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WCM Investment Management | Insight | Beach Reads 9 - 1 | Welcome to Beach Reads and September. In a sure sign that summer and vacations are winding down, the investment world is busy digesting a deluge of IPO filings.
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Beach Reads

September 1, 2020

Welcome to Beach Reads and September. In a sure sign that summer and vacations are winding down, the investment world is busy digesting a deluge of IPO filings. There was also a ton of fantastic content published over the past two weeks, which means this edition is longer than most Beach Reads. So for the time-pressed among you – and those who are eager to get back to trawling through new filings – I'll share my favorite articles from this haul. These are the FT piece on Wirecard (first section), the Nvidia article in the second section (helped me better understand CEO Jensen Huang's thinking around ARM Holdings), both articles in the investment philosophy section, and the summary of Dee Hock's book (fifth section). Below is an outline of the articles in the six sections of this edition of Beach Reads.

  • A look under the hood at three companies: ICE, Wirecard, and MGA Entertainment
  • How ARM may help Nvidia to win the data center stack and new challenges to TikTok
  • An update on Airbnb CEO Brian Chesky's business plan. Also, a teardown of the Airbnb aesthetic
  • An interview with Yen Liow and Bill Gurley's musings on SPACs
  • VISA's chaordic organization and complexity theory through COVID
  • Reflections: Innovation and mud

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Conor Deveney

SECTIONS

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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. Company Overviews

Plumbing the World's Markets: The Story of ICE

This article explains how an energy business founded in 2000 transformed into global financial company the Intercontinental Exchange (ICE), whose assets include the New York Stock Exchange. One key to the transition was founder and CEO Jeff Sprecher's appreciation that he could significantly boost trading capacity by turning the old open outcry system into fully electronic markets – something that occurred not that long ago. Those who criticize the financial industry for being slow moving might look to the disruptive influence of ICE, whose most recent expansion move was the announcement that it is buying electronic mortgage platform Ellie Mae. The author argues that this acquisition follows two key themes of Sprecher: the switch to digital from analog and the increasing importance of data. "The conversion of the mortgage process to digital is still in its early stages," the article says. "Like in other areas, Covid is accelerating it. Electronic mortgage closings (eNotes) have been available in the US for a while; adoption recently jumped to 3% from 1% a few quarters ago. But for the most part mortgage transactions are still largely paper-based and can take months to settle. Venture capitalist Josh Wolfe likes to talk about 'directional arrows of progress'. This seems like one of them, and Sprecher has the track record to do it." Post Ellie Mae, ICE will be a significantly larger company with an even broader revenue base.

Wirecard: the frantic final months of a fraudulent operation

The Financial Times did an incredible job helping to uncover the fraud at Wirecard. This looks to be the last installment on what happened – and it's a wild read. To summarize: "The Financial Times talked to more than a dozen people involved and reviewed hundreds of pages of internal documents to reconstruct the final months before Wirecard's collapse. They reveal a desperate effort stretching from Munich to Manila to cover up the fraud and to hoodwink the company's auditors that continued right up to the very end." The global nature of the organization's fraudulent activities become even more absurd when one considers that Wirecard was looking to purchase Deutsche Bank prior to the truth getting out: "A deal to acquire Deutsche Bank would have been the crowning achievement for a company which within a few years had become one of the most valuable in the country." This wasn't just an expansion plan: "A deal offered the prospect of a miraculous exit from the massive fraud Wirecard had been operating. Around €1.9bn in cash was missing from its accounts and large parts of its Asian operations were actually an elaborate sham. By blending Wirecard's business into Deutsche's vast balance sheet, it might be possible to somehow hide the missing cash and explain it away later in post-merger impairment charges." The scale and audacity of Wirecard's efforts to deceive are striking – and the second in command is still on the run!

Insane Companies No One Talks About: MGA Entertainment

Maybe I live under a rock, or maybe this Substack is living up to its name. Either way, I had never heard of L.O.L. Surprise dolls before, or the company that produces them, MGA Entertainment, an under-the-radar private company that had more than $5B of sales in 2019. Perhaps better known as the producer of Bratz dolls, MGA appears to use innovative, non-traditional marketing strategies to grow the reach and relevance of its toy brands. For example, L.O.L. Surprise dolls appear to be designed explicitly to cater to the unboxing trend on YouTube: "When the dolls first hit shelves in 2016, MGA sent the product out to some of the top unboxing channels," the article says. "They also released a series of stop-motion unboxing videos. In 2017/2018, they launched a new series on their own channel called 'LOL Surprise! Unboxed'." Beyond YouTube, MGA appears to be moving into the metaverse: "This past July, MGA announced that they had licensed out the LOL IP to create a game that will be exclusively available on Nintendo Switch." This furthers MGA's ability to deepen customer relationships with their IP: "The characters we know and love can live on many platforms concurrently. We familiarize ourselves with these worlds, and we watch narratives play out, to some degree, with our own time and space." If MGA is successful in furthering its IP's relevance outside of YouTube, it could potentially help write the playbook for how IP should be translated across mediums.

02. Technology: Data Centers and TikTok's Artificial Intelligence

Jensen Huang's Vision for Data Center Dominance

ARM Holdings is a semiconductor and software design company that was taken private by SoftBank four years ago. Recently, SoftBank announced that it is looking to list or sell ARM. One suitor is Nvidia, a key technology enabler whose GPUs, originally designed for gamers, are essentially irreplaceable in training and running artificial intelligence programs in data centers. According to this article, acquiring ARM would further Nvidia CEO Jensen Huang's ambitions in the data center landscape. The author describes how Nvidia has the GPU accelerator market "on lock-down with their impressive hardware and vast software moat of CUDA/various SDKs," while the acquisition of Mellanox brought "the 'Data Processing Unit (DPU)' of the data center in house as well. They have also continued to expand their vertically integrated software stack to networking with acquisitions of SwiftStack and Cumulus Networks." By adding ARM, Huang can realize his "vision of data center dominance by becoming the only company with the trifecta of CPU, GPU, and DPU." ARM would give Nvidia the CPU IP needed to be an all-encompassing one-stop-shop in data centers: "Huang's vision, if fully realized, would see Nvidia building a nearly impenetrable moat that commands high margins and locks customers in. This may sound nefarious, but Nvidia's solution will be plug and play. The vast majority of companies do not have the resources required to build out the entire software stack to match specialized hardware." If Nvidia is successful in providing each key element of data center infrastructure, it will be well positioned to further capitalize on and enable data center growth.

TikTok Talks Could Face Hurdles as China Tightens Tech Export Rules

Another chapter in the TikTok saga: not only has Kevin Mayer stepped down as US CEO after only three months, but China is now ramping up its defense of strategic assets – including technology assets. As it applies to ByteDance unit TikTok, "On Saturday, China's official Xinhua News Agency quoted a government trade adviser as saying that ByteDance should study the new export list and 'seriously and cautiously' consider whether or not it should halt its sales negotiations." As of now, TikTok's fate is unclear: even if one of the rumored deals gets approved, what exactly will be acquired is now not obvious – what is TikTok without its algorithm? Can it even be sold without it? The last edition of Beach Reads pointed to how important TikTok's AI is. It has proved successful in crossing geographic and cultural divides – success that may now lead to its downfall.

03. Airbnb: COVID, IPO, and Aesthetics

Airbnb CEO Brian Chesky on Drastic Changes in Travel Patterns

CEO Brian Chesky provides a good overview of where Airbnb has been and where it is going post-COVID in this interview. I didn't realize how close the company was to going public prior to the pandemic. In the interview, Chesky says: "In January this year, I came back from the holidays expecting for us to go public this year. And as recent as March we were working on the S1." IPO plans appear to be back on, according to the WSJ, perhaps because of an incredible snap-back in demand, even better than Chesky imagined: "That has been a surprise to us, maybe the extent that we've seen demand come back," he says. "The last few weeks we've seen volumes of business that are actually the same size volume as a year ago. When it was April, or even beginning of May, I could have never, ever imagined that it would have been that resilient." Chesky also covers how the company has gone back to its roots and is more focused on its core community and offerings, pulling back from ancillary projects. This is at least in part because of a new travel paradigm that Chesky sees emerging: "It's going to go from primarily business travel, going to big urban areas, staying in big central districts, to people traveling more for leisure to smaller communities near them. And I think this is an unmistakable trend." With Airbnb housing covering urban and rural areas, I'm curious how the company will further take advantage of any potential travel behavior changes.

The curse of the Airbnb aesthetic

Long time subscribers have likely noticed a number of references to "the Airbnb aesthetic." Recently, the Financial Times' architectural critic provided his opinion on what this style is and what it means more broadly for design, travel, and society. Let's just say he's not a fan: "The greatest irony is that flat-sharing sites have squeezed the spectrum of dwelling into a few instantly recognisable and easily reproducible tropes and made the average the aspiration. We scroll through these images on Airbnb or Instagram and we, albeit unconsciously, absorb it. It becomes an orthodoxy. We long for escape and travel, for a different city, for new experiences and we have ended up remaking the world in a continuous landscape of comfortable banality. The freer we are to roam, the more we browse; the more we yearn for a change, the more we have ensured that everything becomes the same." If we were to invert this, I wonder what answers or further question would arise. Meaning: why do we aim for standardization in our travels? Why is familiarity comfortable?

04. Investment Philosophy

What Got You There: Podcast with Aravt Global's Yen Liow

This comprehensive interview with Aravt Globa founder and chief investment officer Yen Liow covers a wide variety of topics primarily related to investing, learning, and improving. Liow's disciplined approach to continuous improvement and his lifetime study of different strategies results in some striking insights. One that I think more people should work to grasp is learning what "game" you are actually playing, and then applying your energy towards that game rather than one others want you to play: "People can spend hundreds and hundreds of thousands of hours plowing away at stuff and they haven't asked the first order question, where do you focus it? And this all comes, that was all at the paradox of choice. The more accomplished you are, the more choices you have, and you don't have the framework to decide it. It's really tough. And so game selection is just setting yourself up in a game that you can win, and then it's highly lucrative when you win it." When it comes to the game of investing, Liow aims to improve his odds by spending time doing case studies. When reflecting on a conversation where he asked Eddie Lampert from Ziff Brothers how he outperformed the market: "[Eddie] said to me, he spent 50% of his time training. The best investments in history, and he did it through a thing called case study methodology, and I say, 'Wow, if it's good enough for you, it's good enough for me. What does that mean?' Someone gave me a tool!" While used at colleges and universities around the world as a learning tool, I'm not sure many investment management firms employ case studies – perhaps they should. Finally, especially relevant to what we have all been going through with COVID, Liow reflects on the importance of stress: "Stress cycles are a wonderful way of discovering who you are and mistakes are the greatest teachers of who you are, because the tells are where everything is revealed, and this is the way that we operate our business."

Going Public Circa 2020; Door #3: The SPAC

Bill Gurley of tech venture capitalist firm Benchmark has been arguing for some time that companies whose shares pop on their public market debut are evidence of investment banks undervaluing them in the IPO process to give favored clients a quick profit at the expense of employees and owners. "At this rate, 2020 IPO underpricing will transfer wealth of $15B in one day give-aways to Wall Street investment firms and their clients," he writes. "Most of these companies are about 20% employee owned, so that is $3B right out of employees pockets." A second option Gurley touts for going public is a direct listing, the route chosen by Spotify in 2018. While Gurley sees this as an improvement over the traditional IPO, current SEC rules don't allow companies to raise new capital in a direct listing, they can only sell shares that have already been issued. Which brings us to Gurley's "door #3," the SPAC, or Special Purpose Acquisition Company. A large number of SPACs have been created by high-profile investors such as Bill Ackman of Pershing Square. For Gurley, SPACs solve some problems associated with IPOs and direct listings, and their ability to do so is improving: "While the underpricing and true cost of capital of a traditional IPO is trending worse, the economics behind SPACs are actually improving," he writes. "This is why SPACS are a truly legitimate and preferable doorway into the public markets." Should companies looking to go public in a fairer way that provides them with fresh capital engage with SPACs?

05. Complexity: The Chaordic VISA and Complex Systems

Key Takeaways from "One From Many: VISA and the Rise of Chaordic Organization"

I have not yet read the 2005 book "One From Many" by Visa founder Dee Hock but this synopsis of sorts has fast-tracked it to the top of my list. Hock appears to have an incredible mind for leadership, people, organization, and, for lack of a better term, complexity theory (see article below). In describing the namesake of the book, Hock writes: "The theology of chaordic organization writ simple. Heaven is purpose, principle, and people. Purgatory is paper and procedure. Hell is rule and regulation." For many, this likely strikes close to home. Before lean was cool, fail fast and fail forward were in vogue, and culture mattered, Hock grasped fundamental truths as illustrated above, which helped him build VISA by educing behaviors from his peers. Much of this was grounded in simplicity: "Restraint went into the garbage can as I pleaded with Bob to abandon tradition, throw detailed planning to the winds, rely on a clear sense of direction, a few simple principles, common sense, trust in the ingenuity of people, and let the answers emerge." Finally, I found it interesting how Hock described community and its importance to individuals and businesses: "The essence of community, its very heart and soul, is the nonmonetary exchange of value. The things we do and the things we share because we care for others, and for the good of the place...The nonmonetary exchange of value does not arise solely from altruistic motives. It arises from deep, intuitive, understanding that self-interest is inseparably connected with community interest; that individual good is inseparable from the good of the whole; that all things are simultaneously independent, and intradependent—that the singular 'one' is inseparable from the plural 'one'."

Uncertain Times

This article, published in Aeon in association with the Santa Fe institute, is a titillating real world study of complex systems. The authors provide examples of complex systems in nature and in the man-made world, spanning financial markets, social structures in groups of monkeys, and global pandemics. They argue that in the man-made world, reactions to complex systems are often short sighted and fail to solve problems. This is at least in part due to a form of hindsight bias: "Fiascos happen when we use crude data to make qualitative decisions. Other reasons include facile understandings of cause and effect, and the assumption that the past contains the best information about the future. This kind of 'backward looking' prediction, with a narrow focus on the last 'bad' event, leaves us vulnerable to perceptual blindness." To better adapt to complex systems, the authors suggest "designing systems that favour robustness and adaptability – systems that can be creative and responsive when faced with an array of possible scenarios. The COVID-19 pandemic provides an unprecedented opportunity to begin to think through how we might harness collective behaviour and uncertainty to shape a better future for us all. The most important term in this essay is not 'chaotic', 'complex', 'black swan', 'nonequilibrium' or 'second-order effect'. It's: 'dawn."

06. Reflections

When the Magic Happens

In the early months of COVID, I tried to find positive news that suggested that innovation and growth may come from our collective struggles. Collaborative Fund partner Morgan Housel recently put the idea that growth comes from periods of collective difficulty into historical context. Tracing depressions, wars, and now a pandemic, Housel examines how periods of hardship yield new products and higher economic growth. This is partially the function of strong incentives (often survival) combined with corralling resources, especially vis-a-vis the military. "You cannot compare the incentives of Mountain View coders trying to get you to click on ads to Manhattan Project physicists trying to end a war that threatened the country's existence. You can't even compare their capabilities. The same people with the same intelligence have wildly different potential under different circumstances." Housel's historical examples lend weight to the hope that these trying times will inspire innovation.

How Mud Shaped Life on Earth

And finally, something out of left field. I've never given much thought to mud. I doubt many have. This article, however, points to the critical role that mud and plants, working together, played in forming much of life as we know it on earth. "Life has always congregated around rivers, from the very first emergence of plants and animals onto land. That's why the early accumulations of mud alongside rivers — and how mud influenced their flow — is nothing to throw dirt on." Puns aside, our planet looked very different before this change. Before rivers as we know them appeared, water ran across the earth in unpredictable patterns and deposited silt in the ocean rather than on river beds. As plants and mud began to give shape to rivers, new life forms were provided the opportunity to thrive: "The shape of a river may seem trivial, but it has far-reaching effects on the life in and around it. Bends in a sinuous channel, for example, can alter the water's temperature or chemistry, making it different from sections that run in a straight line and creating new microenvironments that plants and animals need to adapt to." From humble mud comes life!

 

Enjoy the Labor Day weekend.


 

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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