possible fines and acquire Kangaroo. Until the end of Nov, there are two more court hearings for the acquisition to go through, and and 75% of minority holders must accept. It is our view that these are all formalities. The Foreign Investment Review Board has okayed it, and if Bayan can sort things out with WEC - which is in their best interest - this is a shoe in. KRL has been trading below 15c since 2012, so long term shareholders are probably happy to accept the terms.

Seems pretty good to me.

Disclosure: N/A

Disclaimer: Do your own research, this is not substitute to professional financial and investment advise. I take no responsibility whatsoever in any (in)actions undertaken by any party who reads this, nor do I take any responsibility for any factual inaccuracies.

I am active trading and investing, just haven't had time to put much thought into blogging. Between uni, work and a startup Jay and I are working on; this has gone on the back burner.

We did see the Turkish Lira plummet and I did start an article on its' weakness on the 15/07. But I never finished it (a few days later it plummeted). Other articles I have wanted to write about include Consolidated Infrastructure Group (CIL.jse) and Rural Funds (RFF.asx) closer to home.

In the time off from this blog I bought into the Vital Harvest IPO (VTH.asx) and bought some Live Tiles (LVT.asx) on Jays recommendation. In regards to LVT with current growth rates they should get ARR of $20m and possible break even in late 2019. I have also looked into BNO.asx, CSL.asx & HZR.asx. And increased holdings in CLH.asx & ALX.asx.

Other financial ideas I have grappling with have been along the risk management side of things. How do you structure an active portfolio if you do not have the time to be constantly updating correlations and betas? Should that mean I go to full passive for the time being? Big ideas with no small answers.

In regards to the start up, Jay and some friends are starting a property analytics platform. Bringing the 21st century to property with data science. That is why this blog has been dark and quiet. But rest assured we are always on the look out for great ideas though.