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WCM Investment Management | Insight | Beach Reads - 07 - 21 | Welcome to Beach Reads. This week's wide variety of links covers topics including Chinese political ambitions and changes in monetary policy application.
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Beach Reads

July 21, 2020

Welcome to Beach Reads. This week's wide variety of links covers topics including Chinese political ambitions and changes in monetary policy application. As usual, there is a healthy investment philosophy section that introduces some interesting frameworks for thinking about companies. As for my favorite articles, the TikTok link is timely; the Alex Danco piece, along with the end of the Charlie Songhurst podcast, cover important topics related to running a business during work from home; and the article about Raphael Bostic is illuminating. Here is an outline of the themes covered in this edition.

  • Chinese political ambitions outside its own borders realized through TikTok, how Nintendo can unlock more shareholder value, and the best AI yet
  • Aggregating demand vs. supply on e-commerce platforms and the impact micro-influencers can have on shoppers. Also, craft as a device to help recruiting in a work-from-home era
  • A fantastic podcast with Charlie Songhurst, two articles that introduce different investment frameworks, and a thought piece on COVID-19's impact on various types of companies
  • Reflections: monetary policy's human impact and an examination of gender wage gaps

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Conor Deveney

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ABOUT Beach Reads

Welcome to Beach Reads, a collection of interesting links that we at WCM have come across and want to share. The goal of this publication is to engage with a broader audience in order to better ourselves and others. Feel free to email us at insights@wcminvest.com with any thoughts or feedback, and click here to subscribe!

01. Tech Companies: TikTok, Nintendo, and GPT-3

The TikTok war

India recently banned TikTok and there are increasingly loud calls for the US to follow. One opinion on TikTok in the US was recently penned by Ben Thompson at Stratechery. He published a scalding review of how TikTok is an affront to western liberal values and an important way for China to gather information and influence the actions of broad populations outside of its own borders. From Thompson: "TikTok's algorithm, unmoored from the constraints of your social network or professional content creators, is free to promote whatever videos it likes, without anyone knowing the difference. TikTok could promote a particular candidate or a particular issue in a particular geography, without anyone — except perhaps the candidate, now indebted to a Chinese company — knowing. You may be skeptical this might happen, but again, China has already demonstrated a willingness to censor speech on a platform banned in China; how much of a leap is it to think that a Party committed to ideological dominance will forever leave a route directly into the hearts and minds of millions of Americans untouched?" While China has resisted western social media platforms for years, the rapid success of a Chinese social media platform outside its own borders is cause for concern and, according to Thompson, something that calls for action: "It is time to take China seriously and literally: the Communist Party is not only ideologically opposed to liberalism, it believes that only one of liberalism or Marxism can prevail. To that end it has been taking action for over 20 years to control information within its borders and, over the last several years, to control information outside of its borders. It is time for the U.S. to respond, both on the government level and corporate level, and it should do so in a multi-faceted fashion."

Nintendo: Capitalizing on Nostalgia

While Beach Reads often discusses high-level themes relating to video games (e.g. the metaverse), this link from Intrinsic Investing outlines an investment thesis on Nintendo. The four keys to unlocking the potential value of the company, according to Intrinsic, are 1) improving the multiplayer and digital experience, 2) increasing direct digital sales, 3) leveraging nostalgia by putting the company's back catalog online, and 4) getting more third party IP on the platform. One other interesting idea that Intrinsic has is that Nintendo can use the Switch, its gaming system, as a platform: "Iterating on the Switch hardware to higher and lower price points and maintaining a consistent software operating platform, much like Apple has done with the iPhone and iOS, strikes us as an intelligent break from the past boom-bust console cycle." The video game industry has long been plagued by booms and busts around different IP launches, and mitigating this cyclicality would be a positive. Following the platform route would likely be smart here, as we've seen the success that platforms have had in video games: just think of Fortnite. I'm curious to see if Nintendo pushes for the Switch to become more of a platform.

OpenAI's new language generator GPT-3 is shockingly good—and completely mindless

The internet has been abuzz lately with all manner of news related to GPT-3, OpenAI's language-generating AI. The software is available to certain individuals through a private beta, and those users have been posting some incredible feats that GPT-3 has accomplished. These range from writing entire blog posts to coding based off a simple English description of what a program should do. This MIT Technology Review article features some of GPT-3's pros and cons. The pros include "a blog post where [a beta tester] showed off short stories, songs, press releases, technical manuals and more that he had used the AI to generate. GPT-3 can also produce pastiches of particular writers. Mario Klingemann, an artist who works with machine learning, shared a short story called 'The importance of being on Twitter', written in the style of Jerome K Jerome... Klingemann says all he gave the AI was the title, the author's name and the initial 'It'. There is even a reasonably informative article about GPT-3 written entirely by GPT-3." However, the software also has an ugly side and is apparently "prone to spewing hateful sexist and racist language." I hope that GPT-3 can clean up its act and am excited about how the technology may be commercialized in the coming months.

02. E-Commerce: Shopify, Amazon, and Craft Culture

Thoughts on Ecommerce (Pt 1): The Status Quo

On April 14, Beach Reads featured Julian.Digital's Signaling as a Service blog post, and on a recent return trip I found a two-part series on Shopify and e-commerce that talks about demand and supply aggregation and mimetic theory. This link, the first installment, focuses on Shopify's not quite direct to consumer model: "Many of Shopify's merchants aren't really direct-to-consumer brands, they are more like direct-to-consumer-but-with-Instagram-in-the-middle-eating-all-of-their-margin brands. Instagram capturing most of the value is a perfect example of why demand aggregation is always more powerful than supply aggregation. Too much reliance on a powerful gatekeeper like Instagram is a risk for Shopify and its merchants." The author goes on to explain how Shopify's "Shop" app may be helpful in disintermediating aggregators such as Instagram: "By connecting you with merchants you have bought from before, Shop will recommend you additional products that you might be interested in from the same sellers. The result is higher post-purchase loyalty and thus higher LTV [long-term value] which makes it easier to justify high initial acquisition costs via Instagram." In this way, Instagram is only the tip of the spear, which Shopify can then better monetize through repeat purchases on its own app. The logic makes sense, but leaving discovery outside of Shopify still means that the platform and its customers are at the will of the pricing dynamics of these discovery tools.

What Shopify and Amazon can learn from Mimetic Theory (Thoughts on Ecommerce Pt 2)

Part two of the Julian.Digital blog post builds on the importance of discovery and how styles and consumption patterns are increasingly influenced by individuals and not necessarily product features or functions. To this point, the author believes that platforms such as Shopify and Amazon could better leverage product discovery and that understanding who people want to emulate (by tracking them online) could be a powerful sales tactic. This is somewhat similar to targeted ads but, instead of pushing products through search history, a platform could push products based on influence and people we respect. An interesting prediction: "While brands will still be important, I suspect that a lot of stores will become commoditized over time. Ecommerce will become more modularized as transactions shift from both retailers and D2C [direct to consumer] brands to individual influencers." And a recommendation: "Should Shopify decide to make its Shop app an actual discovery platform, it should build its recommendation feed around influencers – not shops." Whether or not influencers become a true sales channel in and of themselves remains to be seen, but there is undoubtedly an opportunity to integrate personal "influencers" more deeply into product discovery.

Craft is culture

Past Beach Reads have included the work of Alex Danco, currently employed at Shopify and previously at Social Capital. This recent piece from Danco's blog reflects on the evolution of work culture and today's work-from-home environment (and implications on hiring). At the same time, it examines the role that "craft" has played in building communities, especially online communities. He then connects the two: "It seems obvious to me that this world we're entering is just a more intense, and more widespread, application of the lessons we learned 30 years ago in the early California tech industry and on the early internet. Hiring and craft become the same thing. The more effort you invest internally into craft development and celebration, the more people will want to work with you. (On the flip side, in a remote work world, craft and process knowledge are even more important than they used to be, because we have to trust each other a lot more.)" I love the idea that craft is a signal of sorts: it is an external manifestation of one's obsession with one's calling. Birds of a feather tend to flock together, so when it comes to recruiting, those with the best "craft" expression likely have the most devoted communities, and therefore the best options for hiring. This is especially true in a remote working world where talent is no longer geographically constrained. Check out the end of the Charlie Songhurst podcast below for more on what this trend means for companies.

03. Investment Philosophy

Lessons from Investing in 483 Companies

This podcast, from Patrick O'Shaughnessy's "Invest Like the Best" series, features Charlie Songhurst, the former head of strategy at Microsoft and currently an active investor. Throughout the interview, I was blown away by the incredible number of topics that Songhurst can speak to in depth. These include motivators (money, power, and fame), productivity at startups, politics within businesses, and more. A couple of interesting highlights: Songhurst juxtaposes "East Coast" and "West Coast" investing around the 25:50 mark, furthers this concept around the 39:40 mark when discussing investing aesthetics, and talks about the importance of curation and idea sharing around the 59:30 mark. Additionally, towards the end of the podcast, Songhurst reflects on changes COVID-19 is having on hiring.

Searching for the (non)core

Pattern recognition is an important skill for an investor to develop. Determining which patterns are meaningful is difficult, but this piece from investment firm Seilern Funds highlights one pattern worth looking out for. Specifically, the author examines a unique class of companies: those that are mission critical to customers but represent a small percent of total cost (for the end product). Building on the work of Phil Fisher, the author writes that "the benefit of these characteristics is that, consequently, a customer looking to make moderate price reductions yields only very small savings relative to the risk of it changing suppliers. Indeed, what we have found in practice is that a company which is able to produce a true mission-critical, non-core product actually has stronger pricing power for this very reason. Why risk the quality and reliability of your product for a relatively small saving? It's highly unlikely to be worth it." As examples, the author details the firm's theses on West Pharmaceuticals and Christian Hansen. Investment firm AKO has a book called Quality Investing that highlights other similar company patterns or types that are worth keeping an eye out for. Does anyone have some patterns that they look out for that tend to be predictive?

Reinvestment Moat Follow Up: Capital Light Compounders

This is an older piece, but one that is worth reflecting on given the incredible run in many "capital light compounder" and "reinvestment moat" stocks as of late. In the article, author Connor Leonard outlines a business type that he calls "capital light compounders," describing their key features as negative working capital, low fixed assets, and real pricing power. These are different from "reinvestment moat" businesses, which "deploy incremental capital at high rates within the current business." Leonard also gives his idea on which type of company is best, depending on the macro environment: "Are 'Capital-Light Compounders' superior businesses to 'Reinvestment Moats'? My current thought is that in an inflationary environment the Capital-Light Compounder is the preference because the lack of physical assets enables revenues to increase without the corresponding need for heavy capital expenditures at inflated rates." Without significant inflation in the US for years, it appears that both classes of companies have done very well.

The great acceleration

One recurring theme in business analysis around COVID-19 impacts is that the big keep getting bigger. Consulting firm McKinsey recently published a report that reiterated this theme: "Our analysis reveals that the gap in economic profit between the top corporate performers and everyone else has widened dramatically. In effect, the crisis has accelerated a trend that was already present. Between December 2018 and May 2020, the top quintile of companies grew its total market-implied annual economic profit by $335 billion, while companies in the bottom quintile lost a staggering $303 billion. And while the specific numbers can fluctuate from day to day, the larger trend is unmistakable: a gap is opening up, and it's rapidly expanding." This phenomenon was occurring before COVID-19 but appears to have sped up as of late. The authors also highlighted the important role that speed plays in making sure businesses continue to succeed: "In times of crisis, however, the burning platform is clear, leaders are often in military-command mode, and precrisis budgets have become obsolete. Resources are easier to reallocate when no one needs to be convinced of the need for a rapid response and the individual targets set before the crisis no longer apply. Think of it as a big 'unfreeze'." Today, and going forward, businesses that have leaders and cultures that are adaptable and fast seem poised to continue to grow.

04. Reflections

First Black Fed President Warns of Systemic Racism's Economic Toll

The Federal Reserve Bank of Atlanta's president, Raphael Bostic, recently published an essay detailing systemic issues in the US that primarily affect certain segments of the American populace. The Wall Street Journal gave a brief overview of this piece and Bostic's background. When reflecting on the Fed and its response to the pandemic, Bostic highlights the pressures experienced by minority groups: "The pandemic's economic and health toll has hit Black Americans and other minority groups hardest ... It has coincided with a rethink inside the Fed of how it should evaluate the impacts of its policy decisions on those at the margins instead of focusing on broad aggregates, said current and former Fed economists, including Mr. Bostic." With certain fiscal and monetary responses seemingly largely managing corporate tax structures and supporting equities, it is encouraging to hear that Fed presidents are looking at ways to measure monetary policy success and implement policies that may help those at the margins.

Why Don't Women Self-Promote As Much As Men?

While a large number of studies have looked at potential explanatory factors for the gender wage gap, I had yet to see any work on how "self-promotion" might play a part until I came across this Harvard Business Review article. In it, the authors examine differences in self-promotion in men and women. The result? "In every setting we explored, we observed a substantial gender gap in self-promotion: Women systematically provided less favorable assessments of their own past performance and potential future ability than equally performing men. And our various study versions revealed that this gender gap was not driven by confidence or by strategic incentives, and that it was robust both in the face of ambiguity and under increased transparency." It seems reasonable to conclude, then, that when it comes to compensation decisions, self-described performance may be an unreliable indicator of actual performance.


 

Disclaimer: To the extent that Beach Reads discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. The companies and or securities referenced and discussed do not constitute an offer nor recommendation to buy, sell or hold such security, and the information may not be current. The companies identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the companies identified was or will be profitable. Beach Reads does not constitute a recommendation or a statement of opinion, or a report of either of those things and does not, and is not intended, to take into account the particular investment objectives, financial conditions, or needs of individual clients.

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