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WCM Investment Management | Insight | Beach Reads 11 - 10 | Between earnings, the election, and now the news of a promising coronavirus vaccine trial, it's been an incredibly busy and fast-moving two weeks.
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Beach Reads

November 10, 2020

Between earnings, the election, and now the news of a promising coronavirus vaccine trial, it's been an incredibly busy and fast-moving two weeks. Rather than focus on these events, this Beach Reads provides insights into investors' theses and perspectives, as well as highlights evolutions in industry. One of my favorite articles in this edition is the first piece in the "Investment Philosophy" section, which looks at under-appreciated tools that are available to any investor. Below, I outline the four sections in this edition:

  • Artificial Intelligence replicating human intelligence, Intel's production problems, and semiconductor equipment companies
  • Anti-trust back and forth: Tim Wu and Ben Thompson
  • Investment theses: Lululemon and Copart
  • Corporate governance investing, VC and growth investing, and the latest edition of Graham and Doddsville

 

Bonus content: If you're keen to find out more about Beach Reads parent WCM, Partner Mike Trigg, a portfolio manager on the Focused Growth International Strategy, talks with Ted Seides in this podcast about our investment approach and philosophy, and how that helps to unmask companies with competitive advantages. WCM podcast available here.

 

Finally, as always, click here to subscribe to our Beach Reads newsletter

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. Artificial Intelligence and Semiconductors

AI pioneer Geoff Hinton: "Deep learning is going to be able to do everything"

The most striking part of this short MIT Technology Review interview with Geoffrey Hinton is his belief that deep learning will be able to "replicate all of human intelligence." "Deep learning is going to be able to do everything, but I do think there's going to have to be quite a few conceptual breakthroughs," says the artificial intelligence (AI) innovator. Regardless of whether AI will replicate human intelligence, it is having a significant impact across industries from semiconductors to ecommerce to agriculture, something that might not have been apparent as recently as a decade ago. These changes have meant that Hinton is having a harder time being contrarian: "My problem is I have these contrarian views and then five years later, they're mainstream," Hinton says. "Most of my contrarian views from the 1980s are now kind of broadly accepted. It's quite hard now to find people who disagree with them. So yeah, I've been sort of undermined in my contrarian views." I'd say the idea that deep learning can fully replicate human intelligence may be contrarian – I guess we'll have to wait five years or so to find out.

Intel's Success Came With Making Its Own Chips. Until Now

To fab or not to fab – that is the question Intel is currently grappling with, placing it at a business and philosophical crossroads. While Intel has traditionally developed chips and manufactured them in its own facilities it has had difficulty producing ever-smaller transistors in recent years. By contrast, competitors have outsourced manufacturing. In order to better manage production, Intel is looking to external partners for the first time. However, rather than entirely contracting out fabrication, Intel may instead pursue a hybrid "disaggregation" strategy, "a process that lets it make a single chip using manufacturing processes in different places," this WSJ article says. "Intel might start a chip in one in-house factory and then move it to another, or might start making a chip at an Intel plant and then ship it to an outside manufacturer to add elements Intel doesn't produce as well. The company said it is beginning that type of mixed manufacturing, but on a limited basis with chips including a coming graphics-processing unit." Semiconductor fabrication plants are expensive – really expensive – so if Intel fully or partially outsources production, the capital expenditure burden will take one of its last victims, a testament to the scale and expertise benefits enjoyed by a handful of specialized contract manufacturers. More on fab vs fabless (as it relates to NVDA, ARM, and TSMC) here.

Semiconductor Capital Equipment Series: Introduction

This short primer on the Semiconductor Capital Equipment industry, which outlines the role that equipment manufacturers and fabs play in creating semiconductors, helps explain some of the production process issues Intel is having. Beyond Intel, one semi-related area that appears exciting is the evolution in packaging technologies and the "mid-end" in semi cap. "The emerging 'mid-end' is post transistor, but pre-die-cutting or advanced packaging," the article says. "With wafer-level advanced packaging such as CoWoS processes and more, parts of packaging that were firmly in the back end historically are moving towards the front end. This is really important and likely one of the best opportunities in growth and misunderstood businesses for now." Shifts in the relative importance of different production steps, in part driven by continued attempts to maintain Moore's Law, deserve more attention, according to the author. And it looks like they plan to write more about specific semi cap companies in the future – something to look forward to!

02. Antitrust Evolution - Two Thought Leaders Weigh In

Ben Thompson's Stratechery

The October 13 edition of Beach Reads featured the thoughts of Stratechery's Ben Thompson on the antitrust case against big tech currently ongoing in the United States and pondered what Colombia law professor Tim Wu, might think. Well, in a response, Wu addresses Thompson's "aggregation theory" arguing that internet companies don't gain dominance solely because of unique business models. "Here is the danger: If you think competition is all about flavor and buzz (in the 1890s) or Thompson's aggregation theory (right now), you might end up overlooking all of the other strategies and factors that could also lead to a lasting advantage," Wu says. These strategies include activities such as buying competitors. Wu seems to think that subscribers to aggregation theory will be duped into believing that any online marketplace is, by definition, good. "Antitrust should be dealing with the reality of anticompetitive behavior in markets, not ideals of how companies work. And it is the difficult job of the law to determine which of these durable advantages just described are part of fair competition (for example, a better user experience) and which are not (for example, buying out dangerous rivals, or exclusionary deals that keep out competitors)." Getting the details right about both the business model and competitive dynamics of large tech companies is undoubtedly critical.

Is the Internet Different?

Thompson didn't miss a beat in publishing his own thoughtful response to Wu, arguing that Google is the poster child for aggregation theory. It's a company where "the marginal transaction costs for serving one additional customer are zero," Thompson says. "That is why Google, from the moment it launched, could be used by anyone in the world. Like Amazon, the company didn't need to build out physical stores, but unlike Amazon, the company didn't need to build out delivery infrastructure either. And unlike every retailer in existence it didn't need to pay for supply." Thompson's focus on Google seems well-founded, especially as he argues that it has no "natural drags on scale." Which brings us to one of the key points raised by Wu – the idea that, despite superior business models, companies can still become anticompetitive vis-a-vis things like acquisitions: "The difference I have with Wu, as far as I can tell, is that I see these agreements and acquisitions as frosting on an Aggregation cake, as opposed to the fundamental drivers of their dominance. Google isn't dominant because they broke the law, they are (arguably) breaking the law well after their dominance was established, and that distinction matters when it comes to crafting remedies and regulations that actually work." I think these two authors agree on more than they may think.

03. Investment Theses

The Economics of the Cult of Lululemon

Since its founding in 1998, athletic wear company Lululemon has grown in part by identifying trends in yoga and athleisure. Another strategy highlighted by the author of this profile is a unique ambassador program, which has allowed the company to compete with larger athletic brands such as Nike. "What I really love about these store-ambassador led in-store activity is it provides a sense of purpose to Lulu's brick-and-mortar store base beyond being just another shopping place," the article says. "In physical stores, foot traffic is the ultimate barometer, and making their stores a focal point for these in-store activities/programs and utilizing ambassadors effectively to engage and integrate customers to the Lulu fandom is something that is very very difficult to copy by the competitors." The ambassador program is underpinned by Lulu's culture, which the author describes as being partly defined by the company's founder, Chip Wilson, who saw that "employees are not just a means to an end, but real people who resonate much better with their work when their holistic self are also taken care of." For those that want to learn more about the company, this helpful article ends with thoughts on Lululemon's growth prospects and valuation.

Copart: A Wide Moat + Great Management + Growth Tailwinds

Copart appears to be a compelling business, even if it perhaps doesn't operate in the most exciting industry. One of the most interesting parts of this thesis on Copart is the discussion of the online vehicle auction company's moat. "The best way to deliver [competitive prices for buyers and sellers] is to gain greater scale and market share which creates a more valuable network for buyers and sellers," it says. "The strong network effects created by a leading market share also gives CPRT a lower cost relative to a new entrant. As CPRT adds additional locations they increase the density of their physical yard footprint which reduces how far they must tow cars. This provides CPRT with a lower cost structure than a new entrant would face." The idea of the scale-advantaged network that Copart operates is appealing – those interested in strong moats may also find Copart compelling.

04. Investment Philosophy

How to G.O.V.E.R.N.

It's not the first time Beach Reads has featured non-GAAP's "Mike," an ex-activist investor who provides a framework for investors on how to integrate corporate governance signals into company analysis. In this post, Mike introduces readers to the G.O.V.E.R.N. framework. Each letter in G.O.V.E.R.N. corresponds to a step investors should take in applying a corporate governance lens to investing – my favorite (although perhaps the most nebulous) is the last, which refers to "narrative." From the article: "If you can recognize and/or anticipate the Board and management is about reset around a realistic narrative, significant risk-adjusted returns are available. And unsurprisingly, changes to compensation can be the 'canary in the narrative coal mine'." Understanding a narrative reset and likelihood of execution (backed by understanding remuneration strategies outlined in the post) seems like an important way to find companies that are setting themselves up for improved performance.

Anu Hariharan: Lessons in Growth Investing

Patrick O'Shaughnessy interviews Anu Hariharan, a partner at Y-Combinator who previously worked at companies including Andeersen Horowitz and BCG, in this podcast. The two discuss a wide variety of topics relating to growth investing. One of my favorite topics was Hariharan's description of what she looks for when investing, especially in early-stage businesses. These are 1) team; 2) market opportunity; and 3) performance to date. Give this wide-ranging conversation a listen if you want to learn more about growth investing, opportunities outside the US, and more.

Graham and Doddsville: Fall 2020

I'm a long-time fan of the Columbia Business School's "Graham and Doddsville" publication and this most recent edition features some great student theses on Hanesbrand, The TJX Companies, and Farfetch. It also includes interviews with some fantastic investment managers and of particular note is Oakmark Capital's Bill Nygren's on investment philosophy. "It was important to have an investment approach that was consistent with the way I thought about money and all other aspects – trying to get the most value for my dollar and applying that same process to investing," Nygren says. "I wasn't fighting any cognitive battles inside my own head...I learned that being good at executing one's personal investment philosophy didn't really matter if the people that you worked with were using a different philosophy." Investors who don't pursue a philosophy that aligns with their internal sensibilities run the risk of a critical mismatch. But investors MUST remain adaptable – finding the right balance of what makes sense internally and externally through time is therefore key.


 

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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