Listerine Royalties, Latinometrics, the Fear of Crashing, and the Prospect of a TikTok Ban
Market Talk, Edition 53, July 3rd 2022
Market Talk is a bi-weekly Sunday issue, where I curate the best things I have consumed during the last two weeks. Every second Sunday I will share the following segments:
• 6x Must-Reads: The 6 readings I found most insightful, with commentary.
• Other Items of Interest: A collection of other readings I found enjoyable.
• Great Listens: Podcasts, interviews, or videos I enjoyed.
• Something Interesting: A palate cleanser to round off the issue.
Kalshi: Event Contracts are Here. Bloomberg Announces a New Market Type
Earlier this month, Bloomberg covered the story of the first CFTC-regulated prediction market, Kalshi. The story recounts the revolutionary journey this company went on to create a new asset class called: Event Contracts. These contracts represent shares of future events. Each share is priced from $0.01 to $0.99 and is either in the “Yes” direction or “No” direction. As an event becomes more likely to happen, the value of the contract appreciates. These events range from economics like monthly inflation rates and fed interest rates, to politics like Biden’s approval rating, to climate, covid and more.
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Comments from Me
Since the last edition of Market Talk, I became an uncle for the first time and extended my personal best of “years alive on earth” to 26. With all of that excitement, I had less time to write. However, I am in the process of writing up a ~£50M small-cap based in the UK. It’s been a while (May was the last) since I wrote about any publicly traded company in detail and based on the results of the short poll I sent out on Friday it appears that equity write-ups are what readers enjoy most (~63% of you suggested as much). Duly noted, I will get back on the horse.
Continuing my newly reinvigorated appetite for reading books, I burned through ‘An Ugly Truth’ and ‘No Filter’ recently. Both offer an insight into the inner workings of Facebook and Instagram, with each opting to focus on their respective founders. I believe most readers will take away what they want to hear from each book. For me, as someone who owns Meta Platforms META stock, it strengthened my understanding of the historical mishaps of the company and enriched my knowledge of the bear case.
Recent Publications: Memos I have shared since the last Market Talk.
6x Must Reads
In every edition of Market Talk, I share a sizeable number of readings that I have consumed over the past two weeks. Here are the 6 that I found particularly enjoyable or insightful. Note, that these articles are not listed in order of perceived value.
To access the suggested article, click the purple link after the source subheading.
1) Has the Definition of Value Investing Changed?
Source: (Tobias Carlisle)
Every quarter, Bobby Kraft at the SNN Network, publishes the Microcap Review (and has done since 2006) which features reams of insights, articles, and content related to both the microcap and broader market. In Q2’s edition, I greatly enjoyed the feature that Tobias Carlisle, founder of Acquirers Funds, wrote which asked whether the definition of value investing has changed. You can find that on page 61 of the publication. Alternatively, I have created a PDF version of the specific article below.
Beginning with a synopsis of the original value investing ideology, one touted by none other than Benjamin Graham, Tobias walks through how that has mutated over time, with some commentary on how the last decade of value’s (as a factor) underperformance has tempted some staunch value investors to become a touch more liberal. This concluded by suggesting that “the definition of value investing today is the same as it was in Graham’s day. Buy the businesses that will earn the most on capital and pay as little as possible for them. A portfolio of stocks that earn reasonable returns on investment bought at a price low enough to allow investors to participate in those returns will always do well given time.”
“For a short time between 2018 and 2020 the prevailing attitude in the market was that only the highest growth stocks were worth buying. Damn the losses, so the theory went, and buy. The business would turn on the cash-flow spigot once it won its niche. Just look at Amazon. It lost money all the way to online shopping dominance. Given the number of observations in the sample—one—you might have been forgiven for some hesitation in extrapolating the idea that all the money-losers were going to lose their way to Amazon-like dominance. The base rates, after all, said take the under. But who looks at base rates when there’s money to be made? All we had to fear was the fear of missing out. And so, FOMO-ing at the mouth, investors paid 20, 30, 50 times sales for marginal businesses. Now, two years later many are chastened. They have rediscovered the reasons for Graham’s conservatism.”
With this entry, I don’t intend on highlighting a particular memo. Rather, I want to highlight the publication itself. If you’ve ever heard of Chartr, the publication famed for its aesthetically pleasing visuals of happenings in business, tech, and entertainment, then Latinometrics is that, but for Latin America. I had the chance to chat with the founder a week back, a very switched-on and intelligent sort, and he admitted that Chartr was a large inspiration for their venture. Each edition of their newsletter is short, snappy, consumable in minutes (it passes the toilet test) and packed with visual insights from the world of business, tech, VC, start-ups, etc, in the LatAm region.
Above is a sample of the variety of content that they share. Whether it’s curiosity, idea flow, or a firmer grasp of the trends percolating in the LatAm region, I believe that Latinometrics has a little something for everyone, and couldn’t recommend it highly enough.
“Our purpose is to help Latin America and its decision-makers (entrepreneurs, investors, economists, policymakers, and business leaders) make better sense of the region's market and growth opportunities in a short, digestible format.”
3) Asian Century Sony Deep Dive
Source: (Asian Century Stocks)
The man to call for insights into Asian and Asian-domiciled listings, Michael Fritz, has prepared an excellent report on Sony, the Japanese entertainment company responsible for the renowned Playstation games console. Complete with a full history lesson in all things Sony, Fritz continues to outline how the company has become leaner over the last few years, increasing margins in tandem, despite fairly stagnant revenues.
If you click the link above, scroll down a little to find the full PDF version of the report, as the substack is just a preview of the full report.
“Taken together, you get the picture of a company growing nicely across video games, music, movies and image sensors. Growth may even accelerate with the launch of the newest PlayStation 5 video game console. While it’s already been out on the market for over 1.5 years, supply constraints have constrained Sony’s ability to meet customer demand. Now that component shortages are easing, management believes that PlayStation 5 console sales could almost double in the coming year. And given that each console buyer typically buys 8-10 games each, we should see a significant increase in high-margin digital game software sales. The longer-term question about Sony is its capacity for innovation. Sony was innovative during its Sony Walkman, Discman and PlayStation years. Today, many believe that Sony is resting on its laurels.
CEO Yoshida wants Sony to return to its roots. New R&D projects such as an electric vehicle in a partnership with Honda, Sony’s PlayStation VR 2 virtual reality goggles, and robotic leg prostheses are being prioritised.”
4) New Business Boom & Bust
Source: (Counterpoint Global)
An interesting memo from Mauboussin and Callahan strings a relation between the establishment and subsequent pruning of human neural connections that occurs as we age to that of the formation and subsequent consolidation of new industries. At the peak, a child has ~1 quadrillion synaptic connections. During the formative years, that child will shed ~200B of those connections each day, evoking a literal example of “use it or lose it”. In a similar fashion, nascent industries witness a buoyant supply of new entrants fighting to utilise new technology in their own way to address a new opportunity. Upon maturation, the number of exits surpasses new entrants, and the market consolidates. Investors call this the boom and bust life cycle.
Each cycle follows a similar set of characteristics:
1. As an industry is born it is common for the number of entrants to rise and then fall over time. The total number of competitors is ultimately small.
2. The output of the industry continues to grow even as the number of producers falls from the peak.
3. The market shares of the competitors are unstable at first but eventually stabilize.
4. The diversity of versions of competing products coincides with the growth of entrants. The number of innovations peaks in the growth phase and falls thereafter.
5. Product innovation is the focus early in the cycle. Process innovation is the focus late in the cycle.
6. When the number of entrants is on the upswing, most product innovations come from new entrants.
The duo continue to explain each stage of the cycle, highlighting the importance of knowing which stage the industry of the company you are analysing is in, before sharing some modern examples of industries that are not yet at maturation, such as cryptocurrencies and electric vehicles. Highly educational and informative.
“An engineer confronted with a problem in a novel environment would be tempted to fashion a specific solution. But studies of the pattern of synaptic connections of children, as well as the emergence of industries, show that the overproduction of options and pruning of those that are not useful is a tried-and-true way to solve the problem. This pattern is particularly noteworthy in capitalistic economies because of the interaction between financial and technology markets. Capital flows are often very strong as a new industry develops. This money fuels vital experimentation, but since most ideas fail the investments behind them fare poorly. Capital markets are generally less enamored with the industry when exits exceed entrants, but at that juncture fewer companies capture more market share of a growing industry. Investors are well served to understand this general pattern and to consider where it is in the process of playing out. Examples today include the markets for electric vehicles and cryptocurrencies.”
5) Listerine Royalties: The Origin Story and Valuation of a Uniquely Enduring Asset
Devin Lasarre’s substack, Invariant, has been a recent find, but a great one. I first found his publication through a couple of pieces he wrote about Altria and the Juul fiasco, but the one I am sharing today is quite peculiar. Listerine, the mouthwash brand, has an interesting history in which Listerine royalties are occasionally sold to the public, offering an alternative source of yield. The most recent slice was sold for ~$1.8M and yields ~6.36% (~$114,253) per annum. The asset, unlike most royalty deals, has no maturity and is a perpetual cash-flowing asset so long as Listerine exists.
Devin does a great job of laying the backdrop to Listerine’s history, before diving into the numbers and estimating the projected cash flows and value of this unique asset. Great read.
“This asset entitles the holder to payments related to the global sales of Listerine, based on ounce volumes. The merits of this agreement are robust and have been upheld in federal court. From the perspective of JNJ’s obligation, we can think of this liability’s seniority as being in a weird capital structure purgatory, ranking below debt but above equity, as it is recognized by the product’s manufacturer as a cost of products sold. The asset is intangible, has no additional optionality, and has no liquidation value.”
6) Fear of Crashing
Source: (The Science of Hitting)
Alex Morris, author of the Science of Hitting, reminisces on the Peter Lynch essay, titled “fear of crashing”, from back in 1995 when he first commented the following, now famous, quote that “far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves”. Naturally, some of Lynch’s musings relate to what’s happening today, albeit we are already crashing.
Some sensible, sage, advice from Alex, who prods at what it really means to be a long-term investor. Should an investor wish to be in the market, and benefit from the compounding effect of holding truly great businesses, for decades, then inherent in that decision is the understanding that the market (and the investor’s portfolio) is likely to face several 20% to 30% declines of its own. The argument can be made for hedging, or going all-cash, but I’ll leave that to those who believe they can time the market.
“The key question to answer in this bear market, and the ones that will undoubtedly follow it in the decades ahead, is whether you’re truly a long-term investor; can you accept the fact that stocks will periodically decline by 20%, 30%, or more? If you can, the answer is to structure your portfolio accordingly (to survive whatever tomorrow brings). And when those tough times inevitably arise, it’s worthwhile to remind yourself that the good times will come again. This too shall pass.”
Other Items of Interest
Note: ($) indicates there is a paywall on this content.
• Worth: Fear of Crashing
• Woodlock House: Make Haste Slowly
• Bain & Co: Global Private Equity Report 2022
• Hayden Capital: Calculating Incremental ROICs
• Baillie Gifford: Why it’s not over for growth stocks
• Special Situations Report: Bottom Fishing Biotech
• MorningStar: Do Bear Markets Lead to Recessions?
• Schroders: Finding Opportunities in Stagflationary Times
• Mostly Metrics: What you can learn from this market reset
• Musings on Markets: A Temporary Retreat or a Long Term Pullback?
• Academic Paper: Investor Sentiment, Style Investing, and Momentum
• A Wealth of Common Sense: Has the Consumer ever been more prepared for a recession?
• McKinsey & Co: Reinventing credit cards, Responses to new lending models in the US
• 🕵️ Company Related 🕵️
• Grizzly Research (NIO): NIO Short Report NIO
• Value Stock Geek (MSFT): Microsoft Write-up MSFT
• SemiAnalysis (NVDA): Nvidia in the Hot Seat? NVDA
• Capapult Capital (AAPL): Apple Short Write-up AAPL
• Cedar Grove Capital (XPOF): Xponential Fitness Write-up XPOF
• Stratechery (SPOT/NFLX): Spotify, Netflix, and Aggregation SPOT NFLX
• Stock Opine (PYPL): Key Notes from recent PayPal Conferences PYPL
• Behind the Numbers (DOCU): Write-up on the implosion of Docusign DOCU
• Special Situation Report (9684): Square Enix Potential Acquisition Target
• Devin LaSarre (MO): Altria, Juul ban, and the FDA approach to nicotine, write-up MO
Here, I will share some audio/video materials I listened to during the last two weeks, that I feel are worth your time.
(1) Staying in the Game with Howard Lindzon
Plant MicroCap Podcast
Howard Lindzon is one of the original co-founders of Stocktwits, the original social media for investors. As terrible as Stocktwits is today, it pioneered the idea of having a dedicated social network for investors on the internet. Eventually, people migrated to the likes of Twitter, and Reddit. Nowadays, Howard is an active VC through Social Leverage and the host of Panic with Friends. I always enjoy hearing what he has to say and enjoyed this episode. The central theme of this conversation is staying in the game.
Guest: Howard Lindzon
(2) Berkshire Hathaway: The Incomparable Compounder
There is a reason that a cult exists outside the walls of Berkshire Hathaway. Some investors spend a lifetime devoted to the lessons of the dynamic duo that is Buffett and Munger. I can’t say that I am a member of said cult, but I firmly understand why it exists, and always enjoy learning more about the business.
This discussion takes on more of a case study approach as opposed to an academic history lesson, much of which has already been presented in books, podcasts, and documentaries. As such, this conversation was somewhat refreshing. Together with Chris Bloomstran, the duo cover items like Berkshire’s insurance float, Buffett’s pivoting ability, energy stocks, capital sourcing, stock-picking vs holding, durability, and the future of the conglomerate. Great episode.
Guest: Chris Bloomstran
(3) How to Spot a Fraud When Everyone’s Against You
A great interview with two chaps from the Financial Times about their multi-year effort to expose Wirecard, a German payments giant that went spectacularly belly-up after billions of dollars was found to have gone missing.
Guest: Dan McCrum, Paul Murphy
During the week I shared the below chart, illustrating the growth of respective social media companies overlapped from their first to the current year of existence. I stated that “TikTok [are] hitting revenue milestones far quicker than industry peers. Projected to earn ~$12B in revenues by year 6”. This is factually accurate, but my omission of context appeared to trigger some people.
What’s missing? Boiling it down, we can’t compare the starting points of TikTok vs peers. When Facebook first started collecting advertising revenues, the majority of those were from web users. Even by the stage that mobile ad revenues were greater than 25% of Facebook’s revenues, observers doubted their ability to execute the pivot (narrator: they did). The same can be said for Twitter TWTR , but who scuppered their chances as they have perpetually been a terrible ad business. The second-largest omission is mobile phones. Facebook, Twitter, YouTube, Instagram, and to some extent Snapchat SNAP , near enough, established the market for mobile social media, and the advertising market which followed. TikTok simply walked straight into it. In 2017, a short-form video platform called Musical.ly with 200M users was acquired by the Chinese conglomerate, Bytedance. Merged into TikTok the following year, the app became a roaring success as the world shuttered its doors and found comfort online in 2020. The below visual demonstrates TikTok’s (blue) crunching search volumes relative to Snapchat (red) during that period.
Quickly surpassing Snapchat MAUs, TikTok still lags behind bigger rival, Instagram, in search traffic, and users, but the pressure is mounting. It is undeniable how much attention TikTok grabs from its users, attention which is taken from other platforms. The whole market is a fight for the attention of consumers.
So much so, that Instagram’s latest platform updates are remarkably similar to TikTok’s, leaning heavily into Reels (where users now spend ~20% of their time on IG), and altering the recommendations algorithm to promote more content from individuals the user doesn’t know. As much as this social graph-orientated approach was important for Instagram’s decrepit grandfather, Facebook blue, it’s actually never been an essential factor for Instagram. I have seen copious amounts of commentary that fails to understand that. Instagram was founded upon the notion that users would discover other users they found interesting based on the aesthetic of their grids and interests. Of course, people eventually followed those they knew IRL too, but that’s beside the point. In its formative years, Instagram was a place of discovery and later snatched the crown from Twitter as being ‘the’ place to get behind-the-scenes access to celebrities. Later, regular human beings were afforded celebrity status through the evolution of the “influencer”.
If you are old enough to remember Vine, which was basically TikTok before TikTok was TikTok, the common perception is that Twitter, who acquired the company after feeling threatened following Facebook’s purchase of Instagram after Twitter themselves had courted the company’s founders, dropped the ball and the platform was eventually outcompeted by the likes of Instagram and Snapchat. That is only partly true. Behind the scenes, as Instagram launched stories, Snapchat continued taking share, and YouTube was proving itself to be a powerful funnel for creators, Vine creators, who were making thousands of dollars per video, began to diversify.
Darwyn Metzger once owned a company called Phantom, and back when being a “digital influencer” was a nascent career path, he would provide Vine creators space to collaborate, and help them negotiate deals with brands to monetise their Vine videos. Metzger, seeing the rise of Snapchat, Instagram, and YouTube, felt that the revenue streams these creators were earning would become unsustainable, and so he urged his creators that “from now on, you have to take one-third of your day and start migrating your audience somewhere else” I don’t care if its Instagram, or if it’s YouTube or Snapchat, but you need an alternative to Vine.” And so they did. Part of the demise was also a function of Vine’s “repost” feature, something that Instagram founder, Kevin Systrom, ardently refused to embrace on his platform for fear of a decline in user-generated content. His foresight proved to be correct in the case of Vine. Upon launching the repost feature, Vine users found that there was less friction to share exstisting content than in creating it themselves. The repost feature disincentivised content creation from the casual user. The platform’s supply of original content was choked and this eventually provided Vine’s top creators with so much leverage that they formed a coalition and threatened to leave the platform in favour of competitors if Vine didn’t pay them more money. Vine refused, they left, and eventually, the platform died.
I am rambling now. My point is that, despite TikTok’s dominance, the company still has to execute and avoid the failings of Vine. Short-form video is not a new innovation. Creators today understand the value of hedging their brand across multiple platforms as a method of diversification. Many TikTokers share the same videos on Instagram Reels and YouTube Shorts. As a bystander, the continued rise of TikTok seems inevitable, but perhaps it will be a policy decision that drops the guillotine. Commissioner of the Federal Communications Commission Brendan Carr raised some eyebrows during the week, requesting that Apple and Google remove TikTok from their app stores on account of its sinister data collection practices. As Apple clamp down on the offenders of a bygone era, limiting Facebook’s own dubious tracking practices, there appears to be a more sinister air to TikTok’s “surreptitious data practices”. We, the American people would like only our own government and private institutions to spy on us, and not the Chinese, thank you very much.
I think this is a pipedream. If history has shown us anything, it’s that policymakers are slow to act and have an embarrassing level of understanding of the technology companies that dominate global attention today. But the removal of the foreign body would have some serious benefits for the Western brands that are struggling to tame TikTok. I will leave you to read it at your leisure and make your own conclusions, as I have given this topic enough lip service already today. Have a super Sunday.
Author of Investment Talk