20 Episode results for "Patrick o'shaughnessy"

Podapalooza Announcement: Intel

Acquired

05:25 min | 1 year ago

Podapalooza Announcement: Intel

"Hey acquired listeners. It is Ben and David here with a special announcement for you. David or you pumped. I am super pumped who listeners. Our next episode is going to be a crossover acquired adapting episode. It's acquired in that it is a big tech company that we've wanted to cover for a long time and it's adapting in that it's telling their story of change in the face of dire crisis and coming out stronger on the other side which of course David do you want to give away? What the episodes the reason we chose this one by the way. This also makes me think it's it's the best of both worlds for some reason. I'm thinking of You know the van Halen Song from the eighties nineties. Best of both worlds. I don't have a okay so we have the original. Og Adaptation. We couldn't think of anything better especially for the reason. We are doing this episode. Which will tell you in one second. We're doing Intel the original adaptation pivot. You might call. Although we like the word adapting and I think Andy Grove would agree with that from the memory business in which they were founded and operated for the first ten fifteen years or so of their life to what we all know them as the microprocessor company. Yeah well don't give too much more away. So it's like whole crux of the episode man. Now got to get people excited. Yeah well the reason. We are announcing this is because this episode is going to be released as part of the lineup for something called pod palooza which we're really really excited to tell you about The awesome team at At glow came up with this and as as folks no. We work very closely with them. It is a virtual podcast festival to raise money for Cova nineteen relief. It's effectively like the live aid of our time But at home in sweatpants instead of Van Halen. I don't inhale and was there but you get you get us and many Mercury's instead you have podcasters we're going to be in sweatpants worship the charity that we're working with or that that pot of Pollu- working with called give directly and you'll hear a little bit from them after this so I think it's really cool organization and I'm excited for you to to hear from Katie from give directly about the organization The festivals happening on April Twenty Fifth and twenty sixth. But you can get your tickets now. Podcasters far cooler than us are participating including Lavar Burton for all U. T. and G. I was GONNA argue. But but he's calling us for sure for sure Dan primax who you know. Has has been on the show Patrick O'shaughnessy from invest like the Best The good people at one If anybody who listens to to twenty thousand Hertz that's been I think my carve out at least once Dallas Taylor the host of that is going to be participating so all Really Cool podcasters coming together for for a great cause. A few people have asked. We announced this on twitter. Already This Intel episode may eventually be in the main feed but we'll certainly start as a As Potter Palooza exclusive so You should definitely Definitely check it out if it's for you You can you can donate whatever you feel is right For A ticket I think the suggested donation is twenty five dollars. But you know whatever he's doing whatever you WanNa do at a pot PALOOZA DOT ORG or P L Z A dot Org You can see the full line up there. You can also click the link in the show notes and decide if you WANNA tune in. I think I'm like obviously excited do but I'm even more excited to hear from all the other podcasts. I think it's GonNa be a cool opportunity. Discover new New great other shows totally and excited for you guys to hear back give directly to this is It's super cool. What they're doing. They're getting cash to people who need it right now and Really glad the glow folks came up with this idea. And all the proceeds go directly to give directly and getting passed on directly to people who need it so great to be part of it. Well David Great Segue listeners. We are going to To leave you here with Katie from give directly to tell you what it is all about and we we hope you'll you'll join tune in. Hey I'm Katie. From give directly in the nonprofit partner of pot a police over the last decade gift directly has delivered over one hundred fifty million dollars globally in light of cove in nineteen. We launched a cash relief program in the United States giving a thousand dollars families who have been hardest hit by the economic impacts of this virus. So far we've delivered funds to over fifteen hundred people. They spent it on rent food diapers and even capable so their kids can learn remotely. That's the great thing about giving cash. It allows families to prioritize and spend on what they need most and that's where the money we race from Potter Palooza is going. So thank you to this podcast for supporting the effort to everyone listening. Check out this festival had to potter PALOOZA DOT ORG or P. L. Dot Org for short that's P L Z dot. Org thanks and hope to see you there.

Potter Palooza David P. L. Dot Org Katie Intel Van Halen Andy Grove At glow Patrick O'shaughnessy Lavar Burton Ben Cova twitter United States U. T. Dan primax partner Mercury Dallas Taylor
Deep Basin  Oil Price War and Its Implications - [Invest Like the Best, EP.160]

Invest Like the Best

50:18 min | 1 year ago

Deep Basin Oil Price War and Its Implications - [Invest Like the Best, EP.160]

"This episode is brought to you by coffin. I've become very interested in the best software tools in investing and when I asked twitter for the best Bloomberg Alternative. The overwhelming winner was an excellent new product called Coif and it's a web based platform that you analyze stocks. Etf's mutual funds and other asset classes in one place. I've been using everyday to track. What's going on in the market? And I think if you try you will to. Cohen has a ton of high quality data powerful functionality and clean interface. The best part is that it's free you can sign up at. Www DOT COIF in dot com. That's K. O. Y. F. I N. Dot Com. Hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets ideas methods stories and of strategies. That will help you better. Invest both your time and your money. You can learn more and stay. Up-to-date AT INVESTOR FIELD GUIDE DOT COM. Patrick Shaughnessy is the CEO of o'shaughnessy asset management. All opinions expressed by Patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes. Only and should not be relied upon as basis for investment decisions clients of Shaughnessy asset management positions in the securities discussed in this podcast. This week. I'll be recording immediately releasing a series of conversations on business and market reactions to the spread of Corona virus. The conversations will be on oil and gas corporate credit and the reaction within the venture capital community. Today's conversation is with Matt Smith Ian Singer and Coby Platt of deep bass capital along short energy specialist. We are investors debasement and they were guests on the podcast last year. We discussed the new price war in the oil markets and the impact that it might have on equities and especially on the US oil producers we cover commodities markets equities and geopolitical considerations globally. Please enjoy gentlemen. We're GonNa talk about what the Hell's going on in oil and gas markets over the weekend and the beginning of this week. It's been probably a historic. Maybe the last thirty years most significant big event in oil markets. I thought to begin. We could lay very broad picture with Kobe. Describing in the most basic terms. How much oil is produced in the world in terms measured in barrels? Maybe a part the supply. Where does it come from? And then pick the demand you know. What are the major sources of demand? And where does that come from because that will help us explain what happened with OPEC plus over the weekend? So just laying the framework for the global oil market. It's roughly one hundred million barrel a day market about thirty million barrels a day on the supply side come from OPEC and then the other major producers are the US and Russia US actually surpassed Saturday Arabia and Russia last year. Now is the largest producer of crude oil on in the world and in terms of talking about the global oil market an bucket at one hundred million barrels a day. That's important to note that it's that's total liquids so that includes things like biofuels and gels things that aren't necessarily black crude then on the consumption side that crude oil gets turned into products that are used in industry by various consumers. The main focus for the economy is is gasoline us but there's jet fuel and then there's a host of fertilizer different types of manufacturing processes that rely on hydrocarbons both is a feedstock and as a process element for construction or manufacturing and things like plastics. So obviously the price of oil is very much a function of supply and demand. Can you just at a high level describe? What kind of supply-and-demand shocks we've seen from the virus and from this increase in supply from OPEC some some a general idea for what happened in the last couple of weeks on the consumption side the nano a CD. So China India Brazil have been some major consumers of oil demand growth over the last decade or more and China has been incredibly important engine for that demand growth since the start of the year consensus expectations in the market. Were for roughly a million barrels. A day of of demand growth. Most of that was expected to come from China and the Nano CD. In the middle of January we started to get the headlines about corona virus and the market went through the process of of effectively assigning and trying to understand the magnitude of the demand shock. We could see very quickly that China started a slow refinery runs. China imports crude oil and then runs about fourteen million barrels a day of that crude through refiners and then exports the product into the global market. So when they shut down refinery runs that immediately. Sorta started this backlog to build in the system of the roughly fourteen million barrels a day of of refining capacity in Ron's in China early estimates and sort of the best. We can gauge right. Now they cut three to four million barrels a day of that capacity almost immediately and what that did was caused a surge inventories because the oil was already on the water was already headed to China and so the the oil basically had to go somewhere and it wasn't going through the refinery at it showed up inventory. The situation remains very fluid and now because the virus is spreading its frankly getting more difficult to assess from the demand side so when it was isolated to China was fairly easy to tell what the demand impact was now that it spread to Europe and the US and really the rest of the globe because it so decentralized it's it's much more difficult to understand both the magnitude and the duration of the demand impact. We estimate that it's roughly three to four million barrels a day. So as as you've gained some demand back from China you're losing demand in places in other parts of the world and so right now you know as best. We can gauge that. That seems like a fairly even offset. Sorta keeping that demand loss at the three to four million barrel day level movie described. What happened this weekend? What led up to it sort of the major players Russia Saudi Arabia. Maybe what the world expected and why this was such an unexpected outcome. Maybe even for you guys OPEC has provided the role of swing producer shock absorber in the market for the past forty years and most recently starting in two thousand sixteen OPEC and some non traditional members like Russia banded together to effectively try to provide a floor in prices for the oil market demand. Growth has actually been fairly robust up until last year and it was really just as situation where the new technology and unconventional resource in the US was providing a huge new source of supply to global market so OPEC came together in two thousand sixteen and effectively attempted to put a floor under prices and cut supply to the global market. Russia was on board with that which was fairly historic at the time that it's fairly rare for OPEC and non-opec members to come together. It has happened in the past but but it's rare and they embarked on this rebalancing regime sort of fast forward to to where we are today and trying to respond to this demand. Shock OPEC convened last week and the expectation was they. Were going to try to cut supply again to try to offset some of the demand loss. I think when OPEC and non-opec came together in two thousand sixteen at the time it was viewed as this was going to be a temporary solution to the market that specially the non-opec participants weren't GonNa never envision that they were gonNA need to cut for four years or longer to to kind of bring about this rebalancing and so fast forward to last week and it appears based on reports that Russia. Basically threw in the towel and said look. We can't continue to subsidize the market the way we have and basically create a transfer payments a US shale producers and given the magnitude of this demand. Shock there's really nothing we can do anyway so rather than cut production and by the way Russia didn't say we WANNA raise production. They just said we're happy to extend the current deal which was re solidified at a at an OPEC meeting in in in December last year. But we're not really interested in nor do we think it'd be effective to try to cut even more here. That was a surprise and the ministers left Vienna on Friday night and the next big surprise was that Saudi effectively offered huge discounts on their crude. Oil is priced one month in advance for shipment or at least four auction to their buyers and that was a clear signal to the market that Saudi was going to effectively engage in a price war with all of non-opec not just Russia but Russia's obviously caught up in Madison in. Can you describe what you saw most immediately as the knock on affects of this activity this past weekend in equities obviously most specifically in oil and gas related equities but the entire market was down? Seven plus percent on Monday alone wasn't just energy companies. It wasn't just banks so from your perspective focusing on those sectors but looking more broadly describe what you saw and what you think the important impacts that this move this weekend will have equities. The pieces of the puzzle started coming together as Kobe described several years ago. When you know OPEC refrain from constraining. The market supply number fourteen and at the time the statement was made about letting countries produce to the capability of their resource and November. Fourteen was really at the same time as us. Shale started truly demonstrate its productive capacity and deliverability. It was a time when capital efficiencies meaning. How much crude per unit of capital spent could be extracted? And of course you know the. Us Show Patch had been as we've discussed before over capitalized by a lot of debt and equity in the preceding eight or nine years when OPEC laid out a lack of action in November fourteen and then the US started to go through a period of stress and then some moderate distress in the latter part of fifteen in early sixteen which quickly turned around and heeled investors injected about thirty plus billion dollars of fresh equity capital into the show patch in the first second quarter sixteen and then as sixteen went along really renewed interest in the space with some fresh investor capital all with the hope that OPEC would ultimately bail them out which OPEC blinked in the fall of Sixteen. And of course they brought Russia in with them on in this historic packed and over the last couple of years. They've been trying to work out this year. Trains tour solution but all the while energy equities have been dealing with the gravity of a very clear picture that will is fundamentally well-supplied and all the while as we've progressed up until even January of this year when oil was well supplied. When you take away political frictions such as Venezuela such as Libya such as Iran? The picture was already a well supplied. Range-bound picture with increasing all around you political into January. And if you look at how oil trade between and how energy equities traded between the so many killing in early January the Iran retaliation for that and then that period between that detente that started to occur after the Iran retaliation and win corona virus became very clear to the market about potential demand. Destruction will had already started to really fall given the idea that it is well supplied at the time with including political tensions and with the building very large amount of spare capacity and so there is a. There's a kind of a long history of energy equities not working when there's abundance burke passivity which is the case and so there's been little to bring enthusiasm to the sector and then when you start to think about the mounting concerns over a demand crisis on top of an oversupply situation and then the market loses confidence in the cartel that controls a third of the global supply market plus Russia. It's a cocktail that provided the market with unmitigated fear of holding securities lever to energy over the last couple of days. And I would describe the last forty. Eight hours is quite fundamental if you think about companies stratification by their leverage by their survivability of twenty dollar fall in crude but sloppy and you know many investors have been hurt maybe maybe permanently impaired by that but on the side of this assuming that OPEC Russia don't blink as they did in the fall of sixteen and assuming the US government does not meddle in terms of bailouts. There's the opportunity to actually have a much stronger. More consolidated industry that I think would usher in a period of investable in more capital efficient. Better scaled operatorship among us. You'll companies and I'll defer on building on that idea. One of the principal reactions is what does this mean for. Us energy production and US shale. Most specifically I think if he asked the random market participant they would they would guess that. Shell producers require a decently higher price of oil to be going concerns certainly relative to Saudi Arabia. Maybe also Russia so talk a bit about the your initial reaction to what's going on in the shale patch and maybe build on what that said about the longer term viability of this so that it doesn't become a stranded asset class. I think that seems to be the principal. Fear that supply and demand are two problems investor. Appetite is third problem and to say nothing of yes G. Consideration so it seems like an incredible amount of headwind you know. What are you seeing? This initial reaction. The cost structure of shale is starting to be pretty bifurcated where there are producers who have economies of scale in their operations and in their assets and have moved operating and capital cost structures to place that actually can compete with greenfield projects globally. And then there's another class of shale that really can't and not class of shale has been incrementally adding debt over the past two years while they've been bullied by some reasonable prices but still the lower their their marginal costs produces but capitals been available. And so I think what we saw last really two days and even before that was the market starting to to really sort people by where their marginal costs were. And I think what we're GONNA end up with on the other side pending a reversal in OPEC plus policy or a zero interest loans. To distressed energy companies will be bankruptcies of those high cost producers and or such impairment to their liquidity profiles that they have no they have no capacity drill and they'll shrink in the magnitude of ten to twenty percent a year whereas the strongest shale producers can move into a maintenance capital level or small growth level quickly and they'll be able to survive through the next two to three years if that's what it takes for underlying supply demand to to fix itself so the when we look at at cuts that are likely coming in some have already been announced Occidental. Petroleum just cut their dividend ninety percent and shaved twenty five percent off of their budget. Three or four other producers have already announced reductions in activity and capital for the year. We expect a lot more. It will take time for those to impact production and twenty twenty because wells that were drilled and completed over the last six months will contribute to the production for the next six months so it will take something between six and twelve months for these activity cuts to hit volumes. Will probably start to see a gradual decline in US volumes by the end of this year. And then we think that there could be a decline in the negative five seven hundred thousand barrels a day by the end of twenty twenty one but there are some resilience sees that can come. Service cost aren't static and that do have some baseload activity. You'RE GONNA ASK FOR PRICE CONCESSIONS TO KEEP activity in the field and and some of those things will will help capital efficiency and it is ultimately better for a energy corporation to try to maintain its capacity level even in a low price environment because it still EBA and when they're falling from both prices and then also volumes. It's a further impairment to their capital structure so they are incentivized to try to to keep their production up as much as they can while preserving capital. What are the other important? Knock on effects that you think matter you mentioned twenty five percent sounds a cap ex budget cut from Occidental. I'm sure others will do something similar. Who are the recipients of that cap ex is it other companies just in the services space and energy? Are there other industrials? How are you guys thinking about how this might impact the broader market? Most of the capital that are upstream companies are spending move through energy services companies from the large-cap Integrated Services companies. Like somebody Alberton as well as all the small and mid cap pressure pumping land rulers and other ancillary. You know well well site service companies but it goes. That's kind of the easy easy answer. There are if you think about the local operations and communities that surround all these well site operations you have all the services that support the people who are involved the jobs involved in in greatness great American industry so they're actually substantial knock on effects of what has happened and I would say it's it's difficult to measure other than you can see the economic benefit and measure economic benefit of what the renaissance has led to in terms of prosperity and lower energy prices for US consumers. Over the last ten years and I mentioned there are a group of shale companies that are going to have impaired. Capital structures and their loans and debt are held by banks that are going to feel the impact of of potential bankruptcies again barring a historic intervention by the government. So there's a knock on effect to that as well and I think during the Super Tuesday discussions in Houston was noted to be one of the fastest growing metropolitan areas in Houston is pretty tied to the energy industry and you asked about service companies. There's midstream companies two pipelines. That are going to have distressed tenants on on their facilities and again at the knock on effect that goes through that is tough to quantify but but Darren Kobe. I'm curious how you describe this concept of a price war. A war implies people are fighting over some specific outcome. I'm curious how much you think. This is all motivated by say Russia and others trying to hurt. Us Shale producers versus motivated by their own internal interests revenue or otherwise and sort of what constitutes the end of a price. Where what what? What does victory mean in this context? I don't know that the answer's the same for all the different actors involved. I think what's created this opportunity in some ways is the accelerated demand drop that occurred because of the corona virus and I think the Russians probably saw an opening to recalibrate the market in the midst of a severe but temporary imbalance. I think Russia has been and and really the entire OPEC. Plus Alliance has been sort of annoyed by the stubborn resilience of Shale. And there's an opportunity or a window here to create so much price havoc that it forces a capital reckoning on the space. I don't know that the Saudis are in that camp. I think there's different priorities there. But rather than engage. In a long protracted price war I think the Russians saw an opportunity to do something fairly strategic and create enough short term pain to rebalance the market pretty quickly. I think the Russians have seen how. Us Energy Independence and abundance have given particularly the trump administration sort of free rein to really engage in a sanctions war globally without thirteen million barrels. A day of crude oil coming from the US. I don't think you get to sanction the Iranian regime into possible regime change. I don't think you get to eliminate a million barrels a day from Venezuela or sanctioned the Russians the way that they have and so and this is sort of getting at the point that the other guys just made but the US is now a net exporter of petroleum. Total petroleum now crude oil but when you include products and kind of everything in a in a hydrocarbon sweet as in liquid form the. Us is a net exporter. So low oil prices don't mean what they used to me at the same time. Us gasoline expenditures are only like two percent of disposable income in nineteen eighty six percent so the benefit of low oil prices for the consumer probably isn't doesn't mean as much as it used to and now you're talking about a sort of a structural drag or a headwind on the macro economic backdrop of the US and so. If Russia gets undermined both of those things and potentially even recapture some strategic influence in the global geopolitical landscape. Now is is a really interesting time for them to pursue this kind of strategy. I think Saudi has an entirely different set of priorities and frankly has been very clear and credible about what they have wanted to do. And they've said all along we're not gonNA cut unilaterally we're not gonna just carry the burden alone and when Russia came to the meeting last week and drag their feet in was clear that you know there weren't going to participate in Toronto cuts. Saudi had no choice. You know I think we saw a glimpse at the market for distress companies. That should not be capitalized with debt. Who Have you know? High costs and should as assets be consolidation candidates or. Shut down entirely in sixteen got. We're we're effectively saved by the late. Sixteen OPEC deal. And you know we've talked in the past about systematic fundamental analysis about taking bottom up well by well build up so these businesses and rendering in a low variance pictures of what companies are capable of producing within their the constraints of the balance sheets and companies. And and you can use various price decks to do that. And we've been obviously can dynamically working with our models to try to understand. What what this means that? I I think without Sherry an explicit price forecast. I think what we've learned are a couple of things one. Us Shale will be quite a bit more resilient in terms of the production output at the current mid thirties low thirties price stack than the market. Probably or APAC or Russia in particular believed when it took these actions over the weekend. We need to stay here for three to six months at least potentially to effect the change in very late twenty and twenty one and so the market should not expect that these actions can be short lived and have the outcome of tightening the market that I think against dynamic the situation but that the market probably believes and then the second point would be all of this gets muddied if the US decides to step in and bail out the tarp or other vehicle distressed energy companies and companies that cannot access capital. It'll have the inverse effect and after six to twelve to eighteen months. We'll be in an even worse situation in terms of supply because it would be once again. Somebody blinking and not allowing the markets to work and not allowing boroughs come out of the market at a low price. Would it be fair to summarize kind of all that is we need price discovery real price discovery in the oil markets to have a healthy global ecosystem? And these various forms of blinking. Whether that's backstopping through you know interest free loans or a renewed deal between OPEC plus that although that would effectively only prolong the same problem that we're digesting right now. That's right but with the foundation being that this technology that's allowed us to produce as much as we have almost thirteen million barrels liquids out of. Shell we're not going to unlearn it. And so for any incremental five and ten dollar move in crude oil the US has a significant capacity to produce incrementally and so that knowledge and as much spare capacity has been created by the various political ends being sought as I mentioned Libya Venezuela and Iran. The market should not expect. The the crew price has significant unmitigated upside as in previous cycles because we know the crude is abundant. And so what we're talking about. What what levels. What levels does a healthy market exists? I think that's what we're the markets trying to discover free and clear of any subsequent interference just to capture the motivations you referenced the Saudis having quite a different set maybe of calculus than the Russian case. The you laid out. Could you summarize kind of the key driving variables I know? For example that oil revenues are huge percentage on on the what the percentage is but sort of the market share of revenues in. Saudi Arabia are disproportionately large oil space. Just walk through their calculus a little bit. There's a lot of uncertainty there and a lot of it has to do with the volatility within the political regime and the goals and visions of the economic transition that Saudi is trying to pursue. Obviously they're deeply tied to the old oil world and it'll be very difficult for Saudi to completely ever divorce themselves from that but they have very ambitious broad economic objectives and and social objectives that require a high oil price to smooth the transition. There's been a major political consolidation. That's occurred in Saudi that continues to occur there were there were two high. Ranking Saudi officials family members in fact of the king and the and the crown prince who were detained on treason charges on Friday and so power continues to be consolidated within Saudi. They have about five hundred billion dollars in reserves. They're probably GONNA run. You know the current oil price will run a deficit of or the have drawn those reserves by thirty to forty billion dollars this year so they have a pretty long runway to to sustain themselves in a low oil price environment. If this turns out to be not the targeted surgical strategic price. War that that I think both sides or all sides believe is unfolding so it's really sort of balancing the ambitions in moving off of a traditional hydrocarbon based economy to one of more diversification with a robust service sector. I think a big part of the IPO of Aramco was bringing Saudi into the fold of the of the global financial market and providing some transparency that a decade ago five years ago was unheard of but at the same time. I think the regime struggles with with that transparency and that was made obvious in a very painful way with the death of Kashogi so there are a lot of moving parts. I think I think the Russian motivations frankly are more clear and I think given the political uncertainties and maybe even potentially the the the fragile nature of the Saudi Regime Ohio prices better than a low oil price and they were prepared to cut supply by as much as eight hundred to eight hundred thousand two million barrels a day in order to to try to sustain something of a of a moderately oil price. What's your take on the impact that some of the major quality and other factor exposures that you guys think about in the portfolio through all this. It seems to us that you guys are already mentioned it. There's been sort of resorting. Ranking of higher and lower quality balance sheets in the patch and certainly looks like higher quality or at least very bad quality are doing very poorly in this period of time. What other considerations are you looking at now doesn't have to be quality? Things like valuation things like trend are fascinating in markets like this. What are you seeing inside of the energy space in factors space? I think what's interesting about the factors that energy has sort of looked like the rest of the market. When you really break it apart and growth has had a a very strong year versus what you would define as traditional value and growth energy. You know we. We look at pretty strictly. As dead adjusted cash flow growth predigested share and even in the downturn that adjusted cash flow growth accrues to people that are judiciously using their balance sheet for higher returning projects and so in the market is falling apart. Growth winds incrementally versus bad balance-sheets by themselves in so leverage is obviously at a very tough time. All Year and precipitously difficult time in the past two or three days and log. Growth inside of energy has not absolutely outperformed in terms of a relative performance versus the other factors. That held up quite well. So I think that's been just sort of interesting to watch because energy is not really considered to be a growth industry but inside of it perform select in many ways that the rest of the market has been performing and fundamentally it makes a lot of sense the inverse of that on the value side without really going into great depth. Because I know I know we're a little short time but price to book which is one of the primary pieces of the valuation prices. Sales is another price to cash flow. Price earnings order the universe. Edp earnings yield. We spent a Lotta time internally talking about this but book value of energy companies should not be relied on period. It's determined once a year it's set at a price tag. That's often ludicrous not realistic. It doesn't stress test the model at all. And so you know if you look back for instance you know value just price to book and Energy the last twelve months. It's been pouring acid class. But you started look impairments. Were degradation the book value. Most of those companies have maturely written down their book value because the resource was not economic. Because there were aggressive bookings of wells to be drilled after the five year rule ended when you start to really include proved undeveloped wells and reserves. Most of those have been written off because the companies can't sustain their current plans. Let alone five. Plus your plans and these impairments take book value and throw it out the door so numerous companies. It looked like they were point to point. Four point. Five Preston Book are now zero price to book or negative pressure book. And so we've sort of think about value. Numerous ways that asset value but not net asset value using some unrealistically high priced act. But what's what's that asa value using a downside price deck. What's the margin? Look like without her exceptions with you know. Heavy risking of what has to happen to achieve that we think about NASA value on the current for price curve. And of course we're running it. Thursday. We run last Friday. And you're running obviously different price deck Monday and Tuesday and oftentimes. That answer doesn't change like book. Values impaired through through time because it becomes fixed to the end of any given year. And so I I think we we've steered clear of trying to use the market's traditional definition of value to look at it in our own perspective. You know free cash flow yield but not free cash flow yield this year because the company's not spending money and starting its assets because it doesn't have high return projects to pursue but sustained free cash flow on a multi-year basis because the company's resource or its projects and toll bridges in the case of midstream support free cash return of capital shareholders. Yeah it's a really really interesting nuance take on value. And obviously you're preaching to the choir on on using book value just about anywhere but in energy. It's especially interesting to hear. The last set of questions I have are more on commodities markets. Something we haven't talked a whole lot about today just like the actual trading of these underlying commodities. They look like to you who the major players are in this space you know whether that speculators traders and or airlines hedging cost of their input we describe a little bit of what goes on in those markets just because obviously that's a key component of what's happening here as well. It's a great question. I think just sort of going back to the initial topic of the size of the overall market right one hundred million barrel a day global market is massive but the way prices goverry works in commodities. Is that the market prices. The marginal molecule so a one percent divergence between supply and demand while it may be a rounding error to most people is the whole ballgame in commodities. That's why storage. And that's why a swing supplier like OPEC is such an important participant in the market because they absorb those imbalances when those marginal molecules are required by the market when demand is strong or when those marginal molecules need to find a home. One supply exceeds demand. The major actors in the commodity market are really physical arbitrageurs of value so participants in the market who have physical supply or are physically short. Like airline a refiner who require the futures market for hedging for the purposes of running their business basically creating stability and muting some of the volatility and the midstream? The Way I think of midstream is is sort of the market or that sits between the wellhead and the consumer who is effectively providing logistical services in delivering the molecule Through the system and to the to the user and so those actors are participating in the market every day to arbitrage molecules in this case barrels and find a home whether it be in storage your burner tip effectively for these molecules what. The market is attempting to negotiate or navigate at the moment is what the heck are we going to do with his onslaught of supply? That is imminent. It's not here today. But it's it's it's coming and the market is attempting to re price to incentivize building of storage which starts in the onshore market. It's the cheapest storage in the world and then moves into the floating market in in periods of extreme distress. So Twenty fifteen. Twenty sixteen most recently when supply exceeded demand by significant level and you exhaust or the market works through the majority of the onshore. Storage then tankers. Fill up with crude or product and literally. Just sit on the water and wait for the demand to catch up to absorb those barrels so in that environment which is kind of what we've seen this week you start to get really pronounced movements in the shape of the curve and that shape of the curve of the futures curve and in the case of crude oil provides that incentive that economic incentive to price for storage and what we saw immediately yesterday as the market digested the information that we can very quickly and efficiently was the crude oil curves moving to price floating storage as early as you know overnight really on Sunday and today and yesterday. There were tankers being booked just for that purpose again. Not because of the the surplus. That's occurring right now but ultimately sort of what's coming in the in the next two or three months you guys are all about the resolution of uncertainty providing ultimate price action that reward your positioning in the portfolio. I'm curious maybe one answer from each of you. What uncertainty what set of uncertainties is most interesting to you in light of this recent change in energy market so another way of asking. The question is what are you watching most closely that you don't know the answer to that is going to impact where things go in the energy sector globally the commodity market globally. What are you watching carefully before this afternoon? When an article came out that the United States might bail out jail companies with zero interest loans which might gravitate to the high end of that that list. It was one of the company's going to actually do in response to to very severe but unknown duration price war and the spectrum could be wait and do nothing until there's more information in the first quarter earnings aren't until May and so. They could just wait or they could do something much more. Drastic like Occidental did today and cutting its dividend ninety percent and reducing its capital budget by twenty five percent the majority of companies have yet to explain exactly what they're gonNA do and there isn't one hundred percent guaranteed good strategy because there's so many complexities and and there's extreme path dependency For for how this plays out and how information is gathered so I'm really interested to see how corporate strategy changes in the midst of all of this with the N. on the regulator or government interference with the capital markets. I'd like to see how that plays out. Obviously it really changed the course of things in in two thousand eight and nine and could significantly. 'cause a duration problem for the oversupply that could otherwise be fixed in a short period. Time if you know without government interference. I'm actually on that in that. Same Vein. I'm interested in in seeing if if they will let it play out this time and they they mean OPEC they means non-opec if these market constituents who have taken strong positions last a week can withstand. What's about to happen? Which is a period of very low prices there is a healthier supply and demand balancing aside as we pass through the awful period of virus and whatever that brings with demand and we try to be agnostic to periods like this periods of exuberance periods of severe fear and distress. But as an American. I'm interested in letting the process leading capitalism play out here because I actually think all parties are benefiting aside and I am skeptical if there is political and economic will among all the parties involved in what started Friday in his happen in this week. One last question for you guys which is investor appetite. So I mentioned earlier that that's seems to be yet another challenge facing the space even if there is this nice acutely painful in the short term but healthier in the long term rebalancing as you guys have described that there just isn't enough appetite from private equity investors from public equity investors from investors to provide the capital to this part of the economy just because the returns have been so bad and there are yes. G. Pressures that seem to been conjured out of nowhere very quickly in the last couple of years to divest or avoid companies in the sector. So last question is what do you make of the long term real investor demand debt and equity for energy? I think energy companies have had a hard time demonstrating what value is and what value creation is and and. I think that not not only if they had a hard time demonstrating i. I don't think that they know exactly what investors want to see from it. And so over the last few years I think. Energy companies have actually been given bad advice on what value-creation means and they've changed their strategy to gear towards what investors were telling them but it wasn't even what investors wanted and specifically in the last two years have been a strategy shift from just production growth to free cash flow generation sometimes in under-investment state just to generate free cash flow and not really value creation. And so when you come into a place where the identity of an energy company and how they demonstrate value is is already in question they've pivoted to a strategy that investors wanted but didn't necessarily make sense and wasn't rewarded and then that moves into an environment like we're in today where the price equation underlying. All of this has been totally decimated. It is a very difficult situation. I think at the end of the day. Oil and Liquids Hydrocarbon. Demand is not going away for a very very long time. And the marginal cost to produce the world's demand aside from what's happening right now is higher than where we are at today and so we do need companies that can efficiently and cleanly develop energy assets. And we want those companies to be leaders on the environmental side and the State of Texas. Actually put out a very interesting report about you. Know The the flaring of gas in Texas as an environmental concern and in reality Texas. The largest producer of oil in the United States is flaring less gas per unit of barrel per barrel of oil produced. Then basically any other oil producing country in the world and so from an environmental perspective and something that I think ultimately investors should really think about is we want US companies producing energy because they do it much cleaner and more responsibly than than a lot of other countries and at some point that will be important to think about and there will be structural tailwinds to the sector from a price perspective if we do let the duration angle playout and hopefully on the other side to companies will have a much clearer sense of how they create value and they'll stick to that that strategy versus trying to pivot to the flavor of the day. The that was really will set. So I don't have that much but I think the prevalence of moral hazard in the sector has upset folks for for a decade or more much like it has any other time. It became systematically destructive and moral hazard. It's proliferates throughout the entire chain. And I would point to some things we focus on which is how do you. How do you fix it? What what could you do? Better in. Farrah's we've talked about identifying winners and losers and often winners are the most capital efficient companies with responsible scale operations responsible? Because if they don't have if don't do things well like captured their gas. It's more expensive for them to operate if they spill oil or have a water problem. It's more expensive for them to conduct business if they don't treat people well. There are libraries. And if they don't think about returning capital shareholders and and corporate governance. It's not typically something that we would invest in any way because the economics don't make it as pure business and vice versa. On the on the in terms of the week companies we also try to understand and exploit and but the idea of moral hazard is something that you know. I think goes all the way up through the chain if you were to tie. Bankers and capital markets teams compensation to the paper that they would have sold to investors in highly levered energy businesses that with assets that didn't support the leverage you. Some of this could have been avoided. Some of the pain that is caused street harm could have been avoided. That's typical of almost all industries that go through a period of technological renaissance overcapitalization maturity. And then the true winners and losers are found in. We're we're going through a difficult period for the capital markets in terms of understanding winners and losers are and if if the system works the way it should those winners of which are clear. Couple dozen in each of upstream midstream. You know half a dozen or so in services. Those businesses will prevail. They'll consolidate the weaker peers and they happened. Also be the most responsible and efficient organizations in the sector just like has happened in the life cycle of other sectors. And and so it you know we actually think there is a a beautiful period of investment in dispersion in the energy sector for a long time to come and certainly opportunities in commodity space. The way we're talking about the upton or guys. I really appreciate doing this on such short notice. I'm doing a couple more of these this week. I was really looking forward to this. One upon of nuance onset. Interesting stuff here so so thanks so much for the time for everyone Patrick your again to find more episodes of invest like the best go to investor field guide DOT COM forward slash. Podcast IF YOU'RE A book lover you can also sign up for my book. Club AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum. Right away and then three to four suggestions of new books every month you can also follow me on twitter at Patrick Underscore Osieck S. H. G. If you enjoy the show please leave a quick review for us on itunes which will help more people discover invest like the best. Thanks so much for listening

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[REPLAY] Deep Basin  Earning Alpha in Energy - [Invest Like the Best, EP.81]

Invest Like the Best

54:32 min | 2 years ago

[REPLAY] Deep Basin Earning Alpha in Energy - [Invest Like the Best, EP.81]

"This week we are excited to re-release episode eighty-one Patrick's conversation with deep basin capital. Oh hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets ideas methods stories stories end up strategies that will help you better invest both your time and your money you can learn more and stay up to date and investor field guide dot com. Tom Patrick o'shaughnessy is the CEO of o'shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions clients Kashani Asset Management May maintain positions and the securities discussed in this podcast. I guess this week are Matt Smith and Ian Singer of deep basin capital a hedge fund specializing in the energy sector. I I met that almost ten years ago and in that time I've grown to respect him as much as any investor that I've ever met now having spent time with Ian who specializes in oil and gas exploration companies and the rest of the deep basin team. I have similar respect and admiration for all of them. Debase does almost is the exact opposite of what us wants to in fact their entire goal is to build a portfolio of mostly idiosyncratic or stock specific risk the very thing OSC wants mostly removed from portfolios portfolio's deep basin positions the portfolio to make a series of carefully constructed bats long and short without taking market risk style factor risk or even commodity risk. They use a hybrid fundamental and quantitative process which we explore in detail. This is definitely another good example of who we are all against in public markets. What makes this story store. Unique is that we are investors deep basins management company and so have a clear interest in their ongoing success listeners know that I want to be as transparent as possible on this podcast cast so even spend a little time telling the story about how it all came together a few years ago I have learned a ton about investing for my countless hours with this team and hope that this conversation tation gives you a glimpse into what is happening at the cutting edge of investing in the world of hedge funds. Please enjoy this conversation so as you think about the energy space specifically talk about the features of the universe that you're starting with me define what that is. How many companies is it and what makes makes that an interesting playground. If you will for assessing long short opportunities if you think about as an analyst what you strive to do is find a place place where you can add value where you can do something that is repeatable. You can do something that is differentiated and where you can find yourself in a more repeatedly on the right side of an investment than on the wrong side until the odds in your favor having spent some time in media and telecom and and then industrials materials and then for eight or nine years energy I've just found that not only was his sector where I'm passionate about all of the intricacies of the business business and the complexities of the global energy chain but it happens to be a sector where the complexity scares people and if you dig in and you construct a portfolio to remove some of that complexity what's leftover can be very long term structural idiosyncratic investments on the long side and short investments in structural advantage businesses on the long side and structured disadvantaged businesses and you can do it and we certainly certainly try to here in a way that's free and clear of oil and gas prices free and clear of interest rates and part of our education pseudo was building a hi idiosyncratic risk portfolio. You know read the buffet letter when it came out and you know he I think he still spent some time on Alpha and Beta and I would I would I'd say I care a lot about the attribution and the nature of the returns are processed that my process is an analyst generated an energy like no the second. I've been a part of understanding these businesses at a very atomic level allows you to build informed views and very low variance models models of what the future prospects for the business look like and that allows us to have insights that we think are valuable and and Alpha for generating and the Beta piece is the removal of all those things like oil gas interest rates systematic risk in many cases we purposely to try to get rid of staff accuracy portfolio at what's left are these repeatable we think asset driven insights of his businesses and unlike any other sector we've seventy seventy businesses that make the same product and upstream in the US liquid Canada another fifteen you can build a very elegant portfolio and really isolate specific nuances that you're trying to achieve in a portfolio and we can stay energy investments far longer than most investors can because we can take out lots of the bad things that can happen the energy sector her for me but one of the interesting things about energy as an investment space is that everything is always changing all the time and there's lots of places where that's true but the assets change under these companies over the matter of you know three months maybe six months technology changes changes every sector and that's true energy unlike other sectors a lot of the data that shows how and why those things are changing are available and to the extent that you can stitch that data across a lot of different sources together into into a coherent sort of analytical space you can really get it deep understanding for how and why those assets are changing and what the prospects x for each of your companies are and just like any other sector where data work is being done. It's easy to draw lots of different conclusions from similar sets of data data and so part of what we do is paint that coherent picture across a lot of inputs and continually calibrate those inputs put into what companies are talking about and that calibration effort takes a lot of time a lot of focus. A lot of systematic sort of pieces is in place to capture all of those things and the result is you continue to have a more informed better dialed in version of what the company's prospects are and that allows you to be on the right side of how those stocks move a lot more times than not and the ability to integrate a lot of disciplines together to give a really robust picture of what each of those narratives jobs are but ultimately informed by what the ground level data pieces are painting is a unique thing to energy and we've spent a lot of time putting all those pieces together and throw in with the energy sector volatility looks like on top of that and you have a pretty robust space for Alpha generation or one of the things that's fascinated me. Just talking to Matt over many years is like you said that global complexity of this especially where you've got one player that's incredibly opaque hake you may not necessarily know what's happening in the region and has a huge impact on commodity prices etc at the risk of getting overly simplistic but I just think it's useful since we're GONNA talk about out how to attack a sector from an constructed portfolio around a sector. Maybe we could just spend a few minutes on what the parts of the ecosystem are so I don't WanNa take for granted that people yeah no the key differences between upstream midstream downstream service companies etc so leave it to you to decide what those categories are but maybe just a couple minutes on the taxonomy Zannini of the space just so that if we use these terms later on in the conversation we'll have sort of a record of what the map looks like the chain really is dominated by in terms of market capitalisation but also in terms of whether economic rent lies upstream wound gas producers they go out and explore for acquire oil and gas resources in the ground and they hire services companies like slumber J. Halliburton etc to exploit those services companies are there for many service companies and they've largely bit like debase in become more focused on leveraging technology than traditional service companies that were just iron and if slumber I'm Jay in that regard is certainly about as much technology leader as there is from services were you. They help you exploit the rock and produce oil and gas molecules. Midstream stream companies are next the natural gas needs to flow through pipelines much of it has to flow through processing plants that separate the methane which is the actual natural gas stream from ethylene propane butane isobutane natural gas liquids many of which go into different processes like chemical raw materials or refining process and so there are multiple layers of separation with processing and these gas molecules flow through pipelines into power plants home home heating needs your stoves and they flow into industrial plants etc will can really move via truck train or pipeline and and once they get to the market. Obviously they're going to refineries. It's going on ships tankers. It's being used for ultimately converting gasoline distillate jet fuel asphalt etcetera era so upstream services midstream downstream which includes refining chemicals that all the way through the power plants where gas powered turbines in Tilles these were whether it's our local distribution company that delivers gas to you or whether it's utility the delivers electricity to you all of it starts with really natural gas coal nuclear clear etc eventually love tearing apart businesses kind of the engineering idea the stats background technical background etc as you think about energy the businesses themselves what what is unique or interesting about them. We've joked that it's like maybe structurally some of the worst businesses in the world. Maybe describe why that's the case and any other relevant features that make energy companies distinct distinct from the broader market all of the traditional investment principles I came up learning you know sustainable competitive advantage fi forces the importance of management's management's ability to build a team process and allocate capital to the resources to generate earnings free cash flow dividends returns of capital etc if you look GATT the upstream business and it's changing a little bit but if you look at the upstream business largely they're awful businesses they are depleting assets price takers none of the US MP's for instance set the prices for their products period and that will never change they really control how they allocate capital two exporting rock they control the frequency or cadence in which they drill wells intern wells into cash cashflow ultimate recycling the ground but these businesses are not ever going to be anything but depleting deep cyclicals and they have to be treated as such as be treated treated with great care. I think we could go on and on about why somebody would land an upstream company the fifth turn of leverage on the underlying Ebitda when it's very hard to move forward ten years cover the debt unless they go out and acquire finding resource which currently can't underwrite when you lend the money ten years. There's interesting conversation we had about the high yield markets were energy but the important takeaway though is long only setting or credit setting or private equity setting and we certainly have great respect for lots of smart investors in space but we try to do specifically is in a hiatus credit risk or Beta neutral portfolio. Were you care about the oil risk and the natural gas risk that your portfolio polio exhibits and in this case we purposely try to make sure it's roughly zero you can actually get rid of a lot of the bad stuff about these businesses and and what's leftover are some very interesting value creation companies kissing more about that idea of isolating unique value creation post neutralization of commodity oddity risk. Just curious like what exactly I may overuse this. We've been on the road a bit here recently seen company so not as of late but if you think about out modeling financial institutions and as long as you have good command of their assets and liabilities you can generally have a good understanding of their sensitivity to a given change in treasury curve to their cost capital and understand how that impacts earnings and in the context of portfolio if you do that enough times with financial institutions institutions you can actually build a portfolio of national institutions where you can really tweak your exposure to treasury curve building a portfolio of energy businesses. This is very similar particularly with upstream fairly upstream heavy with what we're doing so far. Each of these businesses has a fundamental sensitivity which we call elasticity the city like a complexity measure to a given change in oil prices or natural gas prices and that is to say at sixty dollars crude. Yuji resources generates rates a couple of billion dollars of free cash flow with that it can reinvest in the ground and generate future wells producing grow production and ultimately they can return cash to shareholders but that there's a measurement. There's an objective measurement modeling exercise that you can do and understand the value in Nashville these businesses at the Strip using using the prevailing oil and gas deck. You can sensitize that which we do for every one of the business models to understand exactly how value changes for a given change in cruel gas prices similar to the idea of understanding financial institution sensitivity interest rates and if you care enough to take the added step after you you find investments that you like on the alongside and investments that you like on the short side with very little tweaking you can actually achieve portfolio where if as a shock and oil or shocking gas you can be fairly agnostic to it and that seems to be increasingly to us a value added way of isolating the company specific if investments that we're trying to make in. I know you spend have spent a ton of time. Upstream specifically a curious for your take on that part of the ecosystem and sort of the levers that you you think that one most interest you what why are you fascinated by these businesses and two from an investment perspective the sorts of things that you like to spend your time on so as you you mentioned his constantly awesomely changing which is probably a good thing right like if you're in a competitive landscape you want it to constantly change because then your skill can shine so. I'm curious how how you think about it. The things that you think are most important to focus on an as we think about Alpha Alpha always requires the broad market has got it wrong so maybe structural ways or or structural mistakes that markets tend to make specifically in that space at a core level. What is interesting along. The lines of assets are changing all the time in companies are changing the way they do things all the time and I mentioned this before we have information well level data across the united the states and Canada and even other countries were we can look to see how those things are changing and more interestingly and more importantly why they're changing changing and so I spend an inordinate amount of time going through data to understand all those things and more or less rebuild. Ild All of the companies that we have in our investment universe from the well level up and you know whether it's two hundred million dollar market cap company that has one hundred Richard Locations are Exxon Mobil. That's the approach and every company is interesting in that regard and how they're exploiting their resource and how they're developing their longer term development programs beside that resource is really interesting something that markets have a bias on for really any any sector is taking a base case and extrapolating that base case too far into the future and we've found that is a commonly repeated repeated mistake in energy and if you think about a depleting asset days which you know we talked about as part of why they're structurally not great businesses. The genesis of that is a decline curve for every single well so the asset base is made up of a bunch of individual assets that are declining winning at some pace which means that when you add all those things together you have a large decline rate for every upstream oil and gas company that they are fighting by investing more capital into other declining assets base case is very very important because you're decline rate is your base case and as wells change over time not just at the beginning of their life but forever there are always times is where people don't understand what the base of the company is and you know we spent a lot of time understanding those deep points where aware activities that companies have done years ago are affecting what their prospects are today and you know. That's a that takes dedication. It takes a lot of carefully elite controlled modeling so that you can isolate all of those things across all your company's all at the same time at it's interesting work and it's nuanced work and the data sets are rich in so for an analyst with the technical background. It's a playground sort of every day to find something interesting to think about or talk about and you know with lots of companies with lots of assets. There's always sort of some new idea percolating to the top of the list. It's a great excuse to talk about data and the quantitative side of all of this and the importance of it. It's an extremely hot topic in all sorts of investment circles. Today I think that almost every successful long term asset managers thinking thinking about how to incorporate systematic tools quantitative methods data itself into their process to make it better than energy is especially interesting area for this particular idea hi dea so maybe you could describe washy get into how you think about building a portfolio now evaluating businesses with this call it man plus machine model. It's just a term that people have have kind of glommed onto which is you mentioned. The legacy from citadel love very systematic thinking structure thinking around fundamental work. Now you've got this incredibly you reach sets of data within energy but from all over the place for my perspective extremely complicated and probably requiring some deep contextual knowledge actually do anything with one of the questions we all the time is like well. Anyone can access this data whether it's an purely quantitative strategy or or in a kind of hybrid like yours you you house. How are you going to have any edge something. That's just free for anyone to access or even if it's not free need to pay for it. It's not overly expensive. How do you answer that question about the use of data and the edge that you derive from in the process going back to this concept of being students of our businesses and whatever sector does you follow the goal is to have an informed arms low variance model of what exactly is transpiring in the operations and financial results businesses and if you own if you imagine owning a company completely clearly outright hundred percent of it you know exactly what's going on in the business from day to day. You have a good sense of the prospects for the business looking forward to hopefully hopefully it's a business where you have more control over the product prices that you're selling and you have a competitive advantage but in this case energy the sector happens to be a sector again endowed with this incredible access to the data. The data represents access to the building blocks of our businesses. You mentioned in certainly oil and gas wells are readily available eligible but because readily available doesn't make them easy two-wheeled having a pure data set and bigger data set obviously the the the hardest wheeled but having said data in of itself is not a solution is not useful investment process. You have to be able to distill the data down into its normalized component parts and be able to take that and turn it into a cohesive mall for the business by wrapping financial statements around the data or put it in simple terms if these companies were factories if they were manufacturing companies understanding exactly how many widgets can be produced used the cost to produce widgets number of people required the length of the manufacturing line cost of distribution Saturday getting to the end market in the case of energy we have have most of what we need to build very inform models and starts with his own gas well data. So what insight are you trying to glean as the welded it gets updated so I certainly understand stand okay. These companies are predicated on successfully finding and and extracting minerals from the ground is pretty pretty straightforward and their uses are pretty straightforward. So what are you learning through those data updates. That's interesting and compelling. Are you building. Some sort of web of understanding of the viability of a certain set of acreage is or regions wins. What is the insight that's different than just getting sort of an updated proven resources or updated asset value or something like that. It's sort of a lot of what you just described live but really when data are updated for all of the wells across all the we get a couple of things one we get more current understanding of what the production of the company is just the aggregation level of analysis. How much are they producing and you know there's some context value that can be discerned from knowing what that level is but more importantly we can understand how different time periods of wells are changing and if you understand how a resource base or the productivity of our resource base is changing over time you start to uncover bits about the second derivative of the prospects of company and really that's really important thing because the second derivative is what makes deltas in cash flow for the business. If the well is going to cost the same but produce less their cash will be lower their economic return will be lower the ultimate valuation will be lower and conversely if they spend the same in the well produces more than you expect but then it also gives you insight into how a company is developing in their asset on a single acre or a unit of acres where a company is drilling. They don't just drill one well. They drill a number of wells in a defined system how they drill those wells at what depths at what horizontal lateral spacing informs how that productive system will produce hydrocarbons and when you can evaluate how how they've done that the type of technology that they've used in the wells to actually get their production and you can see what those changes in productivity the are you really start to paint a very rich picture of what is happening why it's happening and how to take those things things to forecast what will happen in future so a second key component of this. We've really focused on your assessment of the value of the assets of an upstream business or evaluate the business more generally speaking the second key component here is market price so the opportunity is going to be the gap between your assessment and the markets assessment so we have price but how do you take price sort of back into what that means. The market is estimating about the businesses wells about their assets etc so that you can gauge the with and maybe duration of that mismatch of that gap between your expectations and the markets you asked about Mollison. Basically one of my favorite investment books is is by Michael Matheson all expectations investing and it quickly summarize you writes about using security prices to understand the embedded the price implied expectations and if you know any industry sector I followed if you build or care to build a strong model that captures the operating assets and financial performance of of the company you have the jumping off point for iterating to understand what the market must believe today at at reasonable assumptions holding all constant with the market must believe today about for instance production growth or what the market must believe today. If we know production growth costs and Capex with the market I believe about oil price and better they're in or cost or Catholics managers etc and is helpful because that iterative process is required with this living breathing set of companies as these assets change. You're going to go mad if you don't try to slow it down and understand as things change what it means for the change in the value of the business but also what the markets understanding is and you're constantly trying to recalibrate and find these big disconnects where the market doesn't doesn't see the assets quite how you see them yet so we're we're entering an important topic which is the idea of investing energy businesses is values the growth what what's important all the different factors the problem with these businesses most not the more structural technology companies like Schlumberger. The problem with upstream offers from companies is that the intrinsic value of the businesses falls within the commodities fall. There's no margin of safety when the commodities fall which is what we've really seen. Can you know play out over the last four or five years so when you go through evaluation exercise and distill all of these well data and turn them into operate quarterly operating and financial remodels when you're building a model for you g again to carry that example forward. You're modeling the next fifty years by quarter. You're taking all of the known components components of the assumptions that the well data the cost capital expenditures et cetera and you're turning it into a practical version of what you think the operating financial results will be for that business at if there's one endeavor that we have here one pursuits. We tried to do that with as low as possible and what you get. It is largely an objective exercise and so that's a major. I think it's an important takeaway which is that modeling and Energy Business. Modeling Upstream Company is largely an objective exercise is if you care to use the data. LLC You to do it. oftentimes people screw it up by injecting speculation on commodities but in reality most of what you need to know is out there and available to you so if you go through the key to wrap financial statements around the data and you have a good picture of what the companies is producing and generating for cash flow on the prevailing strip strip the strip prices are the Ford commodity futures prices were all participants in the market are voting each day okay and they come up with a price for crude oil in both physical and financial terms seemed natural gas if you use that paroling strip which is frankly if you own one hundred percent on one of these companies. It's worry would go out and hedge the casual business which is why we use the stroke. If you model business in this way the next fifty years by quarter obviously things can change change and you can. There's a margin for the farther you go out but you can start to build an understanding of how differentiated using objective assumptions make your appraisal versus. The current market price the stock and that's where it gets exciting for us is building an appraisal of net asset value. That is what we what we find with wildly different now. We don't just show up each day and buy cheap knives and sell expensive ones. The key is is than finding where revisions to market expectations when the revisions are so extreme that they will force market around our point of view on on the asa exit value just wanting to add absolute price absolute valuation is as you can tell from Matt's description. It's pretty difficult in a in a market market. That's as fluid as energy. Where there's geopolitical factors influencing price saw of of the commodities there's actual supply demand factors Erzen all sorts of other things in a long short approach the ability to take valuation and use it in a little bit of a relative of space is important and being able to take the commodity component out of valuation via the way that we structure our portfolio folio is a key thing to do when we just want to isolate undervalued or overvalued operating performance and when we look at as Asmat said we look at overvalued undervalued companies based on how we appraise those assets? That's really what we're doing. Maybe talk about how you then are building an actual portfolio. We've talked about what it's neutral true which is Beta for the most part commodities interest rates etc fact style factors but how are you than actually taking your working acknowledge your company models all the work you guys do constantly and relentlessly and turning it into an actual portfolio if you can readily force rank these businesses says each day in terms of the market's price versus your appraisal. It's the jumping off point four starting to think about portfolio construction. We tend to to sink a lot about quality. We tend to think a lot about the idea of longevity of a business a lot of these businesses again because they're depleting. How how many future wells they have a drill to generate returns that are as good or better than their current return on US capital is an important feature of how we think about the sustainability inability of each of our businesses and their bill to grow and and do so within the context of their balance sheet covenants. If you think about the world though where you you need to be mindful full of the portfolios sensitivity to crude natural gas and remove those you can't just by quality and short bad companies. You can't just buy a company short backup and you certainly you can't just by management teams that you like and short bad management teams what we try to do is balance out and be style agnostic and find truly we disconnected undervalue businesses on alongside and over by business on the short side but where it could be in the realm of expensive companies where you know something that may look expensive on near-term. Ev to Ebitda is growing so quickly. It's cash flow stream that in three years it's multiple compressors substantially stanchly and it looks inexpensive that juxtaposed with a company that looks incredibly low multiple today but has no prospects to grow production and it's a depleting set of assets so three years from now it's cash flow is less multiple cases of this where what looks like a value proposition today in several years in the upstream business can actually look like a catastrophic destruction value and vice versa oftentimes expensive companies look more interesting from multiple perspective than chief companies because of this idea of longevity and Sustainability Mesic clarifying question there so one of the things that I've always fascinated with his understanding why the value factors an example works and when you dig into it those a lot of competing explanations for this one is that the riskier companies who you're compensated for that risk structurally was a behavioral explanation so people get get overly pessimistic about the prospects of Salo p stock but ultimately like your buying future fundamentals when you buy the stock today and one of the interesting things about say buying low p e stocks is that fundamental tend to mean revert at the market level so if you've got really bad recent trends odds are that it will be a little bit better with an average in the future and that's just a very broad generalization but when you pair a low price paid today with the tendency of bad recent fundamentals which is what values stocks tend to have to mean can revert it ends up being this great deal and you end up earning four percent annualized return over a really long sample even when everyone knows about this so it's it's an open secret that value investing acting works but what you said is is quite different than that. which is that in many cases you might find companies? Let's say it's a one that looks expensive on Vida today but has much better prospects so the opposite of mean reverting fundamentals so maybe you could unpack that a little bit more as to how you might go about identifying that kind of company relative to the more more meaning like broad sample of mean reverting companies the interesting thing about low multiple stocks and especially the upstream universe. You know we talked a lot about assets. Sets can change all the time. There is an element of upstream oil and gas where companies sometimes have assets in geological section that there is no promise to the upside you know the probability of the prospects of that resource improving have been statistically rendered to be very low and so a low multiple stock that has underperformed because it's working don't necessarily have a fundamental reason listen for mean reversion because their prospects are not in a mean reverting type of areas not a consumer stock that is gaining and losing market share over time and into a company with a physical asset that potentially doesn't work and so as they continue to spend money on that asset and it renders sub economic onomic results. It's multiple actually inflate over time and you're sort of doing something. That's counterproductive to what real value investing is has and so part of what we do is try to discern when a company with a low multiple is for a physically geologically weekly structural reason or if it's just the market doing something silly with a stock and so you know we're not factor investors but were very where factors actors we recognize that value can be extremely positive tailwind to investing but figuring out whether it's structural that it's a valid quote unquote value stock or if it's just market perception is where we can come in and really add value with our analysis and there's a Maoist talking a little bit about portfolio construction and how it's not just about buying companies and selling bad companies but finding pockets of dispersion in all all of those areas a good company that has better prospects in a good company that has declining prospects. That's too highly valued companies that can be on different different sides of a trade or to low valued companies that have separate operating prospects can be on different sides of a trade and you're not making a factor bed that is true. Alpha and data's what our process and our whole systematic approach to this business is set up to do. Oh we certainly appreciate some of the long term tailwinds like in described that low multiple stocks have had I think energy energy. There's there's a bit of a wrinkle and that is the price you're paying for. As cash flow today has very little to do with the earnings possibilities awesome abilities for the business five years from now or ten years from now and when we stress this idea of building a fifth year model for each company granted the margin origin of potential outcomes is very wide understanding the prospects of Yogi or pioneer diamondback energy or resources which is quite topical what their ability will be to reinvest their cash flow today to generate earnings next year five years from now ten years from now is of critical importance the longevity of the assets. Let's relate back to the multiple. You should be willing to pay on any metric for one of these businesses and so it's hard about just thinking about pure low multiple appea- or low multiple investing. Is You know it's a moderately efficient market. We know we can argue either side of that but the markets trying trying to price and understand the Utah cash for growth of the earnings growth these businesses all the time the amount of capital. They may need to fuel that growth looking at these these businesses today a low multiple business again may have limited business prospects at a four times company if they only have three years of wells to grill to generate returns earns and then they have to go out and make an acquisition of more acreage or of a company to backfill. They're depleting production. It doesn't matter if you're buying a low multiple companies because they're probably going to have to create a deal of when the time comes and so I think we we try to think about the long term earnings earnings and cash flow potential these businesses we try to pay as low a multiple as we can for longs today and it's high amount was we can't rush today but each of the each of the companies are so different in terms of their resource in rock and their locations in those in quality of those and the prospects for those that comparability ability something if you're careful with peas or VVD or of cash flow multiples. Let's talk a little bit about leverage the portfolio level not at the company level so back to the way hey that traditionally speaking hedge fund portfolio should be constructed which is neutral to a ton of stuff so if you were unlevered you would basically earn return. That's the return spread between your lungs and your shorts. Hopefully we hopefully favorably in your direction. Obviously it's very common than to apply leverage to that unlevered return stream of the difference between long shorts. How do you think about that exposure How systematic is that thinking much change through time. What's like a rough range. This is a topic that we definitely have uncovered before said be interested to hear perspective. I think there are two parts of us and then you can add anything but the first part is the amount of gross leverage but you apply to your underlying equity. Um should be a function of the breadth of ideas ideas in the conviction you have in those in our case in recent critic way so the number of names the more names the more conviction than more timeliness of the ideas the ideal you invest followed today and tomorrow the market comes around your point of view on every investment. It's obviously never happens so think about it like a life. Insurance portfolio flu or you have duration matched longs with duration match shorts hopefully building a portfolio where you have lots of ideas is the first driver of how we think about. I leverage the fewer ideas. Ideas are scarce. You know we do not want to lever the returns of our investments on the underlying equity. The second layer I would say is been quite important recently as we've gotten into less stable higher risk our cost CAPELA regime particularly Jan January and February February how much you lever the portfolio swimming you have a breath of ideas should be lower in times of extreme stream regime uncertainty which we have every bit of that today yet. There's sort of the two sides there's a statistical approach a mathematical approach to risk and leverage and there's a fundamental approach and Matt talked a lot about the fundamentals having a breadth of ideas having conviction in them having some fundamental l. stability in the broader macro landscape and then eluded to the statistical side. We are always looking to provide a target risk risk and from there we can back into what the portfolio needs to do against our risk management calculations and leverage a lot of times holding the fundamental pieces of this constant falls out what that volatility target is if you can highlight the dollar's volatility that you need to generate with your portfolio and then use a statiscal risk management model to estimate to me what that portfolio volatility is. How would you assess the changes like in your relative careers in the Hedge Fund industry what it may be the positive and negative changes changes that you've observed the met you I over the entirety of your career. Now feels like it's gotten harder over. You're using data in two thousand five. When I started professionally investing asking the vice I meant as she egger website you could go electronically poll financial statements and then you get on a plane go see management teams. Today we still go spend a tremendous amount the time in the field with public and private companies to understand what's happening in the energy ecosystem but the the major change that's allowed debase into exist has been this incredible programmatic to these building blocks for businesses of your data and certainly you've seen statistics where the availability of data has grown exponentially and will continue to we've seen that with energy assets with the data that's necessary and frankly it's why small operations small single person or two person teams have a hard time wielding energy data in a way that systematic it takes a fair amount of tieman process to to do it so the major changes has been the availability of facts about businesses to allow us to exist on this sound. I think the the rule of eighty twenty is sort of leaving in some cases and the Investment Universe you have so many people that are specializing in sectors and going to pretty significant lengths to derive an edge that getting last twenty percent right is the edge itself and I eighty percent isn't really it's not yeah exactly and and so I think from a positive side when you work in the asset management field broadly but particularly for hedge funds that are doing a an extraordinary amount of work and trying to find some edge. You're working with a lot of really smart people and the number of smart people and their smartness it seems to be increasing and so you know from my seat that's a good thing and it really makes you constantly fight complacency and then it's a good driver. The negative side changes over the last call it five years. Maybe maybe the only thing I would say is that you know there's there's a lot of aggregation. That's happening where independent fund managers are going to you know. Large platforms platforms are great places. Is there smart people. They've got great resources. They've built by really smart really thoughtful people. They have good returns but it's changing the way that the market works in some cases and how the quantity profiles are transpiring and that's a advantage and a disadvantage in some ways it creates two different profile volatility but in some ways it's better for markets to have some fragmentation to them and that's a change that I think is not necessarily a great one when running very clear changes is the role that passive flows are playing an increasingly driving securities prices some of it can you just paying very low fees for in our case the XL e the SNP energy sector spider or the H. Services ETF. When there is material buying and selling Bellingham those indices we see the correlations of the stocks contained therein as as picking up and driving and overwhelming really in most of what's going on fundamentally in the short run. We've spent time trying to build a portfolio that were we pay attention to our exposure to specific passive indices etc to try to mitigate that happens but we frankly like that in January specifically there were tremendous reflationary forces sources that market started to bet on and we're buying aggressively buying passive energy exposed indices now that's not worked out very well in the recent past Asan in late January February but it caused tremendous distortions in the pricing of some of the securities embedded in those indices and subsequently these companies had to report earnings provided forward-looking outlooks and many cases in any benefit they saw from the passive index inflows flows was turned into serious downside stock price moves when when the companies reported earnings for instance in February so we we try to use and and surveillance and understand what's going on in factors what's going on passive fund flows and we try to use those to our advantage when because as they tend to cause distortions and miss today more than more than I can recall at any point in my career so close to the couple questions on the firm culture is something that fascinates me and then I've gotta the closing question that I ask everybody will close with that so maybe I a question on culture so I think it's probably something that's it's. It's a little bit fuzzy and very qualitative. You're trying unallocated. Let's say to assess the culture of asset management business but there's just no doubt that a strong culture is something that can help firms weather storms can give them even a greater boost and good times so as you think about being just you know a year or two years old with the basin what are like the core cultural elements like if I would not ask the rest of the team mm-hmm if you had to describe the firm's culture and a couple of words like what kind of words would they use. The first one that comes to mind is intellectual honesty and sort of honest wrist holding of everybody to that standard and the byproduct of having that be a real pillar of what we do. Is People art afraid to be wrong. There's no love lost or egos hurt when opinions changed based on the presentation of new information and you know so that type of environment really helps foster intellectual curiosity and removes the negatives of emotion from what is an intellectual pursuit suit and that's a great thing to have. I think we have that in spades and Matt can talk about some of the personal attributes but you know from my perspective. The fact that we've we've all worked together before and you know we have a aside from just being intellectually honest hungry professionals we all strive to be good human beings and that means holding yourself accountable and being honest and being forgiving and understanding and I think everybody at this firm has all of those things that allows intellectual honesty to really be a core component of of our success. I would probably probably add just a couple of traits. One is and this is is really informed by our past experiences that we reflected on but we are obsessive about process adherence. If there's one thing that really gets an energy flow down it's when it would be if I were to decide to take a big swing at what OPEC's going to do in the spring when Russia's going to give in on or take backer renege on the cuts extreme process adherence. We've found found is the most important pillar of sustainably repeatable investments in this sector. There are certainly temptations to have commodities. We we talk about amount of time. Now we use it to get out of the portfolio but we see that temptation thankfully it's now totally institutionalized and and it certainly was from the very beginning but this obsession with processes something that happens daily the second piece that I think is important is there's meaningful passionate about the subject matter. I've been a student of investable sickle companies since I started my career and over long time it's really been focused on energy and that make me very narrow in my focus but it's something that I've come to be very passionate about Yin Graham Koby. Everyone is mostly mostly devoted their careers to this discipline and the sector at this point and for good or for bad we love talking about digging in on trying to get it right and investing in these energy businesses in this idiosyncratic way I find it incredibly important to be as transparent as humanly possible on this podcast cast and so there's an important feature that we haven't talked about which is that both our family and in our business our direct investors in your business and so I thought a fun way to handle that rather than me. Just you know disclaiming it in the introduction or something like that which I'll also do is for you to maybe just tell from your side that story very quickly because it's a neat story on that's been incredibly credibly interesting an amazing way to learn for me and for our business as well so maybe you could just ended a few minutes on that as something fun but also in the second transparency from from the beginning of my career through early seventeen or even really sixteen mile long term goal was always to build a sustainable investment firm where I can be a key the determinant of the culture of this process adherence that I described end of the type of people who surrounded by each day and that that is something that in the case of deep basin I wanted to capitalize like technology company when I left my prior firm and early sixteen sat out a year on a non on compete I thought about who I wanted to be when I grew up and a critical piece was I wanted to surround myself by people who challenge me and make me feel stupid each Wjr Day and I knew where to find some of them but I was grateful to be introduced in early seventeen to Kobe planning our team Garrison Travis Atis and the members of our operate team and in order to pursue build the business that I really wanted to build. We had some options on some. LP type seeds traditional seeds and we were thankful when we sat down and put our heads together with with you and Union Dad that you you saw the vision that I had that we had for the firm and frankly needed to be capitalized like a technology business and like no other seed that we evaluated having a very long-term permanent capital partner that is like no see that you know I saw when i I started thinking about doing this and certainly the fabric of the people were in business with is important to me and it was important when we started to build this team in culture we believe in order to build a sustainable investment franchise to invest in these businesses that were so passionate about we needed to build a team team in process and sufficient mode around business which required a significant technology investments and that's why I describe it as effectively capitalizing like tech company but we spent almost a year building significant technology that allows us to do today you know keep our eye on the horizon and have the head space based to take risk and that for that. We've been very grateful. I appreciate the story I mean. Obviously I want to be transparent. Given that that we have a vested interest in your success in our view is that the future of of this business is far more collaborative. Maybe than it's been in the past. We're lonely business so we're not directly competitive but we found just tremendous value and being open to experimental and new ways of collaborating with other investors second. You end up learning so much more than if you tried to just view everyone everyone a competitor so it's it's been a remarkable experience that the last question that I ask everyone's lesson I'll ask each separately is for the kindest thing that anyone's ever done for you. I'll go first. I think it was the second date that I went on with my now wife and we decided to meet at grand central for officers at the bar there and we were going through our meal and we had a few drinks and we're having a great time and we went to leave and the waitress came up to us and said you know you guys is are all good and said what you mean. We just had like two dozen oysters like very definitely not good. She's another gentleman across the table from you that said he reminded you of him and his wife when they were young and he paid for your tab. You know security. My wife is pregnant with our third and as I think about you know the fourteen months or thirteen months since we started the bill de Basin. You know the kind of thing by far that's ever been done for me is my wife enabling and encouraging me to pursue my dream which has been building a team and process and culture where everyone can come and be passionate about this very in many cases people may think very myopic pursuit which is systematic fundamental investing in these energy businesses in repeat away my wife. I'm lucky very simple. Things make her happy. She loves families. She loves to read she loves to Cook and and I'm thankful that she has encouraged me to go out and do this but she married me and that I consider the kindest thing anyone's ever done for me. This has been really fun as I knew it would be. Awesome awesome deep dive into a very particular kind of investing so thanks for your time guys. Thank you thank you BAJIC. Everyone Patrick your again to find more episodes of invest like the best go to investor field guide dot com forward slash podcast. If you're a book lover you can also sign up for my book CLUB AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum right away and then three to four suggestions of new books every month you can also follow me on twitter at two Patrick Underscore Osieck S. h. a. g. if you enjoy the show please leave a quick review for us on itunes which will help more people discover invest like the best. Thanks so much for listening

Matt Smith analyst Patrick o'shaughnessy US Canada OSC Kashani Asset Management Ian Singer Modeling Upstream Company Energy Business
Jason Citron - Building the Third Place - [Founders Field Guide, EP.4]

Invest Like the Best

1:02:19 hr | 9 months ago

Jason Citron - Building the Third Place - [Founders Field Guide, EP.4]

"This episode of Founders Feel God is brought to you by Microsoft for startups Microsoft for startups global program dedicated to helping enterprise ready to startups successfully scaled their companies. The program has been around for a couple of years, but I recently became intrigued when former invest like the best guest Jeff Ma took over. Microsoft for startups provides companies access to technology including azure cloud and get hub coupled with a streamlined path to selling alongside. Microsoft. In their global partner ecosystem Microsoft startup says it very compelling approach to working with startups and driving. Their long-term business value. If you're a founder running a B. Two B. Company targeting the enterprise, you should definitely check them out at startups, dot Microsoft. Dot, com to hear more about the program. Stay tuned at the end of the episode to hear from me and current program member abnormal security. 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Founders field guide is a series of conversations with founders, CEOS and operator spilling Greek businesses I believe we are all builders in our own way in this series is dedicated stories and lessons from builders. All types you can find more episodes at investor field guide DOT COM. Patrick o'shaughnessy if the CEO of Shaughnessy Asset Management, all opinions expressed Patrick and podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as basis for investment decisions, clients, Shaughnessy Asset Management May, maintain positions in the securities discussed in this podcast. Today's Jason's Citron the founder and CEO of discord discord is one of the largest and fastest growing social networks in the world it started as a place where gamers come to congregate online thanks to how easy it makes it to create a community of any type and it's offering of text audio video. As means of communication, it has expanded far beyond gaming. It has the potential to become the default digital third place that we go to find belonging in a variety of online communities with over one hundred, million active monthly users. It's also one of the most interesting social network businesses since the original social networks rose to power. Our conversation focuses on his background prior to discord discord founding and growth its business model, and how it has evolved over the past eight years and what the future holds for discord as we talked had the sense that I'd be willing to go work for Jason and I think you'll see why I hope you enjoy our wide ranging conversation. So Jason I was wondering how should begin this conversation I'm curious how you sort of made the leap from a video game player in to someone in the video game ecosystem as a creator I know he spent the first part of Your Career Building Games are as game developer before starting open faint in two, thousand, eight, I WANNA learn a little bit about what you learned or picked up at each of those first two stops before discords starting with the years as a game developer. What are the major lessons that you take away from that work? Well, I fell into that Valentine not even the right way to save I ran into it because just love playing video games the kid because of. That they offered and at my thirteenth birthday sleepover party. Everyone fell asleep and being another guy we're up and we were having a conversation. He was like I know how to make video games as just like no doubt there like this magical dark art no is this thing called computer programming I was like what we booted up my pending one computer at the time and fired up this nickel Q. Basic, which is very rudimentary programming environment and he showed me how to draw circles state I was just like holy crap half learn how to do this and I just became obsessed with learning how to program and make games in all through high school in College I just worked on side projects in Games. Screwed around making like tools for Internet and things that would make using Ailsa Messenger more fun, and then I became a developer working professionally in a video game industry was both thrilling and kind of disheartening it was thrilling because I got to work on video. Games was working on titles for playstation two, xbox, three, sixty era, which was really fun. But also like how the entertainment industry in video industry really works and the economics behind it working independent developers for a couple of years. It was tough to be in an environment where as a company you were really depended on this sorta like hit driven nature of the industry that was challenging and so I ended up. Basically going to studio that I was like I'm going to work in one place. I had three jobs in three years. So I changed studios pretty frequently because I was so frustrated with it, and the last place that I ended up was a fantastic experience funding. That's where I had an opportunity to kind of jump to the next part of my career will living with ten. Other people who are going to UC Berkeley I was about age of senior at the time. I graduated college really and one of the people who was living. There was talking to me about how his uncle was starting this kind of tech incubator. He was looking for people that want to start companies, and so I was like that's me. I've always wanted to start a company. My Dad was a small business owner. My grandfather was I always thought it'd be Kinda cool one day to have my own game studios and wanting to another ended up joining up with this Guy Peter and we were building ended up trying to build games on facebook and other social networks that helped bring people together when I learned really quickly from that is it's really hard. To make something that people want I went through probably four projects basically four different start-up ideas that aren't basically went nowhere the first one we literally shut it down the data. We launched it lose another one. We didn't even ship another one that got a little bit attraction, but couple months into working on that actually Steve Jobs announced the APP store and I was like holy crap. This is GonNa be huge and I thought back to my experience working in the medium industry looking at how the industry worked and what I realized was that whenever a new video game console generation comes to market every five to seven years in new videogame. Shifts like playstation and the playstation playstation three. Every time a new consoles ships is always a new set of games. There aren't that many, and if you can be a launch title, you're GonNa make money you're gonna be able to get distribution because there's not a lot of stuff to pick from. So people are more likely to choose your Thailand petition. So I thought that the launch of the APP store might be the launch of the new console and if we could get a game on the shelf, the day it launched, we'd have a really big shot at establishing ourselves in this new market if you can establish yourself in that gives you the to build your next time. You're next title, and maybe we could build an during game sissel saw that. So adult head into building game for iphone and back then it was like there was no technology there was no tools. You basically took apples off the shelf stuff if you wanted to make games like I was in there, trying to work some game engine that worked on Macintosh on. Anyway we ended up chipping a game on the APP store, the date launched, and we got thousands of in into kind of took off. So what I really learned from that was distribution is really important and you have to think about how you're gonNA cut through the noise and not only just build something that people want also get the word out. It's one of my favorite things that I hear from entrepreneurs over and over again, which is the recognition of a platform shift of some sort, and the fact that I always think about it like the literal westward expansion or frontier that if you're just the first, he just started get your pick of the land or out of the goods or whatever, but it's risky right? It's hard to identify them, and usually there's a lot of unknowns on certainty that you have to be comfortable with I'm curious what the leap was like from that early launch of a game to what became open faint, which I think of as like a tool kit for others that recognize the same thing early on that, they wanted to be building on this new platform. We lost this game kind of took off because there wasn't a lot of stuff to choose from. It was cool new experienced using accelerometer and stuff and what we discovered again or maybe that rediscovered that even if you get distribution building business can be difficult. So we got a lot of users, but the time our business model idea was to kind of do shareware harking back to the nineties is in early July phone there was no internet purchases you either makes think free or you could sell something. So my thought was, let's give the game away for free and then build A. Premium version that has multiplayer experiences in we basically built in eight dollar sequel that had all these really interesting multi-player dynamics where you could level up your character you could ask friends and then you could compete on leaderboards and then you could even compete in kind of ghost matches. It was pretty fun but no one was lying game three bucks. We launched the first winter after the APPS came out and it was clear at that point games we're going to be a dollar. Some developers were the system to basically do in purchases by selling coin packs that you could buy a separate apps. And we made. Thirty. Grand. On that game in very quickly realized it wasn't GonNa Fund. We were five people time. It wasn't going to be a business. We started thinking like what also begin to do ahead maybe three weeks runway left in the bank we were sitting around trying to think about what to do and I remember calling my dad. and talking to him and just basically telling him I think I might be moving home soon because I think this whole startup, it's GonNa. Come to an end for me in a couple of weeks. Gambling is it working? We don't have any more money not going to. Get, my room ready. Turns out. We had this idea to take all of this a synchronous social stuff that we built inside of our game and turn into toolkit further develop pursues and the idea came from looking at the ecosystem on mobile and looking at the ecosystem in consoles PC. I realized that xbox live style services should exist on old vices and they didn't time. We had basically built them inside of this game in. So we had the ideal what if we effectively launched the Xbox live fraud phone? I bet that developers would WANNA? leaderboards and ghosts play and all this stuff to their games. But. We didn't have actually enough money to fund really taking the technology out of the game and turning into a standalone project. So this is another really interesting lesson I learned about validating hypotheses. We put together a landing page at open dot com and it basically said xbox live for Iphone leaderboards chat multiplayer game no servers required sign up to get access to the Beta I made fake screen shots in Photoshop or what the system look like. And we convinced tech crunch to cover it. We got like a couple hundred developers to sign up, and we took that mailing list an raised a bridge round financing than gave us enough time to go and actually build an MVP of the service for recruit the first ten developers and we launched it three or four months later with fifteen games, and we we managed to get one of the big indie titles time. To, really cool to integrate just Kinda. Start to take offs in two years. Later, at one hundred employees, they were like seven thousand games in service and we we sold it for decent Chonkin. I really learned how to go from being an engineer to being in that experience. Of Love that story and I love the cell build ship ordering versus bill sell ship. I think that's a common trait amongst good entrepreneurs but it's all sequencing and timing you sort of have to work your butt off to make it possible. What was the transition like from that sale of that business into the kind of early prime real? WHO's of idea around discord? How did you move from the lessons you learned at open faint into the first iteration of discord it. Was Not a straight line. These things always seem neat clean from the outside, but they're often not after I sold my company threshold faint I thought that I was going to stay on and really build a bigger thing I really wanted to help people spend more time together in have these amazing experiences around video games because so many the best memories of my life have been. Around playing games in those moments of playing games the so I really wanted to keep doing that and turned out grit. That's just not what was in store for me of we Kinda didn't see eye to eye with the company acquired. Awesome. Actually asked me to step aside so that they could run the business way they saw fit and I felt like actually the best thing to do would be to leave I left actually after maybe three or four months and I sat in my car and cried for about fifteen twenty minutes when apple's because. I thought I had failed I had poured my heart into building this and it's so hard to build something that gets that kind of scale that I kind of thought that that was my shot and I messed it up which strange financially, it was a pretty decent outcome but emotionally, it was very tangled moments for me and so I ended up taking a couple of months and just kind of relaxing taking a deep breath re-centering myself I'm spending time with my girlfriend down my wife's playing video games one thing led to another in six months left. I was working on concept and just thought to myself. You know what? Let me try again. Twenty six time I'm not done. Let me try. Let me start unaccompanied. What zeroed zero on was this was in two thousand, twelve and IPAD was relatively new platform and had been growing for the first couple of years in what was looking like it was going to become another hockey stick. I thought that perhaps the kinds of long form cooperative multiplayer games that I love playing on P. C. would become popular on tablets because I thought that you'd be sitting in a place. For were extended period of time in that tablets report sessile than PC's so games like world of warcraft League of legends, counterstrike would become popular unease devices. So I thought there aren't any of these games really at this point in time why don't I start a company to build really amazing deep immersive, cooperative multiplayer games on tablets. So that was the original thought. My idea was that if this is true then. There's also going to be an opportunity to build a communication service for groups of Gamers that is mobile focused and possibly more of the ecosystem that exists PC will shift to mobile. So the Vision for this company when I started in two thousand twelve was build a competitive multiplayer game with team dynamics to bootstrap a group communication service, and then once we mass. Bill Business by distributing games on top of making are Oh that was the plan because I thought get to pursue my passions of helping people spend time together around. Games I. GET TO MAKE Games. Having spent so much time in the industry I understood that it was difficult to build a hit. You have to have something durable and what's durable about entertainment is the need for more of it whereas most entertainment content have novelty in sort of people move on from them although that's starting to shift over the last decade now with his service, but at the time I thought. If, we could have a distribution mechanism for games. The need for more games never goes away. That could be the durable core of the business and I thought what better way to have a durable core of distribution services having communication poplin that. So it was sort of interesting confluence of all of the things I had seen in my life at that point of what I thought. Needed to come together to build an enduring important company that could help bring people together out games it turns out. That's kind of what we built sort of if you squint were there early examples in discord of the hypothesis testing mindset that you described a few minutes ago with fake Photoshop images how did you apply if you did that same idea at discord I mean a bazillion time. Honestly, it's just how I approach product development now is treated almost like science. You Express Art through the framework of the scientific process, which is like you have my policies you come up. With. The minimum amount of thing you can do to actually get real signal back on that I've offices you take the learnings from that in a new plight to the next one, and you just run that flywheel. The biggest mistakes that I've made building. This company had been where we went too long before getting signal back it was a hypothesis destruction where it was just too hard to get signal back without doing audit work and I'll give you some examples. So when we started in two thousand twelve, the idea was, let's network by building a game and so we spent. Six. Months doodling around game ideas basically prototyping, using the same framework of like wouldn't it be kind of cool if Howard offensive popular. So like what would a clock tower defense game possibly be like very quickly iterative building that with just ray blocks in cylinders to kind of get the experience together had a couple of ideas like that didn't end up creating enough conviction around them though perhaps not due to getting enough signal, and so then we decided to bring one of the more popular. Titles Chonreznick on PC kind of do a platform court. You see this happen a lot where there's a game that will exist genre that exists on a platform and when a new platform emerges, there's interpretation of that. John NRA. That ends up becoming really popular because I think the game design to actually code a reflection of the way human brains work. There aren't that many new genres because it's hard to discover new fundamental sort of gizmos gimmicks that really enthralled people but they happen from time. I. Thought One way to do risk could be by taking something in interpreting it. So we decided to riff on the mobile concept, which is sort of multiplayer online battle arena concept where it's realistic. Don't play video games. You basically have a team of people three to five people playing against another team five people, and it's conceptually like soccer except there's dragons in fireballs and wizards and stuff like that, and so we built a three version of that game on tablets and we spent about a year and a half on it, but we tried to chunk it in ways that we could de risk the product by getting signal. Back earlier. So one example is test starts style. We actually did concert and put it up on read it and said Hey. We're studio making a mobile like what do you think of this this art style and we tried it with actually a couple of different things in. We got some great feedback that caused us to iterating on the art style. Ultimately, what we ended up with was much better because of that early signal that we got, we did something similar with the game play mechanics where we were testing out different ways it control games can work and different sort of ways at the map could be designed sort of. Sin We got a lot of good early feedback on with the right mix could be that ended up guiding us to launching the game that we launched, which was called fates forever in two thousand fourteen unfortunately though even though we got lots of good signal on away. Ultimately wasn't a hit because I think we picked the wrong platform who picked IPAD and I also think we were a little bit early today. If you look around people are playing these kinds of games on their smartphones constantly, and so I think this was a situation where as it entrepreneur I had perhaps the right hunch about where the market was going, but I mistimed platform and also the timing of the whole thing. What did you learn about the right amount of signal reference at a few times like it almost sounds like the key in all of this is I have to have the mentality, but then second, you need to know what signal is real and strong enough to build upon any broad ideas maybe from. Or for mistakes at signal interpretation when you're running these experiments, one caveat I will just start with is that I have yet to make a hit game using using this approach. So take that for what it's worth with this approach has done is I think the games that I built have been modest successes but I think trevor would have been a modest success but I was looking to build something massive scale and I just knew it wasn't going to get there. So maybe the learning from that is that if you're trying To build something that's GonNa be at scale frequency of usage and jeopardy usage of a product in the early days needs to be astronomically high because as you get to scale, you're GONNA. Get people that are slightly less and less interested. The most passionate people about what you're building are going to be the ones that find you in the early days when you're looking at the sort of behavior of people using your service the early days the people need to be rapidly obsessed with it and this was true with open faint. With our game. This was true with discord when I think about early retention. Metrics Timespan and these kind of things that are good indicators of the objective utility of which are building the amount of time. That people were spending using discord in the early days was just totally ridiculous because people really really really liked it whereas when you look at our game, even in the context of what great teams should look like it just wasn't there and we could have realized that earlier in probably hit it harder to something else. What was that early intense usage of discord? What was the original early adopter use case in what are the product look like at that point? The idea was really about building a better version of the tools that me and my co-founder stand had used when we were playing those games on the Internet using battle net, and early in the most the communication tools that existed actually hadn't changed that much from when we were teenagers to them, and that was probably fifteen years or so two thousand to two, thousand, fifteen when we were starting discord, the tools headingley changed that much. So Stan my co-founder actually as a really story to where he was also sort of like me passionately obsessed playing multiplayer games in his particular story was around falling in love with frontal. Fantasy Eleven, which was the version of that game and really using it as a way to find connection and friendship because of where he lives and sort of how his friends were spread around La you try building a bunch of tools to improve that service in ended up joining up with me to build our game. We were thinking about, what do we do next because the idea was to take the game to bootstrap network and we don't have a game with a lot of users like how do you truck network and Stan actually had a really interesting insight which was that perhaps instead of bootstrapping networks through the game. On mobile if we actually started with P C, where people were already playing competitive player games a lot cleaning us. That we could build a better version of the APPS that people were using then and then be ready when the wave took off on mobile for the next billion people. So the original idea that he actually pitched me for discord was, let's build came speak meets skype with a modern twist that works great across desktop mobile for people who play games like fantasy world of warcraft. and. What literally did it feel like I'm thinking about like the computer screen right now five got some game up on the screen is discord on in the background is it also on my screen? I'm just curious how you shoehorned communication and the different styles of it into the activity that it was surrounding. We didn't shoehorn anything. It fits snugly license gracefully even better even better. Yeah. This is an APP that you would download on your computer in the early days was mostly people on Windows who were playing cooperative competitive multiplayer games and you download the APP on your computer. You create what we call the server, which is kind of a group where you can invite your friends. It's an invite only space that lets you text chat and voice chat at the time. So you could have the server setup for your killed ten or twenty people who you were playing. And when you turn on your computer, 'cause you WanNa, go play dischord will be there and you can see if your friends are there. So wait would work as people would click on what we call voice channel You could name them whatever you want. So you could call the lounge at one CACTUS card and right now you can click on that and it would show that you're in voice chat and Then other people in your server could see that you run voice chat and Click and show up there with you. So it was kind of always on conference call experience this concept. So we didn't actually invent it. They were advocate came before us speak at bumble and early going back to the first one I think was called Roger. Willcox that had this kind of voice communication feature and it was popular. Really popular with a small group of people that played MNO's online, and our thought was like this is the best way to talk while you're gaming. So let's make it really easy really accessible. You could hop into that voice channel and then open up your video game in the video game would be your full screen, but your friends were in your headphones and then because you're playing in a virtual state, your friends, you also see their characters and it created this really amazing experience that made it really easy. So more people were able to do it. And then because it worked on your phone, you could also see if your friends were invoice and talk to them when you weren't at your computer, so you could coordinate between games. I read somewhere about the sort of early days of growing this concept. I always love out businesses are distributed in the early days and how the word spreads. I'd love to hear a bit about how you use existing networks of people that you cared about to reach them whether that's or subsets specific games. What did you learn about distribution and getting the word out about discord once you knew you had something that was popular or was it mostly just word of mouth? It was both but word of mouth start slowly when there's no mouths to have words, you need people to be excited to share it to generate momentum. So I had learned in my early experiences a distribution is really really important in one of the insights that we had was that. People were not gonNA download another voice chat out, and at the time there were other companies trying to innovate in the space game box was one voice was another. They were a couple of the other ones but there was a reason why really one of them was most popular it's because the way that they would work is you have to download APP on your computer and then to join with a group of people, send you an IP address for those who don't know it's basically I think it's twelve numbers basically type in a password in order to join in and you have to pay for it. So it was pretty hard to use the stuff and if someone was using teams. Speak in you had mumble and you want her to go on a raid with them in the game sometimes, you just wouldn't do it because he didn't want to down in salt or APPS. So we knew that it had to be really easy to get people in. This is another one timing things that were just sort of lucky but into thousand fifteen, it was the staying I'm GonNa, technical for second but there's this thing called Web RTC that was becoming part of the new web browser standard html five and just the year before it had shift in in the web browser chrome and it was shipping fire Fox just a couple of months active you're playing launch will stand had the idea of. Louis could solve this friction issue is by. Using web RTC building the APP in web technology frameworks we could make the whole application run inside of a web browser so that you could join it by sending someone a link you don't have to install anything. And then if you really like the APP in the browser, which is just thoroughly a website, you could download it to your computer, and then we had essentially a customized web browser that looked like an APP. That had extra features because we were able to run native your computer, and so having it work in the web browser was a fundamental part of the experience of getting people to even try it. So the way we ended up being people to try it was I were like, Hey, friends go check this after renew a lot of people who play games like this and Our friends were pretty excited about it. It took them a couple of months actually switch to use it, which is a different story, but they were cited about it but once we got them to really use it just through friends. We probably had no twenty daily active users, twenty people maybe using it to actually get the word out and grow at scale. We basically went to where people who play games hung out and congregated in the initial growth hack. If you. WanNa call it was read it where we got one of our friends to post in the final fantasy fourteen Fantasy fourteen was the other that they made and there was a new expansion coming out at the time, and so we thought why don't we focus on this game which can have a new expansion coming out when new expansion comes out there's new content new reason to play. So we thought let's focus there. He knew that blatantly advertising people was probably not gonNA work. So we thought why don't we just ask people what they think about this maybe they'll tell us that they like it maybe they'll give us feedback make it better but that's the approach we took, and so we ask our friend to just make a post. Like asking people what they think about it. So he posted hey, everyone as anyone tried this new voice over Ip call discord. And in the retina posts, actually we went in and responded like, Hey, where the devs here's a link, here's a url to a server that we set up come and talk to us. If you WANNA learn more, this is another thing with the link. So we were basically basically sitting in a discord server, which is what we call the groups and people were finding the thread on reddit clicking the link because they'd have to install anything they'd open the website come into the APP. See us in those voice channels click jumped in and then be talking voice chat to us to the dogs and they thought it was the coolest thing they go back to the reddit thread comment I just clicked the wink was talking to them that seems really cool. Check it out. Try It. We ended up getting a couple of hundred people register that day, and that was kind of the first kicking the snowball, the mountain kind of thing that helped us start to generate or. I love that story I. Love How it's progressed from there discord. Now, a lot of people have used some version of discord whether it's slack or discord quarter teams or something else we're discord has very distinct feel to it and feels like just a place to go to be with people that you wanna be with in a digital sense and there's that famous story about like starbucks and the inside being that it sort of this other place of. Your home and your work that you go to hang out and it seems like discord more than any that I can tell from using the products has that third place tight feel to it and even beyond games obviously, we'll talk about that in a minute but I'm curious how much of that was intentional like as you thought, okay, we got the initial traction I know you said the early engagement was off the charts. High people were using a ton. How did you think about products late from there what has been your product philosophy for how to grow the platform and was this third place idea intentional. The third place idea it's funny question ask if it's intentional because it was intentional. We didn't know that we were making a third place. We were intentionally trying to create the experience of a communication service that like your friends were around. Where you could interact with them without having a lot of friction and do it in ways that Phelps playful and had low commitment. And it turns out those are actually the attributes of a third place. We were doing it because we thought that those were the things that we wanted to has as a Gamer in our communications service and it was only four years later in two thousand and nineteen. When we started really realizing that people were using discord were so much more than just playing games with their friends that I. Actually. Did Research on this concept of the third place and I read the book the great good place by Rail Limburg which was written in the eighties where he actually talks about this and starts to put labels in words to describe the concepts of how these third-place work and as I was reading the book I was just like holy crap this is what we built accepted digital. It's this. Incredible Q. Say a bit about how you're thinking has evolved on who your audience is. So I mean it's incredibly clear early on very often I think companies fail because they don't know who their actual customers and you clearly knew it was yourself and it was built sort of versions of it. Before you knew the community, you knew how to attack it. I think what's so cool about discord. Is that my engagement with it was not for gaming when I first tried it it was for a separate type of community and I think there's all sorts of communities. Now that exist on discord how do you think about that from a philosophical standpoint about starting with a very, very specific audience and core and sort of having more pulled out of you by other types of communities beyond gaming. I think it's wonderful and fascinating. The journey has been really interesting because you start building a company in focusing on a customer set of problems. A lot of that comes from personal connection. It wouldn't founder. Does it truly authentically I? Think like I did have normally interested in video games when they played a big role in my life when we started realizing how people are using. Discord for other things, we started having a lot of conversations around what should we do about it it's cool. Definitely it's great that our work is helping other people find belonging and spend time together. It's not within our mission. Our mission was to bring people together around Games. What does that mean? If we want to acknowledge this and we did a bunch of research to figure out Really how big the phenomenon was and when we look in two thousand nineteen, we ran a survey in self reported that actually not thirty percent it was thirty percent of the people who took our survey self reported that they did not primarily use dischord for gaming. Clearly, we have to engage this because it's not like two percent. It's a lot of people we started having some really. Deep conversations around what are we trying to do in the world? What is our mission really about what we really care about an standing night did this exercise where we both kind of went into separate rooms and starting with our mission bringing people together on Games? We did the five wives exercise I have heard this, but it's a great technique for doing root cause analysis kind of. You just ask why and then you write down the answer and then you ask why that and you write down the answer and you ask why of that you do it five times and why about the fifth time you start to get at fundamental truths that Radyr backup to what you're doing. Standard both did it and then we shared her answers with each other and what was fascinating was the fourth or fifth why we both said? To find belonging in the world or something to the effect of belonging, and that we both realized that bringing people together around games for us was about belonging and connection with humanity in a deep. Social need and the more we sat on this thought about it we realized how profound this was Maslow's hierarchy belonging I think is the third one started to become clear as the started talking to more users and listening to them about what they're doing with this. Gordon how it's about talking in its place and it's about friendship we realized that actually people are just using. This tool that we built to actually help us cultivate belonging in the context of games you're using it to cultivate long in the context of all sorts of shared experiences and activities, and that actually we could just go more fundamental with our mission expand the aperture to what we're doing to be valuable to literally everybody we sort of rewrote our mission as giving people the power. To create belong in their lives, and now that we actually imagine a world where everyone has the ability to belong in a more easier way than they could before because they can using these amazing communications services that we have in our pocket powered by the Internet can keep in touch with friends that may have moved across the country or across the world or you can't hang. Out with your friends on an evening because whatever reason you can hop on your phone or hop online and there there you can talk to them in pop in and pop out and how this experience of running into your friends almost like have your own private cafe or shopping mall or living room but it's online it's in your pocket and we think that it's just amazing. I love it, and I love it makes me just think of and. Listening to be too young to remember AOL instant. Messenger. But just the Internet has been a place where oftentimes you're not there together and the cool thing about him was you'd see that color dot whatever it was and see someone was there and it was like this cool opportunity to just jump in and start talking and it seems like that is belonging in many ways and that's what you've built. Really curious how The business itself has evolved. So people familiar with business models like say slack and other communications like these how do you think or think about or describe discords business model and how much time cumulatively as part of the pie do you spend thinking about that part of things versus say like the product might thing was offers it just seems like there's always so many different choices for how to build the model and. How to charge people I'm just curious what your deliberations were and how that lined up with product thinking. Originally, our plan was to sell video games, the people, and we actually tried to do that. We launched it video game store on E. C. at the end of two, thousand eighteen with that a dozen games and very quickly. What we learned was that people actually just wanted us to build a better communication service. And this was kind of one of the first pieces of signal that we got that. Maybe we were actually over emphasizing video games in our mental model in our audience was in addition to competitive that the market at the time which ended up being rather sleepy for awhile got very, very competitive fast. I think the other big companies saw similar created we did. So while we had a large audience, we actually were not. Capitalized in a way to fight a real content war with Microsoft and epic who makes fortnight it was there was going to become a battle of who can throw the most money at game developers to get exclusive content and as a startup that had scale that didn't seem like a prudent thing to be doing. So we very quickly actually backed out of the Games business and kind of pivot away from it. And then double down on communication services. We had launched this service called discord nitro in two thousand seventeen as a way for users to basically support US gets them chat brooks and it was like a five dollars description service and it was modestly successful as covering I. Think about a third of our burn rate in early two, thousand nineteen when we were moving away from the game store end, we were debating whether we should double down on that the concept of selling ads came up again, we've talked about selling out before it came up because it's a way that other companies have been successful in sort of social media space. But I really didn't sell ads because I felt like selling ads would require us to spend a tremendous amount of energy investing in building. This ad technology that actually doesn't make the end user experience directly better. It actually subtraction the end user experience. So it'd be spending ton of energy taking value away from our users so that we could make money and really wanted to build. A business that the incentives of our team and our user base for directly align our users raw customers. That was why we watch the game store and that's why in that moment I said, let's do the easy thing and just slap ads us. Let's double down on Dischord Nitro, which is all about making it more fun to talk and hang out and see if we can build a real business around that. So we spent a lot of two thousand and nineteen probably about a third of our time. In terms of sort of product had space maybe even closer to a half really trying to figure out how do we make discord nitro more exciting and more valuable to people so that or people would pay for it because sort of early support, molly called it. A donation wasn't super-popular even though it was making a little bit of money. So we doubled now that and we launched a number of features including boosting, which is basically like a way for you to give back to your server to your community by spending some money that. makes. You feel good makes everyone else feel good lovely human dynamic happens there and that just took off and as we've added more features to Nitro people have just continued to buy it and now it's a tremendous business that's growing incredibly fast and we haven't shared the revenue numbers of that but it's clear that we can now build a really massive business by making it more fun to talk in a way that doesn't take away from the free experience either which is an important part of what we offer. So everyone can access hang out. I really want to double click on what you've learned so far there because I think history of businesses that get a ton of people like you have is that they become advertising businesses and some of those are incredible businesses, but it is sort of the natural tendency. My friend goes by the student. A modest proposal on twitter says long enough time scale everyone sells ads and I love this idea that you've of flipped it and said, let's take what makes people love US and try to make the experience better and premium instead, what are those enhancements, the literal examples or the kind of frameworks for how you think about enhancing communication through Nitro? The most popular teacher is actually what we call custom animated Emoji. So people love Emoji you can text cat people love text chatting, and the fact that you can insert visual expressions of what you're thinking whether it's a face or a pizza slice or rocket helps you add in express the color and flavor to your which express undescored we have a feature where each group of people each server can set up their own custom Emoji that they can use to allow themselves to express things in a more fun in sort of personalized way and people loved that customer feature that is. What we charge for if you WANNA use those custom emojis in your direct messages. So in your one on one conversations or in other groups that you're with like he's GonNa take them with you. That's a premium feature, and then if you want also allow them to animate that requires you to pay. We took sort of basic emoji feature we added one level of persons to. Which is free and then sort of next level is where we put the paywall. So we try to make sure that the things that are premium on board are exciting and fun but don't feel necessarily because we want people to really feel left out we wanted to be still fun to hang out and talk. So that's one. Another example is we have a feature on dischord. Called go live where you can basically stream video games to your friends and it recreates the experience of sitting next to a friend on the couch watching him play a game but a mind. So it's ultra low latency and it works great with ten people although it's up to fifty you can watch your Prince Games for free you can do it at seven twenty p thirty. FBI. BS, and if you pay, you can do any sixty F. B. or all the way to source. So you can get older high quality for your friends to watch. So really cool but not necessary but a lot of people like it and then boosting is another one that you have to pay that we charged for. So goosing is you can choose to boost the server. Depending on how many times server gets boosted a unlocks a different set of perks for that server which ranged from more customers to the ability to have a banner. Space Field little more personalized to animated icon or splash screen when new people join and so people can contribute consort of pitching together, unlock those perks for their community and people love doing that and you get a little badge next to your name shows your poster. So kind of stuff like that. When you talk about, it doesn't sound like it's necessarily that profound but I think the reality is that it feels profound when you use those things because they're really delightful and people love it. You have the history of humanity. You said earlier the five. Wise. If you just think about how people act, it's sort of the same as buying certain types of close people like to express themselves and have something unique about themselves to show other people and people spend more time on line. So it makes perfect sense that they would want to do the. Same thing in a digital context, I'm curious how talking about company building here. So you mentioned earlier leaving the the acquirer of open faint not seeing eye to eye thinking very carefully about what you want discord obviously the product, but also the company to be having now overseen I. Don't Know How many employees you have raised a few hundred, million dollars. There's. A ton of our D that's gone into that love to know kind of how you think about and D. as well. But what are the big principles that you have for company building specifically at discord? The first one is to be intentional. My last company I wasn't really what I was doing. I was twenty, three, twenty four never really managed people before let alone run a company and somehow had fifty eight hundred employees and I, remember there was a moment around eighty. Seventy people one of the early employees again, Mandy dill good friend of mine quality and actually works with us. Now at discord he came to me and he said Jason it sucks to work with open fame. It's such working here. I was like Oh crap. That's not great, but I'm not going anywhere but I'm saying a way. Okay. Great and we started trying to fix it but we ended up in the company and it's hard to fix culture when you haven't been intentional about it and you have a hundred people. So when I started discord Andy joined within a couple of months and so we were around maybe six people or so it was three people that, December, he and I and Brandon who is another person was with us we were sitting. Around and we were talking about the kind of company we wanted to build and how we've got to be really intentional about the environment that we create. Because if we're not than, it's just going to be by accident and it's going to have is just not necessarily going to be the kind of place that we want for the kind of role they wanna live in having myself also worked in environments earlier in my career that as an individual contributor, I found very frustrating due to the nature of. Konczal stuff I really wanted to go a little bit slower this time building this company and be more deliberate about it. So we did and a lot of the sort of intention -ality resulted in a couple of early values I have read about. But essentially what it boils down to is as you add more people everything harder because you have to communicate more and it's like an N. squared problem because it's a network. So one of the original insights that I had which to stay holds true is if you can hire slower. Everything is easier. We had this sort of company that small mighty teens. which is this notion you can get a lot of stuff done with really really really smart people that make high quality decisions that compound. If you choose the right technologies in the past to building and realizing your vision, it means you'll have to communicate as much evenings loves management overhead less coordination issues in his largely worked for us anywhere around two hundred eighty people now and given that we have over one hundred million. Monthly users I think are like employees to user base scale is quite unusual for this kind of service. Another one is I really wanted to create an environment where people came because they were in love with the change we're trying to create in the world and so early on we instituted this concept of what I call mission fit when looking to hire people. So we really screened for people who cared about our mission in nearly as that was adopting together out games, and now it's about giving people the power to creep in their life, and so we look for people who have had experiences that allow them to personally connect with the products that we're building. In a change we're making and when people really care about the purpose of your mission, they just naturally care more about everything about the details they work a little bit harder. They pay attention to the details. They don't let the garbage on the floor sit in picks it up, go get it because they wanna make sure that everything is great. So people try a little harder when they really care about what changes Harnett create third is creating an environment that fosters intrinsic motivation. The really wanted people to feel motivated and purpose is part of it and actually there's this guy, the pink who wrote this book called drive which I discovered pen of after thinking about this. In helped me sort of codify these ideas more. But there is some science behind this notion of how you create intrinsic motivation and it goes down to basically three things autonomy mastery and purpose, which is the mission fitting I talked about naiad compassion to it because I think it's important that we acknowledge that real humans. So I wanted to create environment where people felt relatively autonomous were treated like adults they could learn and grow and be challenged cared about rebuilding and felt supported by the people around them, and then the phone, which is the last one is taking a long-term view. So I say it's a marathon. Not, a sprint building enduring companies and creating change in the world is a result of compounding value over time, which takes time having ten twenty year view on what we're doing allows us to make decisions that can result in incredible yields in the future that may not seem necessarily the best in the short term it causes you do things like invest in management training. We did this thing early on route twenty people that we went from just me and twenty people to like okay. Now we need managers Accu was me and my co-founder stand and are early Cmo Aeros, and we now we need middle layer of managers. Instead of just continuing to hire. We actually froze hiring for three months created a management training program asked who wanted to be manager. Those people took the program, and then we restarted hiring and I'll tell you are silicon valley vs they thought we were crazy for not hiring people for three months. But I knew it was the right thing to do. So to this day, we spent a tremendous amount of time on training and learning in development because investing in your people while in a month may not have great returns in two three or four years have credible returns, and if you come back to the notion of smaller mighty teams, had you get more done you either make your people more productive by giving them better tools or you make them smarter? Those are two big things that we do so. Long winded answer. But that's kind of my philosophy for hiking about a workplace knock on wood so far so good. You're obviously very team focused very product focus. I'm curious given the scale you've now achieved in this is with me with my investor had on how often you think about competitive advantage around discord the business I mean obviously, you've got the most prized thing on your side, which is a network effect communications companies tend to have that it's hard to get where you've gotten and and that sort of its own best defense. But you think beyond that intentionally about competitive advantage as a business. Definitely, I, think if you're trying to build a business scale, you have to think about competition no business exists in a vacuum I think it's important to pay attention to competition to think about. Where your weaknesses might be where your strengths might be where you need to shore up defense where you can go on fouts which core is all of these things but I don't think you want to focus too much on competition because this is sort of weird analogy because I don't really play sports but I just sort of remember this thing that learning this when I was a kid like when you're throwing a baseball, you need to look where you WanNa throw the ball. And if you look somewhere else, you're not GonNa get the ball where you want it to go and I've heard this off soon the concept of driving go look at the wall look at the road you're GonNa go where you're looking. Human behavior that you will go where you focus. So if you focus on your competition, you just end up copying them chasing things instead of focusing on customers and their needs at going where they want you to go. So we spend a tremendous amount of time mostly focusing on fundamental human needs. What are people doing what our service heck we better serve them. I love the idea that discord is almost like a bundle of communications because you're able to do text and video and voice, and all these different things. How does the usage shakedown I feel like you're a petri dish for how people like to communicate digitally because they have every option? What is the breakdown of those methods in how often people use each? Well, I think what's important actually kind of take a step back to that third place concepts and really talk about the holistic experience because what really makes this scored? Magical is the particular concoction of what happens when you put all these things together. You have an invite only space with just the people you want to be there. You can organize your communication channels, which prompts people talk in certain places in helps keeps multiple conversations going. So you can have different people gather. We have this thing called permissions enrolls, which allows you to set the rules norms for your space, which in real life is such a fundamental part of how people gather you have hosts and you have regulars and you have entry areas and you have people sitting in you sort of have waste Organiz people. The fact that we allow you to have roles organized people, and then actually have power to have the conversation areas or to kick people out really gives you the feeling of having a space with people that can invite you in and that you have to behave, and then the way that sort of the live features work like presence and voice video makes it feel like people are around. So because you got the green dot are you can see if someone's playing a game or listening to music or if they're on voice chat with two other people, it gives you this sort of I. Call it the busy restaurant phenomenon you look at a restaurant and it's full of people. You'll like that place is cool. It's fun. It's alive. You look at a restaurant it's empty like a that's not so exciting just for service feel like busy restaurant because it's full of people who you know if you don't know them that you want to talk to and so at least three things have like invite only space where easy to hang out in control the rules and norms really Chris this experience of having place that you can go now to answer your question critically when is happening is that people use text voice video kind of evenly split because depending on the amount of focus and attention and intensity you WanNa have in that moment, you can pick a different tool. So chat sort of lower energy lower attention required to be in a text conversation voices. The next level in video takes your whole being it turns out Texas voice about even in video is kind of an up and comer. We just launched video chat actually after the virus that happened mostly because from the context of gaming video chat wasn't that important. But when we started thinking about moving beyond gaming video chat became very it. So we added. You mentioned earlier this idea of. Slow -I and begs a couple of questions on people and hiring everyone always asked what do you look for in somebody bill ask the opposite question, which is when you're interviewing somebody what bothers you the most? Two things come to mind. ONE IS PEOPLE WHO Are Not Humble. You GotTa be humble because if you're not humble I think it's too easy to sort of drink your own kool aid and get carried away with things you have to be curious and open minded and I think being humble is an important part of that. But like a random pet peeve in all-share it, maybe we'll give away part of our interview process Detroit, but I think it's really really great to watch for it to see if people are passionate which. Is, our interview processes. We take a buffet lunch. We have three people who are not part of the rest of the interview loop go out to lunch with the person and we watch for how they treat the waiters and if they don't respect the waiters eye contact polite than we assume that they don't respect people who don't have power over them, we want people who are going to be kind and polite and compassionate when they don't have to be our culture is all about. So we're looking for people that are warm and wanting enjoy being around that. But so that's like a little kind of human behavior that we look for obviously now that we don't take people out to lunch because of the coronavirus, it's harder to check for that interview. So we look for more around when they have our quote ritual lunch, are they speaking to each person? Are they focusing on men more than women, these kinds of behaviors to try and get a sense for are they just like a kind warm person? Are they ignoring junior people talking to? The senior people conflict when people do those kinds of things like we've rejected senior couple of EP candidates because stuff like that. It's a hard line for us. I've so loved the story your story is so specifically unique and interesting. Maybe I'm biased because I like so many the same things that you loved as a kid, a lot of the same games, etc and I think given a lot of what you said about how you hire people. You'll like my traditional closing question for everyone, which is to ask for the kindest thing anyone's ever done for you. I really think that so much of life is about the little things and about the consistency of a little things that people do making coffee for her husband, my wife popping for me it sort of in exceptional grandiosely like it's not the most time thing that everyone's silly ever done to be. But where that comes from in that kind of kindness I think is really what's magical about relationships and when a co worker thanks for doing something nice for the more for a job. Well, done that kind of consistent kindness I think is really what makes the world go round? I'm GonNa go with that is kind of similar to the five wise exercise like there's something behind it all that's most pure interesting I love it as a different kind of answer to a question really appreciate your time here today Jason I've learned a lot it's great to meet you Patrick was fine. Thanks for having me. This episode was brought to you by Microsoft for startups. Microsoft startups Global Program dedicated to helping enterprise ready to be startups successfully scale their companies. In our five part miniseries we were talking to Evan Riser CEO of Admiral Security about his experience with Microsoft startups. In this week's episode with Evan, we talk about choosing to work with Microsoft for startups and his advice for B. Two B. Enterprise entrepreneurs. I think one of the tendencies would be to think about choosing a cloud provider vendor as a pretty near term decision of the you're about to start working with immediately. But maybe there's a case to be made that the decision has a lot to do with where your business will be many years into the future curious what you think about that and how that Wade into your decision choosing Microsoft. So I think that's a great point I do think entrepreneurs tend to be a little bit shortsighted focused on the here now, which is, which is natural. I think is an opportunity for entrees a lot more about what? They want to be when they grow up and where they WANNA be if you're trying to build consumer mobile application, right you probably want to be on the APP store and you're GonNa have a tight partnership with apple other handwrite. If you're trying to build enterprise software product for large enterprises, you'd think about where our enterprises and reality is the grand majority of large enterprises are building investing in the Microsoft ecosystem and I think that you'll Microsoft's critic great ecosystem enterprise startups to help with go to market distribution to help with practice elements and help with procurement purchasing to make it easier for both your startups and customers. Evan I'd be curious even though you're only a couple years into this company, what your advice would be looking back for those that are starting new companies enterprise facing companies for the first time. When advice would you give them? That's a great question I. Mean there's three things or maybe top of mind for me. One is like we talked earlier you want to start with the end in mind if you WANNA create you WanNa have a snowflake or crowd strike Calabro Pio need to kind of understand what in. That business is going really well and build that into the plan from day one if you WANNA have high-speed sales that's very effective cost effective but then you want to invest in things that celebrate your sale cycle in your billy to allow enable customers to procure it. The second thing is a lot of founders to be more clear about what their job is. There's a lot of chaos superhero personalities that start companies tried to everything at some level I think the founder and CEO job also comes down to. Identify the right roles, getting the right people in those roles, host the high bar and getting out of their way, and then finally, just like ours awarded the existential risks business what is the most important thing to focus that team on and the final thing? I'd say is a lot of steps tend to focus on the SNP markets and I don't think they shy away from the enterprise i. think that was me good advice ten years ago but I think it's easier than ever to get into the enterprise. With, all these cloud deployments where customers can install on one click, they can see results they can buy through Microsoft right and they had the credibly behind that. That enables customers to find innovative solutions and procure them very quickly, and just as an example, know we we started the company in. April. Two, thousand, Eighteen I. Think by December we had our first fortune five hundred company and we couldn't have done that without us new cloud native platforms because I getting back quickly and then kind of your accessory best also. To find more episodes or sign up for our weekly summary visit investor field guide dot com. Thanks for listening to founders field guy. Own

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Chetan Puttagunta and Jeremiah Lowin  Open Source Crash Course - [Invest Like the Best, EP.188]

Invest Like the Best

1:00:32 hr | 1 year ago

Chetan Puttagunta and Jeremiah Lowin Open Source Crash Course - [Invest Like the Best, EP.188]

"This episode is sponsored. By catalyst catalyst is the leading destination for public company data and analysis. I'd heard of cancer the past few years and became more interested after meeting the founder and CEO last year to pick his brain about SAS businesses founded by a former biocide analyst who encountered friction in sourcing building and updating models. Catalyst is now used by over three hundred institutions including the largest money managers North America and by a number of guests on the show with detailed. Company specific models on over four thousand public companies, catalysts platform. Let's analysts update their own malls and seconds complete with KPI's and segment data adjustments and restatements. Everything you want and expect in your own models on virtually every investable public equity. If you're a professional equity investor in having talked to catalyst, recently, you should give them a shout learn more and try for yourself a catalyst dot com slash Patrick that C. A. N. A. L. Y. S. T. dot com slash Patrick. O. Hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets, ideas, methods, stories, end of strategies that will help you better invest both your time and your money. You can learn more and stay up-to-date an investor field guide. Dot. com. Patrick o'shaughnessy the CEO of a Shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon basis for investment decisions clients of Shaughnessy asset management may maintain positions, the securities discussed in this podcast. Own. This week or Jeremiah loan and cheating. Jeremiah is the founder of prefect dot. An open software company where my family and I are investors and Jason is a partner at benchmark capital. Both are past guests and good friends. I asked them on to help the audience understand the open source software business model. I've been fascinated with this model in which companies give a huge chunk, their work and value away for free to a community of developers, and then make money by building additional tools, functionality and services on top of their free and open platform while this may strike you as A. Walkie discussion on a niche software topic I think it is valuable for everyone because the ideas can be applied to more than just code. I view much of my own activity as open sourcing investment research and knowledge. It's also important because much of the world technologies built on top of open source projects. I hope you learn something new about this emerging category. Please enjoy. Jason, and Jeremiah thanks so much for doing this with me today, our topic is going to be a single topic, deep dive open source software in the businesses that surround open source software, which is become a category that I'm personally fascinated in I know obviously chafe and you've invested in some of the biggest companies in this space in Jeremiah you're building one. So I thought this would be a neat group to get together as a jump off point Chafe and I'd love you to describe sort of the originator business in this space, which was red hat as a way for the audience to understand sort of what's distinct about this sort of business model. I think one of the things that's pretty interesting in the history of the firm that I work for benchmark that benchmark was an investor in red hat in the very first benchmark fund. So benchmark one was an investor in red hat in the story of Red Hat. Itself is particularly fascinating, and as we look at what has happened twenty five years later, frankly in terms of the evolution of open source which will get into here. It's pretty interesting. How far sort of open source has come in how sophisticated it's become from where red had started in redhead is particularly interesting. Story because of ninety three redhead was actually two different companies that came together. One was a catalog business that sold links in UNIX software accessories, and then a second business, which was actually red hat lennox, which was its own Lennox distribution that Mark Ewing had started. The two companies actually came together in nineteen, ninety five, and that was how red hat software company came together. Red Hat became public in nineteen, ninety nine and lost in sort of the history. But redhead had I think like the eighth biggest or the tenth biggest first day gain in the history of Wall Street. It's sort of broad this open source business into the limelight in such a dramatic way, and also pretty interesting about the first benchmark fund is that the group had also invested my sequel which had also been pioneering the open source business, which of course, then son bought I think that red had. Starting in ninety five and then four years later becoming a public company in having this huge spike on wall. Street. It being categorized as unbelievably disruptive force where you had this open source operating system and you had a corporation that was behind it that had the wherewithal on the balance sheet to support the efforts to push the open source community forward, and you had all this developer excitement around what Lennox was and what red hat links was. And then of course, red hat went through its own evolution as a business and over a period of twenty five years pretty dramatically transform, and then ultimately, of course, IBM acquired it for thirty, four, billion in two, thousand eighteen. But I think that announcement to the world if you will wear it formed and very quickly become a public company and got so much public attention I think was. A real fire starter for thinking about open source as a an incredible commercial business model in Software Jer. My sincere actively building a business that has served open source at its base. Maybe you could describe why you think it's valuable thing within a business versus version of prefect that's not open source. It's just a software product. Talk US through a little bit how you think about it. philosophically. So. Open source is a very complicated thing especially, if you haven't encountered it before because it can be something that's critically important to you that you can look at the source code of software that you're working with or you actually might not care, and you might only benefit sort of implicitly from say network Becker other benefits that come from it. Think the critical thing about open source software is actually not. That the source code is available. It's rather what that represents. So by making your source code available, you can affirm some degree of trust with the community you can, of course, invite contributions into the source code. You can make it very easy for people to deploy that source code to customize it to their needs with an environment without the sort of corporate sponsor. Being involved but more than anything I think it's about reach for a young company especially when like ours and as we've open source more stack, we certainly experienced that and I think you think about a marketing budget versus the fact that we've engaged open source community ones a compounding activity and one is just the pursuit of our allies sort of blindly just dollars. See it maybe my software and so one of the motivating things. Where if one person the community likes it, they can tell another person there's no Barrett entry can maybe that's the person who's going to contribute to the software. Maybe that's the person who's GonNa. Extend the software maybe that's just a person who will. Attract the next person. But that idea of almost I don't WanNa say free because an awful lot of effort goes into maintaining a healthy community, but it's a very qualitatively. Expanding the reach that the software can have been. I, guess some more traditional model. I'd love Jeremiah's just very briefly for you to make this a little less abstract for those listening and just give actual example using your company. So obviously, people use something because it's useful as you guys have both said, something has hired to do a job especially in software. This isn't really for entertainment purposes. So in the case of the open or free product, what job are they hiring say prefect to do, and then on the paid layer, just give the example that slots and everything you just said, which is you're not competing with compute and storage you're providing an ancillary service, but that nonetheless needs to be a paid service. Sure. So prefixed open source project is a workflow engine. It's a workflow management system. You use it to achieve a goal that you have, which is to make sure that code is run at a certain time and place Minnesotan way. That's what it does and we give that away we open sourcing anyone can run it. Are Proprietary Services we described as an insurance product. We actually divorce it from the idea of running the workflow. It's actual job is to deliver as fast as possible the knowledge that something's wrong to put it bluntly like an insurance product and to protect from it. Now we deliver a version of that in an open source form but specifically because it's a risk management product, Patrick has spent my whole. Career looking at risk management stuff. The Devil's in the details on making sure that this stood up in a very specific way to make sure it's robust highly available scales at any time secure. These are all things that can be done, but they're very hard to deliver in an open source way that's infrastructure agnostic, which is one of the things that we try very hard to do in open source. And it's very hard to teach people in sort of read me how to do this. Instead, we hire people who have expertise in doing these things and we employ them in order to deliver this insurance product to our customers. When we go out and we ask people what value do the are paying customers what value getting from using prefect we hear nice things about the workflow engine is easy to use and save some time and stuff like that. But ultimately, the story is always revolve around Oh. And then there was this one time when something went wrong and woken up by slack and whatever, and it's this very real moment where without the software in place and being governed by US monitored by us, there would have been a real consequence all of a sudden we are delivering real value which a funny way has actually nothing to do with the open source except for the fact that the open source allowed this person to very easily describe what it was that they wanted us to do. So are open. That's actually. The open sources away for people to inform us what they want us to do. We. Re deliver that proprietary platform in an open source way. But our challenge is to make sure that we deliver it to are paying our enterprise customers in a way that scales across their entire organization plugs right in. This little configurations possible. Truth and I'm curious in all the companies that you've back that have pursued this model. If you have an opinion about what tends to produce the best business outcomes there've been four companies that have invested in that have had an art sort of like venture capital world we think of his unquote exit. So Mongo DB meal soft elastic, the company behind elastic search. All have become public companies salesforce ended a buying meal soft. In early two, thousand, eighteen for about six and a half million dollars, and then I was also involved in Aqua, which is the company behind droop will not company was acquired by Vista Equity for a little over a billion. So I would say that if you looked at those open source companies and how they went about creating an open community in an open adoption mechanism, I think what was available to these companies call it. In. The late two, thousand in the early two, thousand, Ten's is likely unavailable today in the late two thousands, it was a totally viable business model to say that I'm going to have a completely open software and the way that I'm going to monetize is offer services and quote Unquote Enterprise tooling for enterprises that they can run on their own data centers or their own servers and and has startups trying to build up their. Own Data Centers I'M GONNA help them get up to speed with US Open source project, and then that's a potential way for the commercial entity to support the open source project and as we have all become very aware of the cloud is become. It's huge powerful force in the price market, and if you just look at the three large cloud vendors of aws azure and Google cloud public cloud is becoming such a big market. Opens companies have had to evolve in how they think about not only licensing, but also how they think about going to market and I know this is something Jeremiah thinks about on a daily basis and if you look at somebody like a Mongo DB, the way they thought about it is that there is an enterprise product that you can run if you choose to operate your data centers but they have another product called Atlas, which is Manga DB's cloud, which essentially allows you to run. A managed Mongo DB where Mongo DB the company takes care of all the sort of administrative things that come along with an operational database like replication security, auditing, scaling provisioning, etc, and through outlets, your company or customers able to provision and run in manage Mongo DB clusters across Google Cloud Azure, and it'll be us, and so they can run it in multiple regions it can run. Across multiple clouds and they provide that service and if you look at Manga DB's business, today outlets is by far the fastest growing segment of the company, the introduction of cloud and how fast cloud has come on the scene has introduced not only more opportunity, but it's also forced and abolition in how we think about open source and how we think about the business of open-source. How you react to that Jeremiah, I'm just curious if that lands for how you think about prefects pricing and business strategy. Yet absolutely does I mean I don't think I just think about that daily I think about hourly minutely to I was talking with someone yesterday whom I respect incredibly as a businessman, but to whom open source is a new. Idea, and he said to me said may be old fashioned, but it seems to me you make a lot more money if you charge for your software than if you give it away and I think the extension of that from which was just saying is you have to actually know what you're selling and the answer is you're not selling the same source code that you put up your selling some extension of that. So in the case of Atlas, what you are selling is the convenience of the managed infrastructure or put differently the opportunity costs or the pain. Of figuring that out on one's own. So essentially as an open source business, you're looking to profit from where you can deploy expertise in form of convenience that someone would otherwise have to incur cost. Anyway, how you do that now you do in a genuine way I think is one of the challenges because if you think about it, there's a bit of perverse incentive there and I think we can all think of open source projects where it certainly seems like they went out of their way to make it hard and of course so that you can be sold. The easy version and I think at the end of the day especially with the explosion of open source and best him point out the explosion of readily available compute resources just in these things up people aren't dumb. They don't fall for this. We talk about dark patterns and websites all times they're dark patterns and open source software as well. Avoiding that is I don't even want to suggest that we like think about this something we need to avoid. It's something that we're committed to making sure that we avoid because you never wanNA customer to feel like they're. Held hostage for any business, not just open source customers will pay for something that alleviates some pain. You just need to make sure genuine way that you're not delivering that pain in the state moment with the other hand, you take money to alleviate it, and so this is one of those weird dynamics of the open source world where I think going back to some of those ideas from earlier about just building trust building a welcoming community making it clear that you have your users interests in mind even as you build a business is really important. So I firmly everything from saying I think that this is sort of a great. Conundrum of building open source companies and then the pivot that a little bit. If you think about other perverse incentives or something analogous to it, starting an open source project is less than free by which I mean anyone can put up any code but does anything and just say this is my open source project. We'll figure out the business model later. So it's not just that the barrier of entry is low for a software company. The barrier of entry is negative for young open source projects because I love shining offer I love to play with it, but you'd have to be out of your mind to do something that just. Put up by somebody, even look at the code. These same things I was talking about earlier having to cut available creates trust creates environment where you can demonstrate goodwill. It can also be abused many times. When we talk about open source companies, we look at the ones that were successful at work where Cherry picking a small number of outliers. From probably a much larger denominated and we would even see in a more traditional. Environment because we can actually wait and see the cost of doing this. So win. This is gaining traction of that's not where we can investments for users we can begin to adopt it. It's just a very different dynamic than even what we'd see in a more traditional software world. I'm curious how you guys think about Jason especially defensibility of these companies. So it seems like in the early days that could be really useful tools have powerful and loyal communities solve very specific developer facing problems but once they start to grow I would think that some of these bigger players literally the source codes available like it would be especially easy to fast follow or coop or just replicate some of these services and stash them on aws or something like this. So how do you think about the defense ability of course businesses as they scale? Jason. We have now gotten the most uncomfortable topic. I think the business of open source, which is, how do you coexist as an open source company in this new world where you basically have three extraordinarily dominant public clouds, the open source theme of what does it mean in terms of Ip and what does that mean in terms of defensibility from an IT perspective? What does it mean from a technology perspective and what does it mean from customer retention perspective? I think we have to take a step back and really think about that sort of like huge tailwinds that are happening in enterprise software and then aligning those tailwinds with core strategy. Ultimately what is the point of an enterprise software company is this to provide a utility to a customer when a customer engages in Enterprise Software Company they are in essence hiring that enterprise software company to do a job insult alternately whether you're an open source company or close source company, you have to fulfill a task for a customer and helped the customer accomplish something. Now, that is if you want to create an open source business now, if you would just want to create an open source project, that's his knee and you wanted to put out in the world, you have completely different considerations. Let's just talk about a bucket of. Just. Thinking about open source as a business itself versus open source as a community project. So opens a business you have to think about the tailwinds that are happening in the enterprise software world that you can then align yourself with to ultimately deliver a service that is extraordinarily much better than the closed source alternatives and I do think that the open source companies that have broken out. And Jerem just said is absolutely correct which is the the number of open source companies that have become very successful businesses as a percentage of total open source projects is very, very small. So it's actually very rare for an open source project to lead to a great open source business. So how do we think about this tale win? Using the cloud sort of a macro example is actually is the right one because we can. Talk about all the issues in the moats and all that stuff. So we just think and then we can just go back to. Mongo. So if you look at how Mongo thought about its club product. Mongo DB. Launched at less which was it's racist service that runs in the cloud in June two thousand sixteen. And Alice in terms of revenue run rate. Has Grown from zero to one hundred and forty seven million dollars of annual run-rate revenue within three years after launching based on their Q. One results that they launched. They announced a few days ago. The outlets product is now at a two, hundred, ten, million, dollar revenue run rate. And so that's with less than four years time. The Atlas Product has gone from zero to well over two hundred, million dollars of. Run Rate Revenue, and the number of customers atlas now has astonishing. So within four years, it's gone from obviously zero customers at launch to now the announced that at the end of Q. One, Atlas had sixteen thousand, eight, hundred customers on the service. So that is actually a huge macro trend that we can all think about that open source can certainly take advantage of which is that. There is huge amounts of interest in thinking about rewriting infrastructure in the cloud world and using new components in this cloud world. And if you can provide a service or an offering to customers that is a dramatic improvement to the alternatives that are available, it will lead to becoming a great business and that service itself does have value does have defensibility and all of that, and now I think the part where I'd love to Jeremiah's perspective from an entrepreneur's perspective is the three public clouds have taken dramatically different positions and postures, but how they think about? Running their own services on top of open projects, look at what Google and Microsoft have done versus what aws have done. They've sort of like different approaches in how they think about open source open source partnerships and how open source is monetize across the three clouds. It's a fascinating dynamic, and one of the interesting things is that we're still in the very early evolution of what that means thing ultimately as long as you align with. This massive macro trend of cloud in continue to keep in mind that just because it's an open software. You can never forget the fact that an enterprise customer will hire you to do a job and it has to deliver that job in a delightful an amazing way. I totally agree I think this is going to be my trump to beat here but the job you're being hired for his ultimately not the lines of code, what the lines of code due or extension of that, and just to go back to the public concerts certainly do spend a lot of time with this concern me test the idea that they have all adopted very different approaches on some range of antagonistic too friendly towards open source companies. My idea here is the public cloud's ultimately sell two things. They ultimately sell compute and they sell storage and everything else is to facilitate that every tool that they host. Every product launch is a convenience layer to basically entrenched. One of those two things. Those are the flagship products at these clouds have when you think about an open core company, which is a company that has an open source product and potentially builds closed source or proprietary product on top of it. If the version of the proprietary product that a company offers is nothing more than managing their open source software and their chief competition is actually the public cloud. Because the thing that they are selling over their software is. Views it's just the management of it, and this is where we go back into that sort of perverse incentive unless it turns out, it's really hard to get it onto a CPU in which case they're also selling the convenience factor but I think as I said earlier I think people look through that. So it becomes even more important due to the explosion in just the popularity of public clouds it becomes even more important to differentiate software not just by managing it but by offering some degree of functionality that is reflective of the expertise that the. Software. Manufacturer has by virtue of servicing many use cases are working with many customers or just knowing how the Code Works and Best Practices. They're all these other ways to layer these other jobs to be hired for on top of just the fact that at the end of the day, you have this raw CPU delivery at prefect we went. So the other way on that, we designed this whole system where we don't run code for our customers. We asked them to provide the CPU's wherever they like to advantage for US gives us privacy and security benefits. And speaking of defensibility we hadn't this business model I. strongly believe that if you want to build a defensible business here, you need to find a way to work with these clouds. We says a startup. Not Put yourself in A. Where fundamentally your business model is a directly competitive with their desire to sell CPU's and more specifically provide software that runs on this ups so that alignment can be hard and I think we love Google. Google cloud, we're closely with folks and it's just been a very pleasant experience how they've decided to approach this speak to that. Chafe and one interesting way of kind of framing. This whole thing would be if you meet, let's say a young entrepreneur and they want to build software and maybe they're sort of agnostic as to whether they take a open or closed source approach. How'd you talk a would be entrepreneur through the trade offs of that decision? Are there certain types of software that you think lend themselves more to the open approach versus the closed approach? Yeah absolutely. I think it all comes down to ultimately what? Scribe, which is what? Do, you ultimately envision a customer doing with this piece of software and is there value for a customer? Experience the software in components or modules. If you think about the standard application, they're very few call it SAS applications where you can say, Oh, if I had just this part, it's pretty valuable and I'd like to build sort of custom tooling around it, and that is actually valuable application whereas most applications deliver value when you get sort of the end to end experience, I think that's part of the reason why there have been at least to date a number of commercial open source applications that have turned into big business certainly that can change in the future and where open source businesses. have been successful is infrastructure in the sort of idea there is, is that the open source infrastructure that you put out there is actually differentiated than existing solutions people can pick up that open source project, get a ton of value out of it build custom applications in house applications, whatever on the open source project itself, and then contribute back learnings whether it's through talks, user conferences content back into the community or code back into the community. Often it's more the first two than the vast majority of people that are in the open source community will not contribute Tenneco back. Into the opens for project, but they will contribute a lot of knowledge and Jeremiah describe. The open source community will sort of guide the company in terms of what the community actually needs with the community desires, and then you can also glean a subset of customers have very specific needs that is perhaps expensive to build, but also delivers a lot of value to the customer, and that's sort of the commercial pieces that you can build around and opens for project. But primarily, that's the way that I personally think about it, which is that if you think about a project. Is there value from the core itself that can be delivered dramatically than what's available if so then it makes sense to have an open source project with sort of commercial bindings that's either through cloud or enterprise or through services or whatever that you can build over time. But without that distinction, it's really hard to make the case of putting yourself through building and open source business because building open source business is actually very very difficult. All the data over the last twenty five years indicates that the vast majority of open source projects don't end up being good businesses they end up being great projects. If you think about it in that Lens, you have to really make that case that. This open source project deliver significant value, and from that significant value, you can then derive additional value with fried terry features a proprietary features or modules that you can then offer that creates even more value than monetize and ends up becoming a good business I was just going to jump in and actually be more emphatic unshaven billing and open opuses really really hard billion open source project is really really aren't forget the business I. Think it's As much as we've talked today about open source as driving certain values and whatever the truth is, it's open source that means it is open source that means if somebody doesn't like it. There's a record of that means if people don't contribute to it, there's a record of that. The absence of engagement is visible as everything else that we've been talking about, and that can be very frightening that can be very intimidating. There's not really a place to hide I can't pretend that perfect has any different adoption than it actually has because it's open source you can see engagement of it starting at the day we launched we launched a slack channel twenty people a year ago. It's going across a thousand next week. That's amazing. We love to see that but. If, it hadn't done that that would be very visible as well. I think that that level of transparency can be deeply uncomfortable to people even if they think they want the benefits of it because you have to deal with this potential downside as well I believe that there are steps you can take to do a better job here by the way I. Think it's no coincidence that many open source communities have a reputation for being toxic to be blunt I. think that's because many open source maintainers end up running popular products not because they set out to run A. Fractious because he just happened to be useful but managing and working with an open source community is hard. I remember when our first employees in our CTO Chris, white joined the company yeah. We talked all about like he wanted to build but we agreed on one rule immediately and number. One rule is we're going to be nice and that's it. Today we can trace a line back to that we've customers who are our customers specifically. Because they know that if they go and ask the question slack, they get a full answer in about ten minutes. Can that scale like forever at prefect I don't know we do our best to put processes in place to deliver that kind of experience I don't know I hope. So at the nascent point of an open source community, you have to commit to building this community as much as you commit to building software because the moment. It lags won't you don't see that and tigers out, and this is not something that you want exposed if you don't have to and you have to be willing to embrace that transparency or it will fail. I'm curious. Then point taken this is hard to do is sort of begs the question both from an investing in a building standpoint. So same question for each of you, which is why bother why not start prefect as just a traditional software business that solves the same problem why not investigate than only in companies that do it the standard way and don't have to face all of the scrutiny given the failure rate in the uncomfortable nature of that Chafe and I'll start with you. One of the great things that I'm sure Jeremiah would agree with is that if you ever developed applications on your own and especially in the early two thousands or Mid-2000s, if you were trying to develop applications on your own as an independent developer, one of the truly frustrating things at the time was how little was available in the open source community that enabled you to get going quickly and it was pretty clear that the. Large. Software companies especially on the consumer side that had built a whole bunch of proprietary tooling and a proprietary infrastructure had real distinct advantages from the independent developer in terms of just how fast they could build things up and how quickly they could build things up and it was pretty obvious that developers inside companies like Google or facebook or any of the large consumer Internet companies had a distinct advantage in building a net new. Product because they just had these gigantic software internal software projects that were unbelievably enabling of the development internally what really I think changed all of that is you saw an incredible explosion of opens projects in the late two thousands and early two, thousand, ten's and that really changed the landscape of how productive developers could become and how fast you could build applications and how fast you could build technologies and fast forward to today to. Twenty twenty with the last fifteen years of this amazing exclusion of really great opens for projects. Building. An application today of extraordinarily high quality. You can do it actually much faster than some of the large consumer Internet companies primarily because of the number of open source tools that are available and the advent of public clouds which makes running these applications at scale pretty easy. So that movement has been I think frankly as someone with. Limited Development Capabilities. It's this incredible to watch and the amount of creativity that you unleash behind that and the amount of sort of economic and innovation opportunity you unleash behind that is really remarkable and I think it says up for what we're really watching in the enterprise, which is basically a trillion dollars a year that spent on the entire enterprise market. Now sort of unlocking itself as more people. Starting to see that you can reinvent whole parts of the infrastructure stack in the application stack and part of that movement is going to be driven by open source. There is a large economic opportunity if you can get it right and I talked about the Mongo DB numbers earlier, and then if you look at the financial figures of all the really successful open source projects, you quickly realized that. When it works and when you do get it right it works in an extraordinary way in delivers value to not only in the open source users but also this users of the cloud service, the oppressed product or whatever, and that pushes the Innovation Economy Ford and I think the economic opportunity when done right is pretty terrific to. Yet I echo that but I guess in an attempt to be still relevant on this podcast it's hard to volume them. I'll talk about the more pragmatic decision like at the moment of starting the business should open source of closer. It's very permanent decision point and without the luxury of knowing how things will play out I think a big piece of it is sort of knowing your user knowing your customer knowing what they expect and what they'll be excited to us. So I come from the Python data world in struggling thought my head to think of. Python package that's delivered in a closed source form. There's an expectation that people have users have that will lead to their adoption in an open source way because they're familiar with it feels familiar to them, and then there's also a growing just ethos within again within that same community this is a good thing but they want this that they'll choose this I don't think it's enough though I don't think it's enough just to be open source close source competitors that are terrible open source competitors that are also terrible. It's not enough just to be open source but. going. Back to what you said a moment ago, it is a bit of a gamble if you can get it right there's an opportunity to have the massively compounding effect as it ripples out and we've seen this I said I was going to say tickets to the moment of deciding how to start the company, but we actually two months ago in the midst of course, we decided to open source even. More of our stack, make it more available to more people and our doctrine numbers took off again because fundamentally nothing was different we were actually delivering the same product that we made available for free through men service but the fact that it was open source sparked something sparked some interest. Even if these are people aren't gonNA use the code or on could contribute to it so you can tap into an ethos. In that way and you can find goodwill in that way I think at the end of the day, it's sort of like could you deliver an effective product in closer former foreman and different businesses? The answer will be yes or no for US I'm not sure how we would actually deliver a product that does what we do, which is says interfaces the customer code in the Python data world without being open source. So it's it was in all honesty was a fairly easy decision. I'm curious what you both have learned about digital community building. You both mentioned it as a key component of an open source project and therefore open source company and I think in the cove era. It's especially interesting question because community is such a popular word concept we all want it. We all crave for we're social creatures that's in large part been stripped away from us and for open source in particular community is really important at prefecture at the companies that you've been involved with, and I'm curious what you would say are the most effective ways of building a strong community in addition to just being Nice Jeremiah, which I think is sound simple but probably a powerful thing. I mean you just have to be nice I. Know it sounds ridiculous but I've probably poked around more open source communities than you guys have and not being nice is a real problem. It's a real problem in. Many software communities and I know it sounds fluffy and I'm not saying this in a fluffy way I mean in a very real way if someone takes the time to join in our case slack and ask a question which first of all takes a certain amount of bravery or humility if they're gonNA, take the time to do that and they're going to be met with silence or a brusque response or anything other than welcoming them and thanking them for taking the time to use that you wouldn't the world. I mean, it's just crazy to me but. Takes enormous effort and dedication and willingness to do that to provide the other end of connection. But a majority of our customers started that way that is in the beginning. That's how we convinced people. That's how we earn their trust that we were worth working with and so being nice I really do think it is so hard to do. It is so alien. So many open source communities where the maintainers have an attitude that they are volunteers. They are unthanked and by the way that's true. Most maintainers are unthanked. They get an unending series of people showing up to ask why they didn't do this or how come. This doesn't work this way or how dumb is it that you didn't think to do this that is true. There is an unending parade to that, but if you want to run. A community that is truly open. You have to run a community truly open have to make it welcoming for the people who choose to participate in the nets. self-reinforcing behavior I. Think it's a challenge to be completely frank about it in the case of elastic were I'm on the board, our products we disclose us in the ass one which we filed. A believe in two, thousand, eighteen coming up on two years ago we disclose that our products have been downloaded on the order of three hundred and fifty million times. The community that we had built up over the period we had something like one, hundred, thousand meet up numbers across nearly two hundred, meet up groups across forty six countries take a step back. And realized the enormous size of the developer community that actively engages with your projects, and that's not only sort of concentrated anyone geographic area but it's a global community that's engaging with you. That then creates quite a bit of responsibility on your shoulders to create avenues of engagement as Jeremiah said that are additive and positive, and so it takes a lot. Of Investment in developer communities and being very sort of purposeful about thinking about creating spaces and avenues for people to share how they're interacting with the open source project I. Think you see that also not just in the open source community right? You see that in the rise of like the developer advocacy role and movement really about access to even proprietary software. And Way of welcoming people in and using them in. Yes. It may have a business objective behind it in some cases but this idea that reaching out to these developers who had the ultimate users of the software has certainly taken on a wider scale. Since I thought I'd give something more concrete in this case, which is I'll tell you exactly how we. Measure all the things that we're talking about right now are these how do all of this idea of compounding and community and all the stuff for me? It's very simple. The metric is how many times to someone who doesn't work for our company who isn't paid to do this respond to someone who asks a question and if that number keeps going up. Than we are achieving this whatever you WanNa, call this flywheel this compounding effect whatever it is, and if that number stagnates and we are failing going down is very, very bad. Because at least you hope someone maintains a level of engagement, but that is a way to actually capture track. Remember like I said earlier, this open sources open you can see everything there's nothing is hitting. That is a very tangible way to actually measure the degree to which this is happening, and by the way you can feel it. You can feel these communities if you're not getting a response communities, not actually they are the communities just of mob asking questions very different feeling. In addition to this community aspect, which I'm just endlessly interested in think is a powerful concept to be deployed in lots of different ways not just in software. Are there other elements of this business model or this building approach that you think more traditional companies could successfully apply whether that'd be mindsets or best practices into their own businesses It's a tough question. Well. Let's pointed him for a second while we turn this around segment ask me questions you have a model involves the word share learn build share repeats that right. Yeah so this is an idea I don't think anyone would call. Oh Salmon Open source business, but there certainly is an open source element to what you're doing. You just have this idea of like knowledge and by making that available by making that raw material available, you are creating an extra analogy from the work that you do. You're inviting other people to participate and observe and draw conclusions and. Maybe agree with you and maybe disagree with you. I, think your challenge in some sense if you want to apply not just the open source ideal to that. But the business ideal to that is to figure out as we said earlier, what job do you provide? What do you do by virtue of the fact that you are the curator of all that information and how do you deliver that? You really can't see this idea that by looking for compounding effects other fly wheels within a business. You don't have giveaway little source code to have an open source everything they were talking about work for you. You just have to find ways to involve people and bring them into an ecosystem constructive way. Of Thinking about this recently, which is a simple litmus test where something is. I'll call it low cost or free to produce and free usually to share. So marginal cost of distribution. That by definition, it should be free and I just wonder the implications of this. So obviously, like a Netflix show which is free to distribute should still call them because it's really frigging expensive to make. But that if something falls in that category at least mentoring your question Jeremiah I'm trying to come up with a standard with an operating principle for when we decide whether or not to share something because my experience teaches me that. The best things to share are the ones that you have to think hard about whether or not you want to because they feel like they give you an advantage of their proprietary or their ip or something like that. But almost every time that we've always made the mistake if we try to keep it close to the vest I share, it falls in that category of really low cost to find or produce free or or near free to. Distribute. So I'm curious if that's a litmus test that may be more traditional businesses might try to inject more value into the overall ecosystem of their industry versus keep something proprietary I. Think it comes back to the same idea of what is the value provide, and again trying to extend this we don't need to stay in the open source world. We could talk about completely close source business as well but really not what value is and knowing what? You are providing your customers is critical and helps you make decision obviously in an open source context has massive permanent ramifications as well. 'cause you're actually GONNA make available. We sort of said, this isn't strictly true but in some sense are GonNa Forego. Your opportunity to profit from what you open source gonNA profit in a different way for skipping it starts into selling access to it. So in our case, this is the knowledge of what is for. workflow management, we're going to open that and what is for insurance we're GONNA keep that as a product that we selling that we provide and drawing that line I won't lie to you. There's moments as we choose what we're gonNA open source who what we're working on fraught moments. There is a very permanent decisions that we have to make an and you worry a little bit is this thing people are paying for? Are we about to release the? Completely misjudged our customers are we about to give away that thing they're paying for? The goodness you don't have to actually wonder the thing you can ask people we did I. Know exactly what someone thinks they pay for when they purchase are software and I know exactly what they learn that they're paying for when they offer and by the way they're not the same with, which is frankly a challenge. We have our business how we align those things that we better educate value. We can deliver at the time of the purchase, but that understanding and knowing what you produce that is value and then second order. How does your customer? That value received that utility I think it's a really critical question for any business I think it's a little bit harder to hide from it in the open source context. And I think that every business that is engaging in public learning are open learning ends up. Deriving, tons of benefit if you think about it talked about sort of the explosion and sort of open source communities especially on the software side in the late two thousands and early two thousand, Ten's one of the companies that engaged with open source very early on was Google and they simply were putting out these white papers that we're talking about all these proprietary technologies that they had come up with internally and I think if you think about what value that ended up creating to those companies. And we've talked about before is that it turns out that engineers and this is fairly obvious thing to say is that engineers want to work on really interesting problems and really challenging problems and I think that not only applies to engineers but most of us that are engaged in our jobs that we want to work on interesting problems in sort of engaging in this open learning system and open feedback system where you're putting your workout in, you're putting out sort of the ideas that you're exploring. Really then encourages really great and bright people to engage with you as a company and engage with your ideas and I think. The sort of open source ethos if you will of sort of putting ideas out there putting projects out there and sort of engaging the community at that sort of level of here's something that we've tried the pretty interesting here. Some lessons we learned then collecting feedback ends up creating immense value, not only in terms improving the businesses, products and offerings, but it also has. The second revenue effect of being an enabler of attracting really great talent to the company because you are now essentially showcasing really interesting problems that you're contemplating publicly, and I think that's more and more companies are starting to realize that and you see companies that maybe fifteen years ago you would have never imagined engaging with an open source community being huge proponents of it. There's perhaps no better example of this and Microsoft which famously call Lenox a cancer many years ago. But is now one of the biggest contributors in the open source world. I think that shift that we're all experiencing, which is the sort of learning in public learning very openly in open source is a great way to do that ends up being not only a way to improve your products and services, but also ends up becoming a great source of talent for the company itself. One of the things that I've experienced for sure that everything you guys have said rings true for me is this you could always think about building a magnet versus building a megaphone sort of create this inbound gravity through community building and through open learning it's hard strategy to pursue in the early days because the returns don't show up quickly takes a couple of years for that convex payoff curve to really be visible and be felt. But ultimately is way more powerful than even the most powerful megaphone because stuff's rolling downhill in your direction I was thinking that metaphor within that taught me the go slow to go. Fast. I. Think that describes this extremely clearly. I see that in our business, we say our job is to deliver value to to extract it, and it's just trying to bring that community those and obviously we are a business and we do need to deliver and receive value intern I should've mentioned this earlier way didn't come to mind. We actually named ourselves strategy open source sales because we try to bring some of the learnings from our open source engineering effort into our sales effort. So that manifest in some ways in chafing Douglas's you'll be horrified like. Doesn't doesn't really call people back. They say very genuinely they say, no, I'm. Not going to hear from me again under some circumstances, this is horrifying to or has sales as well. The first thing we came, but we can point again, we can draw a line to customers that resulted from that from that. Obviously, we need to be smart about that. We need to be part of our strategy, but looking for ways to bring this idea seems so silly to say comes on to be nice but we'll give the levers that elsewhere has mattered. Can you take too far? Can you be really stupid about yet you absolutely can we try not to be but finding that balance isn't anything finding that balance critical? That's. What major aspects of open source the philosophy or the business model have we not touched on that? You think it's important for entrepreneurs and investors to consider when looking at these businesses. The sort of opportunity said that's available to businesses at the moment is much greater than it's ever been and I think new industries and new workflows are unlocking and I think it's the macro transformation that were a part of which is that we're seeing a previously sort of locked up spend and core functions coming online. Now, where enterprises large and small are now of the mindset of well, if it's been done that way for twenty years, why has it been done that way and we do it better faster cheaper and there's just much more openness to think about new tooling new. Solutions etc. The number of opportunities that are available to open source companies just sort of rewrite fundamental infrastructure components and address them in really unique ways I think frankly has never been greater, and so what ends up happening is that you're seeing just really unique solutions and really unique projects come out of not only sort of your traditional policy of technical talent but they're really coming out all over the world from an investment perspective I. Think Investment Opportunity is massive and I'm certainly very optimistic that some of these projects will end up becoming really incredibly big businesses in the future. One of the more frustrating questions that we get is, how do you compare to X. The reason that's a frustrating questions not because I can't be answered because it rests on such a subjective need at the user has and we don't know what that is now. We've got in the habit of saying us us US X. and you decide which everyone feels right to. You just use that which everyone solve your problem just use that we're not gonNA waste time trying to pretend that we know we have this diagram features and you've been diagnosed features and we overlap here and we differ here, and if the thing that we differ in his critical to you, then you don't have a choice to make and if the thing that we overlap in his critical to you then. I can't defend the choice that you have to make because I don't know what's valuable to you, and so that's one of the things that I think is challenging for those of us with younger companies in the space is it can be very tempting to say, Oh, these six companies do x y or Z. But if we're all honest especially because we're open source and that creates a very rapid pace at Aleutian I, don't think any of us know precisely what ex wires the are as companies as entrepreneurs, and it'd be quite a stretch to think that are used to. So people are always going to look for the best. Tool that meets their needs and the challenge is to again. I guess this really is my drum beat challenges to really know what problem you solve and not be seduced by the expanding circle of well customer Xer user y once this let's build it it would be easy for us to both it on. I, think instead you want think in the opposite competition if we all pretend as a business gophers I'd competition is a good thing because it makes companies focused on what differentiates makes companies stronger unless they can't they die. This idea is something that we think about a lot as a young project that's emerging that is evolving. That looks like other projects. How do we maintain our competitive advantage from defensibility perspective from a utility perspective from a value perspective is challenging but part of the game. I closing question for each of you is to ask what has you most excited about the future in this space maybe Jeremiah, we'll start with you. I have benefited so much from open source software in my career I mean my career spans risk management and machine learning. So I was building models in two thousand eleven when you say machinery and somebody can ask you what, what's that? That was based on open source software that progression has exploded as a research scientist. Open source availability open-source Research Open source tooling. The explosion of a applications is grounded in this idea that we can. Learn cool things. Build cool things and share them. And build on top of them. In this amazing way I love seeing the research I love keeping up with the latest research that's coming out. It's built on open source tools that has code available Ben lets me if I choose replicate these otherwise unreachable algorithm advances on my laptop, just because someone was kind enough to share and make that available and so I have loved seeing that I would forward to continuing and I think that that is just in its infancy. I would say that the main thing that I'm continuing to be really really excited about is very similar to what Jeremiah talked about, which is that one we've seen over the last couple of years infrastructure components start to change. We're seeing cloud happen in a real way, and then what's also happened behind that is that data has exploded within sort of enterprises. So data across applications, data across servers, data across infrastructure, etc tooling in new components of infrastructure to handle all that data whether it's at the storage layer at the database. Layer, at the analytics layer or at the processing layer, and then how all of that enables machine learning and how that enables faster and more efficient processes are all opportunities available to open source software and to people that are looking to build open source projects right now, and I think that the opportunity said is also really valuable because enterprises are very ready to engage new solutions to help them solve these problems. If you look at enterprise workflows, still today in how many of them are done manually and how many of them take. A really unreasonable number of hours to accomplish. You can just quickly zoom out and realize that the opportunity said is quite large all these components offer. Huge opportunity for new companies and in addition to that, and it's something that I've talked about on twitter is we're starting to see the new trend of what I like to call quote Unquote Super Infrastructure which is essentially API enable infrastructure that enables you to outsource a core function to an API call and in the world of E-commerce, we've seen that with sort of new components like shop Affi- and Patrick Toby on and that was absolutely fantastic. You see it with Chop. With Stripe and you're starting to see with brand new components, we have companies like. Content. Full and commerce layer, which are both open source companies that then enable API super infrastructure for companies to then go leverage so much like we saw in terms of super applications where these applications did. Tons of stuff for the user. We're now starting to see these new generation of what I like to call superstructure companies, which are really being developed to do lot more than a single infrastructure thing they're starting to do lots of things with one API call. It's a really fascinating trend that. Companies can really really take advantage of that. I'm pretty excited about. Anything else to add your my there on the API. So you can tell like I'm honing around this same API first business concept as one of the most fascinating business models out there. Any closing thoughts on that you're my. What this represents is certainly the epitome of everything we've talked about today where open source says about delivering more than winds of code about delivering a convenience or solving a problem or something like that van the API call represents a way to bundle up what might otherwise be disparate open source winds code and turning them into business logic. And potentially that's the negative space that if you have an open source business where Patrick you and I've talked a lot about the metaphor. Work focuses bunch of lego bricks. So that's great if all the Lego bricks are open source but someone needs to I come up with them and follow the instructions to create something with them, and that can be something that someone can choose to do themselves fully particularly open source, or that's something that someone might want a company to provide an API. In simple sense is a way for us to take that business logic. Take those instructions bundle up the building blocks behind them and expose something that is semantically aligned with businesses objective as opposed to asking the business to. Learn at themselves but that to me is what the API represents it's not just the fact that you can hit an point and get something done. But in an open source context, it's more than matched. To layer semantic knowledge and expertise in domain expertise over the otherwise individual components. As somebody that is again, not technical but using a lot of these tools and building software I can attest to end the conversation in a very tangible place. It is amazing how fast and efficiently you can build stuff now with a relatively small team to accomplish your business goals without having to recreate the wheel each time, and I think I think fundamentally that is why I wanted to have an hour and a half long conversation with you guys on something like open source, which can appear to be a sort of wonky topic but I think is in many ways unlocking creativity in the business world in ways that nothing else before has it's a remarkable thing. Well, thanks for having US Patrick. This is so much fun. This has been great patrick the three of us talked quite often, and so I'm glad that we're able to do this podcast. It's awesome. Really take a learning in public to a a whole new level. You know you're my go-to references on all things in this area. So I, appreciate your time today I learn more as always. Thank you so much. Thank you. Thank you. If you enjoyed this episode, you can sign up for a new email newsletter sent out. Called inside the episode each week I convinced that weeks episode to my favorite big ideas, quotations and more. I've been recommending books to members of this email is for years and we'll keep doing. So in this weekly email, you can sign up at investor field guide, dot. COM FORWARD SLASH Book Club.

Jeremiah US Google developer Red Hat Patrick o'shaughnessy aws Jason Chafe North America founder and CEO Best Practices Catalyst Shaughnessy
Chris Bloomstran - An Update on Public Markets - [Invest Like the Best, EP.171]

Invest Like the Best

57:58 min | 1 year ago

Chris Bloomstran - An Update on Public Markets - [Invest Like the Best, EP.171]

"This episode is brought to you by coughing. I've become very interested in the best software tools in investing and when I asked twitter for the best Bloomberg Alternative. The overwhelming winner was an excellent new product called Coif and it's a web based platform that you analyze stocks. Etf's mutual funds and other asset classes in one place. I've been using everyday to track. What's going on in the market? And I think if you try you will to. Cohen has a ton of high quality data powerful functionality and clean interface. The best part is that it's free you can sign up at. Www DOT CO DOT com. That's K. O. Y. F. I N. DOT COM Hello and welcome everyone. I'm Patrick o'shaughnessy and this is invest like the best. This show is an open ended exploration of markets ideas methods stories and strategies. That will help you better invest. Both your time and your money. You can learn more and stay. Up-to-date AT INVESTOR FIELD GUIDE DOT COM. Patrick o'shaughnessy is the CEO of Shaughnessy Asset Management. All opinions expressed by Patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes. Only and should not be relied upon as basis for investment decisions clients of Shaughnessy Asset Management May maintain positions in the securities discussed. In this podcast. Award I guess today for a Flash Update is Chris Blue Strand the founder and CEO of Semper Augusta's in a popular pass guest on the show. We talk about his view on the state of the Public Equity Market. Why it will be hard for the market to deliver. Great returns for the next decade rolled in the last decade and where opportunities may lie. Please enjoy our conversation. Talk to me a little bit about how you are thinking about. Or actually making adjustments to your portfolio in light of what has to be the most bizarre and challenging macro backdrop that we've ever faced as investors in our collective careers well. There's no doubt nobody's saying anything like this. You can draw parallels to periods like the Great Depression or the World War Two period. But I don't say you've ever seen the enormity of entire broad swath global economy just stopping on a dime going into this and one of the themes of my letters in the last few years has been that we've really built up inordinate levels of debt in society at all levels household debt corporate debt government debt and for that we think that the debt stock relative to the size of the economy is unsustainable. I think given where we are trying to work out of over levered capital stock comes with deflation over time and because of the dangers of leverage. We've intentionally really timid the other way. In the last handful of years even prior to the crisis we've gone out of her way to ensure that we owned businesses that if they don't have net cash on the balance sheet to the extent they're using any material levels of debt that it was taken on purpose. Save for an acquisition. It makes sense but with an eye toward running the overall capital level leverage wise at a reasonable level overtime as evidence. But I tell you you get these kinds of periods where you get. Enormous downdraft on a daily basis and investors can do two things that we sat there at the market lows really and late fall of weight and into marge about nine looked at portfolio. And said you know we could flip out a number of these businesses that we own that we think are really well run rate balance sheets. Good Management's if we're right and we're at a market low we would make a whole lot more money liquidating big trump this buying more lever businesses. Because you're going to capture a lot more the upside when you flip into things that wind up surviving the worst part of the downdraft. Don't fail and come out and we refuse to do so and so the opposite way to approach that is you get a decline like this or at least like what we have up until a couple of weeks ago and we run around with a working list of businesses that we don't own but we'd like to own and I think the world has caught onto the notion that's durable returns on equity make a Lotta Sense. Owning businesses with pricing power makes a lot of sense. So there's generally very outstanding good businesses that just typically are very expensive and expensive enough to take a lot of the expected. Return out of the equation if you own a business that you've got a sense of reasonable organic growth just in terms of simple yards dixie. And if you think twenty-five earnings is a fair number we'll communities things trade thirty five to forty times and if you believe company trading at Forty Times. Which would be an example of a Costco talked about? I think at some point Costco Trades it twenty five times. The growth curve is not what it was when we bought stocks the first time in two thousand four. I think it was. They'll open stores rate of twenty five saved thirty per year. The net number of new stores per year is not as creative to the installed base of stores. They're still gonNA have terrific same store. Sales rose it. Still traffic franchise great business but I find a multiple close to forty times for the business to be pretty high. You can say well sure. But how much of. The depreciation of the fixed assets of the business are actually real. And that's and that's a fair point. Zero draw couple three points off by just two expense if these downdraft. And you're getting to the point. Where a lot of businesses that? We'd like to own. We're getting close enough to buy. And then we almost flipped the switch and launched into this recovery phase when the Treasury and the Federal Reserve Dot more active in the Capital Markets. And for that or just bewildered where we are today and we had done some of that. If you want me to talk about things related government the Fan Treasury. I can but we've been very active. We'll go entire years and do very little in the portfolio last year. For example we simply watched everything goes straight up. We added one new business to the portfolio. What Olin Corporation? We brought in small position. When was the price decline this year? We've really made it a material position for the firm. We've had the opportunity to liquidate some things in the portfolio that our businesses are there just to expense so dollar general which we talked about. I think last time we recorded late last summer dollar general. If you had to pick a business that was going to sail through this crisis. That's the what food supply chain is essential. The economy dollar general sells into largely rural America. Seventy percent of their stores all their stores are open with access to food and necessary household goods. There's rift and you have a sense that we're in a recession. I think we're in a very deep recession my senses. The recession lasts a lot longer than people would probably think coming up. The backside and dollar general happens to be a business that historically has done better recessions than they have during boom times. Some of that is that the margin on increased use of the Food Stamp Program but the stock has done to well. We had dollar general veteran the portfolio for more than three years. I think we're in it at high sixties per share. We couldn't avodon any better. We bought all the retailers. Were being chucked out because Amazon's GONNA take over the entire swaddled the retail economy which probably is the case for a lot but it certainly not the case company like dollar general or COSTCO TO RETAILERS. That we And the stock is up to the year. And it's just performed well in its trading at price where you look at opportunity cost. We had other names in the portfolio and other businesses that we kind of been hoping to buy for a long time that some of which rebound chance to buy in so taking dollar general down over a series of transactions from four percent of capital the one percent of capital has freed up apple to buy things that are very good businesses but at much much better price points that give us a much higher expected returns for the duration so not allied two thousand eight. We've been very active. And my sense is that with his run-up leaves a scratching our heads. You know we talk just a minute before we got on the line. I'm sure you look at your portfolio since well and Sam and if you had said to me Chris let me paint a scenario for you. Three months from now four months from now we're GONNA have the entire global economy stop. All the restaurants will be closed. All of the retail in this world will be closed the airlines will be running five percent of their fleets aircraft manufacturing will have stopped globally auto manufacturing. We'll have stop globally and you're down twelve percent for the year. It doesn't reconcile them. There's something wrong with this picture. I think was wrong with that. Picture is just an enormous amount of intervention on the assets government which we understand. I mean I get that. You don't WanNa penalize households and you don't WanNA penalize businesses for this stoppage in the economy for however long it lasts and so the folks in Washington are expending every resource times ten trying to inject liquidity into the settlements for that. I spent too much Easter Sunday. Rereading parts of the Federal Reserve Act trying to figure out whether what the Federal Reserve is doing is even legal. I'm not sure it is but you can't flaw. What's taking place right and doesn't matter as an investor you have to play the game. We HAVE TO PLAY THE GAME. And then you have to decide because we're playing the game a we like to think we play the game a little bit with our heads in the sand and we like to thank you can ignore the macro and just focus on business business business and price price price. And that's what we do and for that. I think we've got a collection of businesses that will farewell any economic or monetary environment. Now that's not to say that Disney is not on. Its back in the moment with big swath of the company not running not but we would look out the case like Disney to where they were in the nineteen. If you were on the back end of this occurs and we're going to put people back to work. At what point does Disney get back to full levels of capacity utilization or? What does that look like? Is there any permanent? Draw down to their use of their entire capital stock. And so we're doing a lot of that kind of work but I think you look at just what's happened with the economy and you've got projections all over the map. He's got a couple of Wall Street house in saying that. Gdp is going to be down. Forty percent annualized basis for the quarter. A for a six month period of time. We've got the FED president here in Saint. Louis James Bullard came up three or four weeks ago and said thirty plus down on GDP. So you kind of break down the components of GDP. There are several ways to look at it. But I mean there's no doubt. Consumption which is seventy percent of the economy is going to be doubt so if. I've got the numbers in my letter. I've got the table in the front kind of showed where we were at year. End Versus various secular peaks and troughs throughout time and our sense was introduced team that we were on almost any fundamental metric. You can use price. To sales cash flow yield prices were very high we overlay that was total credit market debt-to-gdp which has been three hundred fifty percent since two thousand seven again. I go back to this too much leverage but GDP is going to be down consumption if it's seventy percent of what was going to be a twenty trillion dollar economy. I mean it's not unreasonable. Thanks to GDP comes this year. Nominal GDP now not inflation adjusted comes in maybe ten percent below expectations. I don't think for the year it'll be near as bad as some of your pundits have suggested but if consumption is seventy percent of that number at fourteen trillion dollars is going to be wade out a look at our own household consumption. My Wife's lover. Yes she's professional shocker. She's not running around the stores but she's leaning heavily on Amazon. I think if you looked at our house from Google Earth to think the balloon strands are under now Amazon Distribution Center right there and say Ross. You mentioned already the surprise if you were to have been given the setup at the start of the year and to have had a broad portfolio only down twelve percent. I looked today. The Nasdaq is now up on the year. Which is just kind of remarkable. What has surprised you most given the setup that we've already discussed so said differently looking at the market what market action in sectors or industries or companies has been most odd to you so far in the Kovic market period. Well I think the five big tech companies that are wrote about in my letter this year. It was remarkable the degree to which they held up now. They're outstanding collectively outstanding businesses music about Amazon's business being up during a crisis that's happened. Microsoft's Cloud Business Asher being up during the crisis. So some of those were to be expected but going into the year when I was writing my letter this year and I don't know February. Eleven or twelve collectively. Those five businesses together were valued at twenty percent of the overall S. and P. Five hundred we ranchers fund mass and letter effectively. Said if you're expecting these stocks to compound for the next decade at the same twenty four percent that they ads last ten years if you're expecting the revenues to grow at nineteen and a half percent. You're delusional. You're just not GonNa get it and I would say for most of the last ten years the they stocks generally as a group and even individually were not very expensive. You take the cash out of Google really cheap at times. Microsoft. We own for a decade. I wrote about Microsoft in January. Two thousand predicted shoulders. Lose money for the next fifteen years which they did but we bought the stock in the low twenties in two thousand and six owned it for a decade trimmed it when it was expensive. Bought it when it was cheap and finally sold the whole thing without a doubt three or four years to I didn't get the clowns. Would it be as big of a deal for Microsoft but the stock traded at thirty eight times earnings in two thousand traded twenty one times earnings when we bought it into the duration of ownership most of our ownership for ten years and traded back into the thirties to earnings profit margins had fallen they were washed out in the low twenty s? Now they're back to thirty percent so that roope really I don't think is going to produce even near the same results not just in terms of share price but in terms of sales and the margin structures. They've enjoyed just real quick interrupt there so they're sort of prices if they will maybe especially given the backdrop here and the fact that many of them are at or near highs despite the macro environment. Just say a little bit more about what you discussed in the letter as to why you don't think those kind of nineteen percent revenue type. Compounding experiences are as likely over the next decade for those huge tech companies. It was the same logic. I use twenty one years ago now to Microsoft when the market is six hundred twenty billion in revenues were only twenty assembly. The price is too high. We took a ten year horizon in a twenty a horizon using market cap using sales and using that income and ran scenarios at compound growth rates of on the high end twenty five percent twenty percent fifteen percent ten percent and then four and we basically said yes when p. five-hundred if we assume for the next decade or two decades will grow at four percent a lot of people would say well that's crazy except if you look at the last ten years and consider that sales have only grown three and a half percent a year for the S. and P. Five hundred kinda matching nominal GDP. Ross most people wouldn't believe given the performance of the Stock Market for the last ten. But it's been three and a half percent and you've got profit margins that peaked in my opinion and probably won't return to those levels perhaps even in my lifetime in the third quarter of thousand eighteen we saw net profit margin of little over twelve point one percent on the S. and P. Five hundred most of that during two thousand eighteen was on the back of the big tax cut which took marginal rates from thirty five percents to twenty one percent through editor more accelerated depreciation. There were a lot of angles but a lot of benefit was exhausted. Over the course of the first three quarters so you had peak making the assumption that sales growth for the next decade at fifty basis points more than they had the last decade which. I don't believe you assume. Four percent of you assume no margin increase so you hold profit margins at year end two thousand nine hundred levels in the low elevens and you just extrapolate those out at four and you assume no more multiple expansion. So we went out with the S. and P. Five Hundred Trading at twenty three times trailing earnings on reported basis of the end of nineteen so at twenty three trailing. We'd make the case that you're not gonNA get any multiple expansion malicious whole multiples at twenty three. Let's hold margins at eleven eleven percent so I think it's reasonable to assume the S. and P. does four percent by those three yard sexual next ten years or twenty years starting at year end. Nineteen running the same and then running those various same. Three yardsticks for those five companies individually and collectively you simply get to mathematical impossibility by growing at twenty percents. You grow if you're starting a twenty percent base if these five components or twenty percent of the index and they grow at twenty percents the next decade or two decades. You start to get to where the five components are more than one hundred percent of the S. and P. Five hundred. She gets impossible figures in running those scenarios and kind of working backwards down the growth for all three again market cap and sales and net income. I kinda got to where I could buy. Revenues which were stocks were twenty percents. Revenues were eight percent of the S&P five hundred. Let's say a net income was fourteen percents. I could get revenues growing at ten percent a year for the next decade and becoming a larger multiple somewhere south of twenty percent but those five companies can't become in my opinion more than twenty percent of the sales of the entire SB. Five hundred decide the laws of large numbers diminishing returns and I wrote and I still believe I don't what stops it if it's simply a nurturer but regulation comes along the point where these five get so big and they're already having regulations Europe you to stumble into new competition. Who knows what it's GONNA wind up getting. Who are known that a company like Google was gonna come along and just a visceral the entire traditional advertising business. I've got a couple of friends in here in town in town here who ran. Southwestern Bell's Yellow Pages Directory Business and our Number One. Google is in its early days had just gone. Public is guy swore on a stack of bibles that that wasn't a threat because locally they had boots on the ground well it wasn't but two or three years before they were done the advertising agencies. They're all inside the big couple conglomerates. Now I'm the calm. They're all trying to cut cost just to stay alive and they're gone. I don't know what it will be. And that's not a conversation for this cova crisis but these are generally great businesses. They have very very good balance. She's balance-sheets collectively. They've got net cash Lavalle sheets. We simply found. The price is too high scales. The businesses in aggregate being too large but for the last ten years. If you're only own those five companies and maybe throw on a visa and Mastercard so seven businesses if you'd only own those seven that's all you need it and then you get to the first quarter here and all of the chaos if you just own those five you were down. Maybe nine percent quarter end when the S. and P. Five hundred was off. A what was it off. Nineteen percent twenty percent down thirty two or thirty three percents low. Those five businesses held up better than all you take the top twenty companies and the S. and P. Five hundred and collectively. They've held up better so I think good businesses tend to keep you out of trouble. It has a point. Where if you're thinking beyond what's happened during a crisis next ten or fifteen or twenty years he's not GonNa get the same returns but I think the problem is you probably not going to get very good returns out of the broad stock market either. Let's go to the literal opposite story which I think in this market has been the energy market so if the big five tech have navigated this with sort of amazing resilience I think on the other end of the spectrum just like no one could have predicted what we're facing economically. It would have been very hard to predict the action that we've seen in oil markets and therefore an energy equities love to your take on this space. Since I know it's one you're interested in and maybe even have a few investments in what you're taking what's happened in energy. And whether or not the relative carnage there versus the Big Five Tech has created any sort of opportunity for much better long-term returns than what you see in the S. and P. Five hundred we've owned oil and gas and various iterations over the entire history of our firm. And we've done well. We've made cyclical investments early on and in a couple of the deepwater drillers late nineties. Oil was under ten dollars. A barrel oil thought it was headed for. We spent a couple of weeks in Houston and talked all of the drillers and wound up owning transocean. Diamonds we wound up. Triple your money with way too little chapel. We did the same thing again with the same companies the next time. Oil traded down to those lowes. We've owned Exxon Mobil. Cyclically we I think have a good history buying it when we thought it was cheap sully. When it was deer the problem was oils is and the world. Learn this lesson in our hurry here. This quarter WIS oak pack really existing in perpetuity with a sword over the head of the industry few take us production of oil and gas. We were a bit player. Globally twenty years ago the United States was producing four to five million barrels. A day are net. Consumption is in the high teens for barrel. Today it's twenty million barrels a day before the crisis twenty million abruptly down for a very short period of time so we've gone from producing twenty five percent of our crude needs to producing twelve out of twenty barrels and so at the margin that incremental seven million barrels. A day over the last decade has really eaten indo-pak in it's really eaten into the international community. We stand up and say were energy of independent while we're not. We still important that eight million barrels a day but now restarted exports various products in your Saudi Arabia. And you see this and forever Saudi and most of these nations. The per state OPEC's are very dependent upon oil and gas to meet their federal budget. Their spending needs you know. There's very little middle class. A lot of these countries very wealthy in Saudi Arabia apprentices mistakes. And then you've got the poor. The poor the vast vast majority oscillation they need OPEC needs as high of a price as possible to run their affairs and generally they'll go in cycles for they will typically keep oil off the market place and never run full out will here in the United States. We've been running full out and it's kind of a nutty thing. We saw the lessons this year with the collapse in crude but if he followed cycles even Exxon Mobil which we think at least historically had been best of breed best cap alligators. We own Exxon today. And I think of the last ten years the businesses eroded considerably they used to zag when the industry would zag when their competitors were ramping up capex exploration and they sensed the we were going to get to a oversupply. Exxon had a great history of backing off their Tabak's when everybody else was spending money and then they go make investments when Uranium Cyclical downturns will in they bought x t O and. They couldn't under worse time really at the peak of the gas market and over the last ten years. They've been hitched his dividend policy. They've just increased dividends in perpetuity to the point. Where IN THE LAST COUPLE OF YEARS? They've modern the dividend if you're the CEO of a business that is hitched to a high dividend payout. It's absolute handcuffs owens in that same boat. My recommendation took folks that run all and has been during this crisis. Got A couple of evidence. Eighty cents a share there in the list of the dividend aristocrats. Which is one of the stupidest things you can have? Because you're obligated is a cyclical business to always pay the DON dividend. Well in Olen case. That's one twenty million dollars. They ought to be freeing up but they haven't read out and Exxon's case they've got a dividend that's going to be three dollars and forty eight cents a share this year. But they didn't even that year they didn't earn it the year before they didn't earn a year before that their history read. That's over one hundred percent of their capital was you're not earning on a free cash. Basis your dividend. You're borrowing money in so Exxon has obliterated their ballots. She they've gone from ten billion dollars in debt. Going into the air they had about forty seven. Maybe fifty billion in here in the crisis. They've done what everybody's doing drawn down revolvers and they're floating debt issuance. They've had to bond issues in the last month. Were they've collectively raised. I WANNA say eighteen billion dollars. Now they've got seventy billion dollars that got more cash proceeds of the issue but their burdens or capital to cut the CAP ex budget by thirty percent. A couple of weeks go but they haven't touched dumbed Emdin so we did a deep dive on a bunch of little independent love. Gas Companies last year because crisis didn't just start. These businesses in the service sector in particular has been incredibly weak. The small independent producers have been incredibly weeks from the last couple three years. He has really good. Investors really highly regarded. I WON'T MENTION COMPANIES LIKE INTEL RESOURCES BIG institutional ownership from high class investors in. These stocks are down. Were already down ninety five to ninety nine percent prior to what transpired the first quarter. So you get into the depths of the krona virus and the global economy flat on its back and we really had an assault from OPEC when they said they were GONNA pump out. Couldn't happen at a worse time. I think intentionally happened. It was couched as the conflict with Russia. Russia was going to produce Saudis. And we're going to produce and we're GONNA flood the world with too much crude. Well that just exacerbated the problem and so the entire oil and gas patch just got absolutely crushed. Exxon traded at thirty bucks a share having traded a hundred dollars a share a couple of years ago. They were numbers of businesses. That were down already like say ninety ninety five percent and during this died inordinate number of businesses and could not get comfortable with any of us what you've seen but I think the world's not miss is a massive amount of debt that finances this industry at the end of the day. This is not a business that generates sustainable freak. Ashcroft's they're cyclical profits. They don't generate returns on tap their actually net over long periods of time capital destroyers and so there were an enormous amount of debt. Coming due late twenty through two thousand twenty one. Two Thousand and twenty two. You're going to see an enormous number of bankruptcy so here we are with Exxon. Mobil has made it a bigger position. We look were. They produce around the globe and we think they've got pretty reasonable Brady Evans in various places. The refining operations are running at sixty five percent acidy but they have fields that break even at thirty dollars. Thirty five forty dollars a lot of production. So you're not back there on oil down on a current spot basis or fissures basis but back to say forty five to fifty dollars staying Exxon's in good shape when they calculate the reserves. They're overstated using a longer term higher oil price. But I think they're fine at today's prices you'll wind up making a lot of money but they are not businesses. You can own durably for thirty years is going to destroy. Apple is a shame for lotteries. Spot they're cheap and so as long as you get through the capital structure and you get through. The capital leads some sources of the quantity and demands for Apple. You find the ones that will survive and you'll wind up making lots of money be will come out of this thing and we're going to put people back to work and we will use more oil and gas. We're not going to be topping up our refiners. Which can't even take more crude. We're not could be layering on crude. On tanker ships will use it. It was a painful downturn. The industry auto learn you still live at the mercy of and only for their mercy of keeping crude off marketplace and four that these are really terrible businesses and yet we own a couple of them right right well obviously ultimately prices key variable in all this reason for I loved the expression from famous value investor that they made all their money going from very bad to bat in businesses because the price is just too low so yet another variable that one must consider in this strange market. I think that's very well put. That's kind of the nature of investing in circles. Is You can only own them. When they're very bad you can only buy them when they're very bad. You can't have an expectation of good. I think it's a perfect way of putting it. Everyone listening that knows your work will know your deep exploration of Berkshire Hathaway model. You've been a big investor there for very long time. Know the INS and outs of their balance sheet. Maybe like nobody else and so I think it's been a very curious thing to watch. Berkshire in the Corona Virus. Smart period sort of doing perhaps the opposite of what many would expect of them given buffets famous spy American. Im OP ED. In The New York Times in the two thousand eight crisis when he was aggressively bidding and setting up interesting structures with places like Goldman Sachs and Wells Fargo to sort of act as a backstop and get paid very well for doing that whereas in this period he's really. The only notable activity seems to be sales of banks and airlines no major landmark purchases at least announced and a huge cash pile by absolute standards if not by relative standards. I'd love you to talk to your reaction to berkshires activity or lack thereof so far in the coveted period. Well there's very little activity to observe yet because to your point. They've been extremely quiet. Thank the all-white crisis evolved over a longer. Duration and so when companies like Goldman and GE needed capital. You didn't have the massive federal intervention immediately. Like you've had this crisis and was going to say you know screaming. Berkshire doesn't own airlines and money center banks. While they do their meaningful positions you saw them take their southwest airlines Delta positions below ten percent. Just last week they shrunk their banking the your position to ten percent which was really regulatory driven in that case. So it's hard to know what's going on inside the business. I think you've not seen the deals. Like they did during the crisis yet because of the nobility of this federal money. That's coming to the party. You've got the airlines with their hands out to the government trying to come to terms over whether and how much equity ownership via warrants that the government's GonNa wind up taking raw. Berkshire can't get in front of that. The same way to get in front of outside of the Krona virus of bidding war for outright ownership or companies when private equity has so much capital on the sidelines. Waiting to deploy. I'm not sure they were at the point where they were able to get capital on terms made sense to Berkshire when there's so much more free money coming from the federal government. But it's interesting. It's hard to know what's going to happen. I think the airlines are going to get diluted. We own a couple of suppliers of parts to airlines. They're good businesses and we're struggling with what the back end curve. Looks like replace the parts? We're looking struggling with what the build profile looks like for construction of wide body. Jets the seventy seven and the Airbus a three fifty for example in the case of exile which supplies Inter modulus carbon-fiber But tarnaud at Berkshire has done. It's GonNa be really interesting to see my expectation would be of the hundred and twenty five billion dollars in cash that they would have bought back a whole bunch of shares. They spend on the order of seven or eight billion dollars last year. Binstock back average of two hundred two hundred three dollars on the b-shares stock traded as low as one hundred sixty and I think there have been days and bullets where I can spot. Berkshires buys on the opening on the clothes. I'm probably I could be wrong. But I presume they've spent a fair amount of Catholic interesting on the Equity Franc's to see what they've done. The airlines we held off in a big way owning these things. It was obvious coming out of the late nine when the all restructured. It was a different business. Got a lot more religion in terms of cost structure the got control of their gates the work till each other on price but all these actions were gone outside of recession. I think the carriers figured out how to sell first class seats for price that people would actually pay instead of getting those seats away to their frequent-flier Platinum stands customer. I for free because nobody was buying the seat instead of selling a first-class aid for three thousand dollars. They would sell it for twelve hundred dollars or nine hundred dollars so there was a lot of good down where we started sidelines. It's near and to see how this industry fares when you get the next recession. Who BLINKS FIRST IS? You've got a history of blogging and taking fares down to levels below brave so load factor. Start to get below eighty five percent. You start to get into trouble and obviously nobody could seamless thing coming. Rea- really shutdown global airline traffic to agree we have you've got federal money county in on one hand. I wouldn't be surprised to see Berkshire having sold out. Or Materially. Sold down the airlines structure knowing that this will not be the same business going forward knowing that demand will not return to a hundred percent of two thousand and nineteen levels. I don't know it's adding to the portfolio. I don't know if they've sold down banks. The bank seemed to be in more trouble than the world thought they had to be. Graham Dodd Standards and they apparently were better capitalized. But outside of the banking structure in shadow banking the fact that you've got all these credit funds that looked like long term capital management's leveraging up at Obscene Multiples Equity Capital. Twenty five to one fifty to one hundred one. I wrote about two years ago the degree as debt in levered loans and the COO marketplace. We went around talking to them. University endowments and their. Cio's pension. Ceos. I bet you that nobody runs cash fixed income by simply owning individual credits so Berkshire goes into one hundred twenty five billion in cash. Or what's their cash invest you? They've t-bills. Nobody does that. It's a crazy time for such an interesting company. I can't wait to see the buyback. Titi looking back now. Once we get the data but it has been somewhat surprising perhaps their method for capturing value created by. Cova is simply in their own stock. I'm curious you mentioned energy on one. End The top end of the tech ecosystem on the other end as contrasting examples other other areas that you see as sort of wildly cheap or what seems to be wildly expensive in this market today on April fourteenth. Two Thousand Twenty the places where you still have enormous upsides if you believe the durability of Federal Reserve and treasury intervention in the marketplace or businesses that were destined to fail lousy retailers. That were already going out. Macy's is just in a slowly they were GONNA go from nine hundred stores. Eight hundred stores coming out of this downturn if they don't follow chapter eleven very quickly which may not be the case. Now that you've got access to capital for the time being I think they'll still accelerates number of stores. They'll close the mall retailers even Mr Buffet is invested in at least he wasn't vested than Sarah. Taj Her Simon property all of the big malls just long-term businesses. That are probably going to zero in a lot of cases are still cheap. Even though they're fifty percents one hundred percent off their lows. They're still down sixty seventy percent off high. So if you're willing to swim in that off and go find the most over leveraged businesses even though you've had an enormous recovery. There's a whole bunch of them that are still down seventy eighty ninety percent. We're not doing that the things that we own today. There are a lot of businesses that are really cheap and still down maturely for the year not as cheap as two weeks ago but I would contend that coming out the back side of this. The we'll have deflation for an inordinately long period of time. I think a better way to think about what to do with capital today. It's like about how apple's work for the next ten or twenty years certainly in the next ten years and if you bake in short-term interest rates which are already at the zero bound if you bake in a Federal Reserve that will be determined to try to compress long-term Treasury rates as close to zero bound as possible and you go back to the Fed's treasury accord that existed during the latter part of World War. Two the end of the period obediently after the war that allow them to run enormous federal deficits increase the household savings rate the point where we actually managed to finance the deficit from hustled savings. We rationed a lot of was consumed at the household level. Coming out the back side of this you can bake deflation. And if corporate credit levels were at all time highs in government debt levels on balance sheet debt levels which were already at the point where you get diminishing returns out of the next incremental dollar of death taken on this all smacks of deflation in so ren period where none of these things are going to fail. I mean if you figure this out and realize they're not going to let businesses fail. We're going to probably violate Federal Reserve. Act AND BY secondary corporate bonds both investment grade and now high yield as of last Thursday's announced. We're going to buy each by high yield. Ats which is way beyond the Fed. Charter put a stake in the ground and said we're going to get enough liquidity into this extra and we've got the fire. Pardon or yes. They fired hard to do it. But it's GONNA take a four plus trillion dollar deficit this year which is going to add an enormous amount of debt to the Fed balance sheet. We're GONNA take total credit card debt from seventy six trillion dollars to somewhere north of eighty trillion dollars debt to GDP which has been three hundred fifty percent is going to be at least four hundred percent of GDP. The only way to deal with these kinds of debt levels is deflation which comes austerity which comes with things like lower wages versus higher wages for. We're not mentally stuck to that. We haven't seen this the nineteen thirties. And so if I'm right and we have deflation for the next ten years. Let's say then finding businesses they have pricing power. Because see. We're going to have it. That also has rock. Solid balance sheets is the way to survive and make decent returns for the next ten years. If you survive this Cova crisis because you happen to have access to capital because the Treasury has allowed the Fed lever up its balance sheet at ten to one for grade corporates. And for the scariest that they're allowed to own treasuries and agencies may be Muniz but not high-yield ninety s not CEELO's not commercial mortgage backed securities. This is all crazy. Thraw GONNA live. But YOU'RE GONNA come out of this thing with even more leverage than you had. Even good businesses Disney is gonNA come out with more debt on the Balance Sheet. And they already had that on the balance sheet vs the Fox Dina last year. We're introducing more leverage into the capital structure of business then existed prior to two thousand nineteen. And if we have deflation then these companies are going to bleed badly. I think you've got a decade of restructurings. You have to be vigilant. And so yeah. I think. The companies that we own are the right businesses and today extent. We've been able to ask those. It's been the right thing to do. Can you say a bit more about this? Deflation versus inflation concept. I think your viewpoint on deflation is a bit against the grain. Where maybe the simple would be with as much money being pumped into the system the expansion of M. Two of the money supply of everything. The Fed has don to introduce liquidity. That the naive expectation would be inflation. Not Deflation and that the way to get rid of that day would be inflate your way out of it. So can you just maybe draw a little bit more detail around why you expect deflation versus inflation? Yeah the problem is the same problems that the Japanese had. The last thirty years for. Peaking nights eighty. And that's you can run up the money supply but an increase in the money supply if you WANNA call m-2 money M Two's really your monetary base times little land. Which is the money multiplier? But em to let's just say am two's right number will if your GPA was gonna be. Let's say twenty two trillion dollars going into the year. Probably Twenty by year end. Ma'am to at last week. Sprint was sixteen and a half maybe sixteen seven trillion dollars off thought my head which means the velocity of money which is what nobody thinks about isn't working so none of this federal money none of the two trillion dollars endings. None of the leverage that's incorporated from these special purpose vehicles will occur show paper deal the various credit funds the various term asset backed facilities. None of these are stimulus. And I think it's been proven academically that at higher and higher levels of on balance sheet federal debt the incremental use of debt starts to produce diminishing returns where it's not effective and so that's deflationary so the answer then becomes and. I think you're right the end game. The end game is inflation. The end game is probably hyperinflation given where we are is here on broad. There's so much dog. She debt but we will go through various iterations. With the Japanese dot we did the first generation of quantities enduring the financial crisis. And we had to do that. It'd be as we were going to. Nineteen thirty style down to Berlin. We had the thracians of quantitative easing one. Two and three and I didn't push up GDP. I talked about earlier. That sales for the S. and P. Five hundred of grown at three and a half percent nominal. Gdp is barely grown. If you go back with beginning of my career and my investing career total credit market debt. Gdp was about two hundred percent up from one hundred fifty eight percent. During the middle of Reagan's first ministration will interest rates. Were Sky High. It took a thirty years coming out of World War. Two forty years to utilize capital stock. There was overbuilt the nineteen thirties. And we have this glorious gross in real GDP per capita an enormous love well in the subsequent twenty years in two thousand when the tech bubble peaked in the nifty fifty. Fifty big caps peaked at forty to sixty times earnings. The Nasdaq traded two hundred. Forty times we had taken out on an enormous amount of debt to that point and that was two hundred and fifty percent of the economy and we were stunned to that number. It was just crazy. Gdp was ten. Trillion in debt was twenty five trillion dollars. So we had the downturn the stock market broach. Snp dropped fifty percent. Nasdaq dropped eighty plus percents. We had many recession in two thousand and two and then recovered and we really put credit works in things like the mortgage stocks we household finance and Covenant Light No covenant loans and. It was a stunning seven years from two thousand seven in the GDP grew from ten trillion dollars fourteen trillion dollars but the debt stock total credit market debt doubled from twenty five to fifty trillion dollars. We took an incremental twenty five dollars debt to grow the economy by or think about that so we have the great financial crisis. We've been taking the Fed's balance sheet from eight hundred fifty billion dollars. The first thing they did was took up that first bailout with various SPD's various cities they had the conduits and we added a trillion a trillion dollars to the Fed balance sheet. That had to be done to avoid going to a nineteen thirties. I'm not sure needed to qe's but in the subsequent years when taking the Fed balance sheet for what was eight hundred fifty billion dollars it got up to four and a half trillion dollars a couple of years ago and then we tried quantitative tightening. We're GONNA run down. I remember the president of the Fed in San Francisco. Saying we'RE WE'RE GONNA get this balance sheet about halfway to where it was so you would have said two and a half trillion dollars what they cruised was. You can't do it. Yeah we had nine increases in the Fed funds rate and you started to really weaken the economy we in the global economy. We got into a trade war. We'll China was already weak in the last five years even though profits for the S&P five hundred rose profits more broadly under Nipah. National income accounts have been in decline and last year we had the SNP up thirty one and a half percent. Prophets were flat and it looked for most of the year like prophets. Were GONNA be down year over year so tax cut benefit was gone? So here we are. We came out of. Oh Seven Oh eight. Oh nine at three hundred fifty percent de GDP. Now we're sitting here three hundred and fifty percent against over the last ten years we've taken on three dollars and fifty cents in debt to grow. Gdp by dollar so for most seven GP's grown from fourteen to twenty one trillion dollars we've added sub but now he's seventy six trillion dollars in debt. There's an inefficacy of the ability to get money into the economy and have organ that gets back to this philosophy of money so velocity. I remember when I twenty years ago when we started. I was hounded my head that M. Two Times Las Vegas. Gdp was always about half of the size of the economy so back when we had a ten trillion dollar economy 'em to had been five trillion dollars. The velocity of money was to run out of LAS MONEY. Down to about one point three hundred client. There's no way to get this money working because we've already got an overbuilt apple. Stock that applies whether capital is harvey equipment. Or whether it serves we simply have too much stuff. We have too much retail square footage. We have too much restaurant. Square footage re too much manufacturing capacity globally and syringe big decline. And you can't simply introduced bore debt on top of debt and call that solution so yes I see her. That hyperinflation is the end game. But we're not there yet. I think everybody thinks that all these. Qe's is absolutely crazy inflation and it's not only when the Fed really turns liability side of the balance sheet into notes currency instead of going through the treasury when the Fed directly monetize the debt buys treasuries that are not issued first by the Treasury Department to finance deficit spending. Then you probably get but tell that it's just deflation deflation and so we'll do numerous ongoing to try to get inflation in order to try to get inflation up to that said target or two percent. I don't see it. We fast forwarded by a decade over the matter of three months in terms of how much debt the system could really bear now. It's beyond kind of that. Tipping point where there's no ability to take new debt and grow the and I think that's problematic and so my bet would be deflation deflation deflation and hopefully we. Don't get hyperinflation in my lifetime. I'd always hoped we can get it through my kids lifetimes my grandkids. All bets are off. You can't control that much from the grades so it's coming at us yet. I'd love to review the characteristic profile. You mentioned one or two already. Which is this notion of pricing power maybe capital efficiency in contrast to the very capitol inefficient growth. Which is how I would characterize the increasing debt load to produce the same amount of few DP as sort of capital on efficiency. What other characteristics do you think are most important to look for businesses to own perspectively over the next ten years alongside pricing power? Well I think you'd better sell things that are essential that households need if you go back to the Great Depression when GDP fell by half nominal GDP got cut in half. The consumption was similar to where we are today was seventy percent of the economy when GP was one hundred and three billion dollars. Nineteen twenty nine. We cut the economy and half consumption grew to ninety percent so everybody now knows unemployment went from three percent or four percent up to twenty four point nine as long as the headline numbers. We still have to eat drink so businesses that sell things that you need food food products drink. Consumer goods companies should be in terrific shape unless they've just layered on too much debt. Because was GONNA wind up happening is if the price level starts falling by two percent. A YEAR IS PROBLEMATIC. Reverent portfolio companies like dollar general. Which I think is perfectly weathered for a deflationary environment except that if the overall cost level cost goods sold declined by two percent. You'RE GOING TO BE PUSHING BACK ON WAGES BY CHEAPER SENATOR. Try to maintain margins but if you're levered business if he's got an enormous amount of debt capital structure even nominal declines in. Your top line can have profoundly bad impacts on the backside so I would make sure you own company. I regret now having owned and sold Pepsico a few years ago because a company like that. It's perfectly situated there beverage franchise but also they're salty. Snacks PepsiCo stills business that has pricing power. Now they may ask you. Adjust the price level to the overall inflation level. But they're in a command position in terms of distribution in great shape companies like that businesses. That are GONNA have a permanent a long tail fall off into Ma'am I go back to these things that I struggle with the supply chain to the airline industry might experience had always been when you had a deep recession. That the backlogs at Boeing and the backlogs at Airbus would disappear and that was the case. Go Vivid memories over the last thirty years during recessions where we would park airplanes in the desert but the thing that happened during those downturns was even though the backlog disappeared production never really stocks because there was still enough order. Slow WELL IF WE'RE GONNA wind up eighty five percent of capacity utilization tourist three years from now all of these new aircraft that have been built is a game changer so that really impacts companies that sell into the supply chain that you'll that sell into the parts. Business for replacement very disruptive. I think this three month period is being incredibly disruptive for the economy any closing thoughts. Chris you look forward things that you are most heated on rates of change that you're paying close attention to whether it's in your businesses or in the economy things that you would leave with to consider. I've watched the economy for the thirty years that I've managed. Money moved production to the lowest cost of production so nike moved production to Vietnam and then as Vietnam grew they moved production China. I think our relationship with China is irreparably harmed from this episode and so we all know that the Chinese held the supply chain for our pharmaceutical industry. Kind of over our heads at the most inopportune moment. But I think about if I'm running manufacturing company and I need to grow passivity and my decision now is am I gonNA locate a plant in Dothan Alabama's are in on who bay products. I'm going to Alabama the southeast cadaver research as we bring manufacturing back home. I think about companies like starbucks. We we've always said we would never directly own a Chinese this so lockin couple of weeks ago. Had A lot of people laugh at unless you're on the company. The we own starbucks starbucks top fivefold and the premise on the growth curve at starbucks is very heavily dependent upon opening new stores in places like China and if we really have generally irreparably gone the other direction and you've seen Japan now introduce federal money to try to help industry take supply and manufacture out of China. If we go down that asked which we very well may and perhaps even should. Then you get to wear. We've seen governments around the globe. Commandeer assets we'll starbucks as a whole bunch stores already on the ground in China. They ended their east China joint venture which was done on a license. Basis a franchise basis announced company owns those stores. I on the table. My biggest concern prior to this crisis had been that at some point the Chinese commandeer starbucks stores and kick him out in the country something that gets very much on the table. And if that's the case then starbucks is not worth mid twenties to earnings if they have sixteen thousand. Let's say company owned stores. Another sixteen thousand franchise license we. The the number of stores will grow high single digits over the next ten years but they have to grow in China. And so yeah I everybody's going to do. A lot of thinking about what the whole landscape looks like on the backside. If were more insular economy if globe becomes more insular that absolutely has a bearing on world trade. We have seen in the last three years getting back into that. Gp discussion this year will probably be accretive because probably the total number of exports imports are both declining precipitously. Just like the thousand eight during most recessions. The aggregate numbers don't declined to whether they're both going to be negative this year. But think about the equation. Exports MINUS IMPORTS EXPORTS ARE probably declining less abruptly than imports so that differential will be creative GDP but the absolute number is going to be down thirty percents where it was the absolute level of trade. So if you go back to nineteen thirties the absolute levels trade was only exports network's rolling three or four percent of GDP then will be read net exporters so if we were one hundred and three billion we were exporting four billion and importing three kinda rounding up on it. I don't know exactly what they were. Well now those numbers were like thirteen and eighteen percent of GDP and we're in global trade and global supply. Chains are much more fabric the global economy and I wouldn't be surprised to see a retrenching both here and abroad and that has very profound implications for a whole lot of businesses. So you really didn't understand your cost structure but you really. I think I think we win this because we were ahead of the curve. I kind of feel like the patio poker game because the last two weeks we've lost because everything else that has too much leverage. Things getting bailed out by all this federal action. But if I'm right we have the flation then yet has to be a lot more careful with debt and balance sheets. I think the world has grown accustomed to over the last thirty years I love. It's such a fascinating place to close. So many interesting topics covered here today. What a crazy time and it's always fun talking to you about what's happening in markets. Chris I appreciate your time yet again. Well Patrick by look forward to maybe a month out two months out and seeing you in New York City. We're all definitely declared travel and we'll have a cocktail and look back on. What hopefully is the covert or three or four or three or four but hopefully this things in the rear view mirror before long? Chris have a great day. Thanks better everyone patrick. You again to find more episodes of invest like the best go to investor field guide dot com slash. Podcast if your lover you can also sign up for my book. Club AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you up to receive a full investor curriculum. Right away and then three to four suggestions of new books every month. You can also follow me on twitter at Patrick. Underscore Osieck S. H. G. If you enjoy the show please leave a quick review for us on I tunes which will help. More people discover invest like the best. Thanks so much for listening.

Federal Reserve Exxon Costco Microsoft Treasury CEO Disney Forty Times Google United States apple OPEC Patrick o'shaughnessy Amazon Berkshire
Ryan Petersen - Where There Is Mystery, There Is Margin  [Founders Field Guide, EP. 22]

Invest Like the Best

1:08:56 hr | 5 months ago

Ryan Petersen - Where There Is Mystery, There Is Margin [Founders Field Guide, EP. 22]

"The episode of founders field guide is brought to you by teague s. I started hearing about teague. S when several of my close professional investor friends sent me passages or ideas they'd found on the t. gets platform conducting effective. Primary research. shouldn't take weeks. it should take hours. Searching for answers. Shouldn't be lengthy cumbersome process. It should be easy and nearly immediate expert calls should not cost. Thousand dollars is solves these problems and makes primary research faster and better. For professional investors tikos has built the most extensive primer information platform available for all investors with teague s. You can learn everything. You'd wanna know about a company in an on demand digital platform. Investors share their expert calls allowing others to instantly access more than ten thousand calls on a firm tele. doc. Roadblocks are almost any company of interest. All you have to do is log in still want to do your own calls. 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Clients of the asset management may maintain positions in the securities discussed in this podcast. Will i guess. Today's ryan peterson founder. And ceo of flex flex board is a technology platform for global trade. In this conversation ryan takes us through the fragmented world of international shipping and we dive deep into the history and inefficiencies of this system we also cover shipping containers were standardized. How new protocols get adopted internationally and the challenges of doing business in the no-man's-land of international waters. Ryan is the type of entrepreneur. I enjoyed talking to the most. He has an incredible domain knowledge high energy and his tackling enormous global problem. I hope you enjoy my conversation. With ryan peterson ryan. I think a neat place to begin this conversation just for those unfamiliar with flex port is to ask you what the business does. And then i'm going to ask you how you encountered the problem that flex port originally designed but i just as a basic overview for the listening audience. What do you do in. The world is a platform for global trade and for tech enabled global trade services effectively. What we do is coordinate. All these really complex transactions to move goods around the world we live in a world where anybody on earth can trade buy or sell things with any other person on earth regardless of what country. They're and where they are in. The world is sort of like sometimes say to do for adams with the internet. Did for this right now. It's just like a super messed up. World find a friend who's ever tried to ship something to another country. They will tell you. It's like a black box. It's really confusing. And it's not about free trade. I mean there's good reason why the regulations and even tariffs in some cases. But it's more about pain. free trade. Make this simple. Ultimately we think trade is fundamentally good for the world and the fact that it's really inefficient and high friction is creating back pressure that holds back almost every other industry china overcome that high value service that we provide in providing a lot of services around trade and that's freight transportation customs compliance in brokerage clearing goods across borders cargo insurance. We have a trade finance group that provides inventory financing to the customers on the arms. How did you first encounter this world. We're your user of infrastructure and frustrated with it. What was the entree graduated from college. I worked for my older brother. Who's also an entrepreneur and really the best entrepreneur. I know is taught me a lot. We were importing had a brand of motorcycles. Actually our supplier was a company called jelly. Which is the chinese car company. That bought volvo. It's now become famous company but this was in two thousand and two way before they bought volvo and. I didn't even know that made cars at that time. We were buying their motorcycles and selling them both through the internet outlets like ebay motors and then would happen with ebay. Motors is crash. The price pretty quickly does not a very liquid market there. And we'd end up with like container loads of stuff that we couldn't sell and we built up a network to sell those motorbikes used car auctions. We're selling brand new chinese motorcycles through car auctions until distributed them all over the country and so that's when i discovered the world of freight forwarding. Which was this. It really felt like every freight forwarder was out there to rip me off of these old companies no technology. They're pushing paper. The turns out the actual pieces of paper were serving his titles to our motorcycle cargo. If i'd lost that piece of paper what would happen. Was you'd have to dry compound fees like every day at the port past seven days. You own hundreds of dollars in fees if you're not the piece of paper just like in a vicious cycle number one was lack of tack. Why pay per serving his titled merchandise in the international trade in the two thousands. And that's still true by the way is still the default for global trade and then second. Was this like ethos. There is no customer obsession. It was black box in this information. A symmetry forwarders always no more on. What's going on than the orders. Exporters in the world and they use that to their advantage to make money. And you'd always get hit with weird fees that no one told you about and stuff. So i just felt like those two things combined was just a huge opportunity to create a great business. I want to hear a little bit about the number of steps from something leaving manufacturer or something and arriving at a customer's door. But i think it's helpful just to orient people in the universe for you to describe the difference between parcel and freight and y. Those are different universes. The difference is super simple. Parcel is just small and light and afraid is heavy. And i think the threshold is around one hundred kilos. Depending on the network. I mean the threshold is determined by the parcel carriers. What can fit in those ups and fedex trucks and now amazon. What can fit down there. conveyor belts. How heavy is it. Can the driver lifted up. Once it crosses that threshold it goes into the world of freight. so that's the fundamental differentiator. Now why are they so different or the parcel world. You can have an end to end network. It's all the same company it's all fedex from door to door a fedex. Driver picks it up. Puts it in a fedex. Truck puts it on a fedex plane fedex agents the customs it's all fedex from door to door in the freight world no companies big enough to do that themselves. Just the scale of these industries is really really remarkable. The modern container ships carry. Twenty thousand t. E. us or more t you is a twenty foot equivalent units cutback half truckload a forty foot. Is the standard container so half a truck lawsuit. Ten thousand trucks need to meet that ship when it arrives at the port and of course you have multiples Ships arriving every day every port needs to be connected to every other port in the world every day to run the modern world. No company is that big to have ten thousand trucks every single port everyday or hundred thousand trucks and so what you get is a federation of companies and the role of what's called a freight forwarder. It's sort of like antiquated businesses. That coordinate that. I often call them free. E mail forwarders. They're just pushing paper around making phone calls. And yet you'll have as many as eighteen companies involved in a single transaction from door to door. It's a really complex network. Global trade is like half global gdp. And it's run on these very antiquated systems. I think probably fedex. Ups together if you look at their market cap. It's like a couple of hundred billion dollars something like that. Sounds like if everything was publicly traded. And you could add up the market cap of all the businesses in this ecosystem. It would be some multiple of that. Is that fair. Yeah well if you cut the whole ecosystem off the finance side of trade which is another whole massive area and really interesting and important. The acid owners plus the coordinating layer is several trillion dollars. Just a coordinating layer. This old companies called freight forwarders. That's probably a trillion dollars in market cap. So when you first encountered this tell me if this analogy is off. Because i don't wanna stretch too thin. But it almost sounds like it's so fragmented there's so many pieces that have to coordinate the flex port sort of becomes like a protocol almost like a standard almost visa mastercard. So that each bank doesn't have to have links to each other. They can just link to mastercard and then linked back out is that a fair analogy sort of the protocol model apply to physical goods. Yeah exactly and that's exactly what's different about four dente freight forwarders that we are building. That protocol layer. We are data interchange later to allow these companies to come together and transact create standards and create in some cases user. Interfaces but i think at scale you'll see more and more people using our api's other than the user interfaces bigger companies want to really automate these transactions and smaller companies. It's much more like. How do i make this super simple so anybody can come and do it. What does it look at the very beginning. So how did you attack a really big complex fragmented space with a first product or customer. The very beginning we started as a customs brokerage you can think of a customs broker. I probably shouldn't go too far into this analogy. But it's kind of like a lawyer you get charged with a crime you can represent yourself in court going to represent someone else have to pass the bar and that's a bit like customs broker like if you want to import something you could just import it and you file some paperwork and you're fine as an individual or a company to do that but if you want to do it on behalf of somebody else you need to be a licensed customs broker hard process yet to pass a background investigation and takes probably a couple of years to get licensed as a customs broker. What you're doing is helping companies to transact and clear their merchandise through customs. It is a very good business in my view because is where all the data sits. You want to clear something through customs. You've got to provide customers all the commercial invoices packing lists. The bills of lading does that title for the merchandise. A traditional customs broker tends to be someone who just takes that data. Keys it in the us. Custom system france. The document puts it in a file cabinet for record retention and moves on generate. Some cash is a nice little lifestyle. Business what we do differently. What we did from the start differently was like. Let's take all that data. Digitize it gives people analytics let them see. They're importing give them trends. Make sure that data stored in the cloud for compliance purposes forever and start to automate these transactions. Actually the first time. You do a transaction with us through customs. It's probably a little bit more costly because we're digitize structuring. The data making sure that it's accurate but the second time you clear customs on the same product. It's really like an automated one. Click operation first business that we lost a customs brokerage and sort of the crown jewels. Still today affleck's sport as a business because this is where all the data sets and this is where you build a relationship people say like old school freight forwarding world. They always say you date your forwarder but you marry your customs. Broker 'cause know it's compliance. This is like really. It's not as something that you take lightly and so built that and then from there you see every transaction and you're able to extend your services then we from a technology platform started there and then we added transportation services you can buy. Aaron ocean freight were now. The third largest american company by ocean freight container moves organized competing with those traditional legacy freight forwarders air freight transportation port and airport trucking. We added cargo insurance. Which is really great part of our business and then trade finance. And you'll see us. Keep adding new services that are needed for global trade. What were some of the darkest parts of this world when you first came to it and started building flex port where there was the most leakage waste graft was sort of the dark side of the shipping world which is seems wildly. Opaque a lot of its. I think part is the most broken and it's still pretty broken. We're trying to fix it. We're working pretty hard. Sometimes some problems are systemic in a single agent. Can't fix them on their own. But the one that seems the most broken to me and it's really causing problems for the whole world is contracts in ocean freight are not enforced in any direction. And so it's like what does a contract if it's not going to be enforced. It's a repeat game theory's kind of enforce the year after biz on like. Did you do what you said you were gonna do. Last year and a thing and the lack of the enforceable contract to some really bad behaviors on average thirty percent of all the ocean container bookings that are placed with ocean. Carriers are cancelled. they don't show up. You have a book to show ratio seventy percent if you're an ocean carrier and you're going to go bankrupt if you sale at seventy percent full you've got to be at least eighty five percent full. Probably i don't know what the exact number depend on the vessel in the carrier but sort of like percent up the rest jobs to the bottom line but below eighty five percent. You're gone bankrupt. So if you're notion carrier what do you do. You must overbook your ship. Now if i'm booking freight and if you're not flex or if you're a traditional freight forwarder or a big customer that rate you're gonna place to bookings because you know that ship is overbooked. And you don't wanna be what's called rolled that's like getting bumped when you find a passenger plane so you double book so you have this terrible vicious cycle that transact and it leads to whenever karo rolled probably another week before it arrives so now we're having a stock too much inventory. You're carrying all these safety stocks. You can't get the kind of quality quality in the sense of like repeated predictable results from system. Instead it's like really stick casting and all over the place and so this is one of the biggest problems we've we've gotten the industry average roll rate pre pandemic and pre all the craziness. I think we'll work through that. There's problems right now if we want to talk about we can. But pre pandemic the industry average roll rate was eight percent fleck. Sports platform has managed to get our role rate from the same ocean carriers down to two percent because they see that. We're using data to be much more predictable. We're not playing these games. When we place a booking we in for one hundred percent book to show rate and you never would probably get to one hundred percent but we're much higher than the industry average of seventy and they reward us with more predictable transit times. You can sort of heal the system that way. Yeah that's probably the most broken because a lot of broken things though. It's a fascinating world when you peel the onion back. How much has the technology itself changed or the pieces of the logistics network those container ships. You'll get a picture of one from the however long lago looks pretty much the same. What have you learned about the potential. If reducing roll rate is one way to create more efficiency in the system. And then i want to talk about like what those efficiencies might mean but are there other areas of this that can get better in the atoms piece of all this and the atmosphere for sure. There have to be now. We don't spend that much time on. It were much more in the data interchange layer and i think there's tons of optimization there too but in adams just as an outsider. Looking at it. I guess i'm a little bit different than a pure outsider. Definitely an interested outsider. The shipping container. I think revolutionized the world. I would argue that. In the last fifty years no invention did more to lift people out of poverty worldwide than the shipping container reduce the cost of shipping things globally by something like ninety five percent which has enabled this huge boom export economy. Mean a lot of it's free market economics and better governance developing world but a huge amount of it is like well you can ship anything anywhere and you can put your supply chain globally and it'll be even cheaper and faster and lower. Carbon is a lot of reasons that ocean freight is awesome. But it hasn't changed much. The one thing we did was double the size of the ships which is a real efficiency. We're still unloaded containers. One or maximum two at a time off a ship. It takes eight hours downloaded containership. You've got three hundred million dollar assets sitting there for eight hours like why. what are we doing. Couldn't we get smart. I'm like crazy thicker. I'm like what if we just turn the ship upside down and dumped them all out and there's gotta be some radical thinking on how to unload the ships faster. That would be one that. I'd love to say one that takes place inside of the ship inside the container. So inside of a shipping container pre shipping container the way that the ships were loaded by the way guys hole and stuff onto the ship. I mean it was really backbreaking labor. You had cranes and then they would rope everything inside the ship so it'd be like tied down so it wouldn't fall over well that's kind of how the inside of the containers looks today. It's like everything's kind of manually loaded and roped off and literally tying ropes so that the stuff won't fall over if it's not full what's really broken. There is at the unloading moment. The person who loads the freight has no connection shares. No information pretty much whatsoever with the person who's gonna unload the freight out of that container. So in the world of less than container load freight this is when you're consolidating multiple customers freight in the same container. The prison unloading it. I've got six different customers loads in here. Who's free is. Who's the way that they get it as they get a piece of paper which has a list of all the shipments that are on that and then each one has a field called marks and numbers and the marks numbers feel does like what are the marks and numbers on the outside of the cardboard boxes. Detective style like. I had this. Is that load and fly human judgment. Like where should i put it inside. His warehouses loaded. That seems like an obvious area for a really smart innovative company that come around and build like a smartphone clift. it's not even about human labor saving. I'm not that into robots that save labor forklift. Drivers don't cost that much especially in developing world. You're not gonna make a lot of money replacing that with a robot. it's too expensive. The reason the iphones still made by him. But you definitely want to reduce the error rate of those. Humans allow the data exchange. Okay what am i. Loaded container into the container and then when unload it. What is it and this forklift should just know that. And where should. I put it in the warehouse. So i think there's a lot of fertile ground for things like that loading docks unless interested in replacing labor. I'm more interested in. How do i. Augment that labor. With data i see the box of one of my favorite books on your bookshelf. Which tells the story of the shipping container. What about that idea is most powerful to you if you had to summarize why you think that's such a world changing invention or standard. What is it like. What's the magic that is the key word is the standard sort of like what she did for. The internet is like set a standard so that we can exchange in this case atoms with each other and make uniform across the world so that everybody can agree on that you can build all your logistics assets. haven't done it for planes and they won't but ships trucks and trains line on the same single standard super powerful allowed like i said a massive reduction in the cost of freight and i think there's a couple of interesting things about that one. It was invented by an outsider. The guy who invented the shipping container was a trucker. He's like why. Can't i just put my truck on the ship like wait. What have i just unloaded this truck and put it on the ship that work so i thought that was really interesting. It's often and outsider comes into an industry and sort of sees it. It's hard to understand the system when you're inside the system. The second and really important thing to understand is that the standard was done wrong. It's a bit like your keyboard. It's the wrong standard. It's like intentionally made to be slow in the court case because of typewriters in this case it wasn't intentionally chosen to be wrong. It was just government. Set the standard. And they don't understand what it'd be very careful when he's at the centre. Why does the forty foot container wrong. Well the united states trucks are fifty three feet long so every time you move a container by truck you're losing thirteen feet of space ratios just off. You could get a thirteen percent while thirteen over forty. You could get a pretty significant efficiency improvement from your network if we had all aligned on a fifty three foot standard or whatever the longest allowable safe truck container would be but once it set. You never going to change the whole world to a new standard to be fascinating. It would cost billions or trillions of dollars to start a company that fifty three containers as standard on ocean rails also fifty three foot so it was like a builds chips that are fifty three foot but the government the way they set that standard was they saw that there was this thing emerging shipping container. Everyone agreed we should standardize. This would be awesome. They did like a committee. There were two companies running containers neither of at forty foot containers at that time. They did not involve them in setting the standard. They created the standard and then they said we will subsidize shipbuilding if you use the standard. Everybody adopted it and that became the standard. I love the idea the outsider. How do you think about that for flex. Port is there an ideal ratio of insiders with domain knowledge to first principles outsiders just approaching the problem with fresh eyes. I don't know if there's an ideal ratio there's certainly a equal that you want to maintain. And i think we go for is like twenty percent. I think you wanna have like five or ten max. Ten person teams. And so you want at least one person on that team to know how it's done so you at least know what reality is today but not two or three because they'll team up in like convince everybody and be the loudest voice in the room. And you'll do it that way. That's kind of my working model is like make sure someone knows how it works. But then there's lots of people asking why bunch of times and challenging wire planes different. Maybe the same standardization won't happen in planes. What's different there. You're really about focusing. On arrow dynamics in the shape of the plane there are containers in air but every plane is different slightly. Different in the arrow dynamics is going to drive that rather than just like a standard rectangle the air containers rounded to fit the contours of the plane plus shipping containers. Just heavy. you don't want to fly those things around right. So is the north star in all of this like if you think about the potential opportunity for impact of improved efficiency or technology in shipping space. Generally speaking is the way that it just ultimately manifests more selection and cheaper for consumers like is that sort of the right way to think about it that if you do a great job building flex board ultimately will cost end users less consumer goods and services or goods in this case is actually. I'm very inspired by amazon. And i think if you look at what bezos laid out his wall. We don't know what's going to change the world but we know what's going to be the same and people are gonna want cheap stuff. They're going to want lots of selection. They're gonna want shipping. And i think ultimately as we succeed we're going to deliver those three things to the consumer we do. We try to work backwards from that. Our customers are trying to compete with amazon. And say live and thrive instead they need to be able to offer that to the end consumer sort of building everything to enable that so that our customers sort of businesses of the world can do that. There's a couple of ways that that manifest itself like right now. That coordination layer these old companies called freight forwarders. Let's take their l. So you get a hundred dollars in of that. Seventy dollars goes to the underlying asset owners. So you got thirty percent take rate of thirty percent. Twenty percent is going towards labor costs and ten percent is going to. This is a really well. Run one of that twenty percent. I mean that's just like a huge overload in tax on the world economy. Logistics is ten percent of gdp. So that's the cost saving side of things and that's just a pure logistics costs. There's also financing costs. Every shipment is working capital its inventory and transit at sitting there. It's just cash tied up on the water or in the air. And so if you can speed that up transit time in working capital two sides of the same coin if i can run your logistics thirty percent faster. I've reduce your inventory. Balanced by thirty percent and midge business. A lot better right from a working capital return on investment capital implant. So that's another way that you lead to lower costs and these days. It's about to our shipping. Two hour delivery is like the standard amazon is setting out there. At least in metro major metros and that is a really complex system the old world sears catalog world you just have one distribution center one fulfillment center in memphis or something and serve the whole country and you get a three week or seven day delivery time. If you wanna hit two hour delivery you need to have a little micro fulfillment center in every neighborhood. And that is a really hard problem for the existing supply. Chains just aren't made for that. They're running on the paper. Their phone calls or calling needed ship this many containers. You need to be able to optimize 'cause now you're talking about too much inventory in all these local sites and you go bankrupt too little. You're the customer buys from somebody else. So it's how you help. Brands meet those promises to the end. Consumer that's going to be the big differentiator so it's more products. Cheaper products more selection and faster shipping in that chain. He said as many as ten to twenty different companies might be involved in getting something for me to be in the forwarding world who is making all the money when you showed up to the prophets tend to pool in the same places over time. We'll sort of the stack when you came to it in terms of who made the most money. The most margin of my favorite quotes is out. Where there's mystery there's margins by peter kaufmann who's the author of poor. Charlie's almanacs one of my favorite books. I think there's a lot of mystery and we're still peeling it back. It's one of the fun things about working in this industry is you're like that's how that works like we're making money there and we thought we were. We thought we were buying directly from the source and there's a middleman and a lot of that goes on and it makes it interesting. Pure support ocean freight. I think everybody can agree. It's a commodity. It's like the most commodity thing in the world is a rectangle moving between two places. You you only have price in transit time and maybe a quality metric reliability from there. You're not gonna make a lot of money doing that. But it is like the bulk of the ben from the customer spending a lot of money on this. They care about it. They're gonna put through a process to get a good price etc the margin it comes from the complex coordination. It comes from the customs clearances. It comes from the insurance wherever you taking risks finances really interesting one just the end to end. Coordination is where the margin's gonna sit in one of these businesses. Lot of information asymmetries in where somebody knows what's going on and you don't is where they're going to make money whereas that it's gonna be emerging markets is going be countries and cultures. Where you don't have the right experience you hire the right team to figure things out. That's what makes it such a fun adventure. As a business building a platform in this area is like we gotta go figure these out and learn these markets and added conversations. Hire the people that know allowed where the money is made and unravel the mystery and defined all the margin. You've mentioned the finance side a few times. What is the most interesting thing you've learned about the finance side of trade it is that under ancient maritime law older than the. Us constitution the freight company. Has i lean in the event of a default if a company goes bankrupt a customer who is shipping freight we as a freight transportation platform as the intermediary. There get paid back. I and that is really fertile ground for building an interesting financing business because the four attributes have a great finance business. It's sort of low cost to capital cheaper customer. Acquisition underwriting advantage through some kind of data or understanding risk and then fourth is collections. as a company. You actually have three of those for you. Don't have a cost of capital advantage. But you do have collections. As i just mentioned yet i lean and possession of the merchandise. So it's not hard to collect given underwriting advantage because we're seeing as a customs brokers. We're seeing the wholesale price of what you're buying this stuff for and you're seeing trends. Is this business growing really fast. They pay their vendors on time. Do they pay their afraid providers on time and the customer acquisition while they're already our customer the way our system works as you place orders to your factory through the system to can think of it like pay later button for global trade. I was really delighted to discover that some of the great finance institutions of the world started freight companies. It's american express was a freight business. Wells fargo was a freight business. Lehman brothers was like a trading freight business. I shouldn't call brothers one of the great financial blow up. I guess when you go into that world and it's a natural right it's like okay. There's money flowing one way and goods flowing the other. So it's sort of a natural fit to be in the flow of those financial transactions and provide working capital for businesses to grow. It sounds like the ocean is just like an interesting place. You mentioned this old maritime law. You mentioned the lack of enforcement of contracts. How should we think about law the ocean at a high level. There's a macro risk. Here is will the united states navy continue to ensure safety of freedom of navigation. It's something that the us said after world war two was like. Hey no more of this nonsense. Anybody can trade with anybody. We're going to provide that global security blanket and allow for this world that we live in. Will the us continue to do that. And i think that's the giant question mark for everybody. We did it originally in the cold war to like make sure everybody was allied with us and the us doesn't need as trade as much as all the rest of the world does. I think it's beneficial for us and zero-sum game so we all win by having that but that's my view it. I'm not sure that it's shared by everybody. Congress or everybody else. The ocean is sort of the wild wild west. You're a no-man's-land. And the regulatory bodies are really inscrutable. To an extent the official regulatory body for the oceans is called the international maritime organization. I m oh and their biggest area right now of emphasis is gonna be well. It's safety so they've done stuff around ensuring safety of sailors and things like this but second is carbon reduction there are some things in the pipeline that they're pushing through. I can't get a straight answer from people like do they really have enforcement or is it just a governments that subscribe but if one government subscribes to their regulations than like sort of everybody needs to comply with their pushing some pretty aggressive timelines through in terms of carbon reduction for the fleets. I look at a guy. I don't realistically. I don't see how they can achieve to reduce that and so that's going to have a big impact of like if it can't actually be done what you do. For example in twenty twenty three every ocean container ship needs to reduce their carbon output by thirteen percent. Not the fleet the ship. And it's just like okay. What did you do the way you do. It is by the way to go slow but if you go slow now you just need more ships. And you haven't reduced the net carbon on a per-share basis you. Have you have more chance. I feel bad to the regulators like i you solve some of these problems. Somebody second order effects. What percent of the original problem. If you were focused on the digitisation of this weird email Paper and pencil very manual process. What percent penetrated are you. How much is there left to do. Just on the digitisation of information flows in freight-forwarding. I think less than halfway. We have a huge runway roadmap for many many years of just persisted. There's no silver bullets or relentless this feature saves fifteen minutes of labor costs for whether it's for our own operators but it's increasingly for third parties like the way our business works is that we have software that over one hundred local forwarders worked operate in one hundred plus countries relentlessly trying to improve their operating costs because that becomes our end cost. We look at the system. Wide labor costs. Not just our own headcount. I think we have a huge amount of runway just from relentless chipping away at things. I try to remind our team like focusing on the cost of labor and on a transaction. It's a bit like when the telegraph was invented. Looking at the labor costs that that resulted from worse back writers for sure you saved a lot of labor. You improve your message transit time. That's not really. What's so special about the telegraph. Even though it's incredibly powerful what happens with the teller ups you get this. Emerging property wants the network. Has everybody connected. All of a sudden you unleash this insane. Amount of potential for new types of messaging experience for what's ultimately what's up. What's happened the beginning when there's only two people on it. I'm saving you money on. Sms costs what everybody's here as signed up. All my friends are there. And i've got friend groups and there's means going around emergent properties. We have not yet unlock those emergent properties but we have signs of them. That are nason and really promising. My belief is that the emergent property that you'll see is much more like a private beat amazon once everybody is here every time we get a. Us company on boarded were on average on morning. Four point four of their overseas suppliers as users. they're exporters it's sort of a manual process. I gotta go one by one and onboard them and teach the onboard their entities in their product libraries and their users and their network locations different warehouses and factories. But that's a one time thing per entity at scale there's a future moment that unlocks when you sign up like. Oh although those guys are here because somebody else on boarded them. We're seeing these industry. Clusters or rehab that density in taiwan for example. We have like all these bicycle manufacturers. We have like everybody and so if you're a bicycle manufacturing sign up reflects what it's like. Oh my factories are already here. And you'll see us industry by industry and like get that geographic clustering in that network effect. And i think that you're going to unlock something really special. There were companies can start trading with each other in a seamless way similar to. What's you start messing with each everybody's here. I didn't have to teach them how to use it. Yeah i love the idea. i guess. Technology generally that as you reduce friction in crete standards non-linear like weird emerging property. Start to happen taking like even one step further than that. Because i'm not quite sure. I follow the potential magic of the sort of direct connection. What's an example of what that might unlock if everyone was on flex board in a perfect state five ten years from now give us a flavor of what that might mean for example. Let's say you're brand. You and i sit together. We're like hey love lululemon yoga pants. But i can make this thing a little bit better for my body type. I don't we we make up a brand right now. The amount of friction. That would go from that idea to getting it manufactured and creating a brand or two incredibly hard problems. I don't think we're gonna solve that. But everything else in between should be automatic and taking that brand global and saying like okay which countries do. I want to be in one click. I'm hooked up to all of the fulfillment centers that are going to be relevant in that market. I'm able to clear customs and get it into the country. I'm able to optimize. Inventory flows. So that when i'm getting an order from a customer flexible automatically places the right amount of orders to your factory to get the right amount of goods in stock and deliver them and i'm to cash out and just focus on making an amazing product super hard at scale and building a brand with customers and having those customer relationships and all this other stuff like bureaucratic shipping departments. And how do i finance added. How do i clear. Compliance like everything should just automatic. And you're able to just take any brand global almost a one click operation. That's the vision that we're building towards. I do think it's like a decade long thing and and one of the jobs that we're doing attorneys like how do we sequence that. It's sort of all encompassing. It's permission to build everything so we need to make sure it's like no this year. We're doing this and we're going to be really good at it next year. We're going to do that and sort of sequence it a little bit better for our teams in for the outside world. Understand the business what we're doing. So maybe even think about it. Like the effect that the internet's had with will call permission less innovation on top in the world. Bits the end just explodes of stuff. That's being tried and experiments new products. Whatever you reduce friction like the end blows up. This might be a part of that happening in a physical world. Yeah and create huge opportunity. One for entrepreneurs might people and it's always been big big part of what we do democratize access to these things and global trade is just like. It's this weird black box and big companies have been the ones that have the resources to understand it and solve it the expertise right instead of participate in it and entrepreneurs have been cut off from that so i think we can really the playing field there which is awesome second. Big companies are getting circles. Run around them. By these direct to consumer ecommerce companies then was all run on flex for all of them will if they knew about us and spend some time to get into what we do. But i don't wanna see these big legacy brands. That are conic fail. The retail apocalypse for me is super sat. And when you see a retailer go under. It's not just the towards the rest failed. Which is that would make. Every all of us have settled because our childhood dream was to get a trip to toys r. us right like what the hell out of business but when twitter is not just them and their employees that suffer and their dusters there's dozens and dozens of brands that just sold thirty percent of their product through that channel. That are also now gonna probably fail because they weren't built for this lean infrastructure econ directors consumer one so building that allowing these companies to thrive. How do you create lots of opportunity for lots of experimental niches products. They try things out. Every there's gonna be a product for everybody were also unique and have our tastes and want to be able to. There's a brand appeals directly to you and that's awesome right in there should be a flourishing of brands and there should be infrastructure to make that super easy so people can experiment. It's a bit like in old days when you're doing tech startup series. A had to raise all this money just for servers. And like if you're doing a hardware product you're raising all this money and hiring all these people just for the infrastructure of shipping stuff and doing purchase order management and optimization hiring. Mba's did you excel models. For how many units should i buy based on my demand forecasts and like a lot of this stuff should happen. You can focus on what matters making an awesome high quality product at scale there should be this infrastructure that's awesome and easy and a bit like a utility when you flip the light switch in your room there. You're actually controlling power plant in real time. There's a power plant getting a little bit hotter just for your light. Switch you just pumping out more luxury for you but when you place an order on an e commerce site. That's not what's happening in real time. All these things happening is like no like someone's modeling and excel file like one more order and then emailing it somewhere else valuebill. That sounds great infrastructure for commerce. A lot of that is obviously software. I think i've seen flex for planes flying early. Lose few of them at love counting at my house like the number of trucks that come that our amazon branded now with their new logistics network. How do you think about capital deployment capital allocation cataracts into some of the physical aspects of this longer term. I hate owning assets and we will not owned assets what we do occasionally do a sign long term leases on assets. And that's done based on looking at our forecasts and knowing what our volumes are and then we'll make a commitment to make sure we get the capacity we need we have to seven forty sevens right now but they're not are seven forty sevens. That are run by major air. Cargo airline what we do is basically signed a three year lease that we commit to flying three flights a week each with those planes. We're willing to make bets where we know. Look i know. I'm gonna feel this and it's a good return on capital but it's not like the return on capital that you get from software. It's much more like hey the only way to get access to the capacity that we need to support our growth is to use the balance sheet. It's not like a high risk endeavor. They're sounds like a well-considered decision to say a bit more about why you hate owning assets like is it just a return on capital story. Talk me through that primarily. It's a return on capital. I mean we look at it but it's not a doug medic thing like as you see it we've made some commitments where it's the right thing to do for the end customer and where it's going to do something dramatically different for the customer experience unlocked growth. Unlock transit time. Another example is today. We run five houses around the world that we have another fifteen that run our software and that's my preferred model to things that we got from running the warehouses ourselves. I was learning. We're in their learning. What's off for these warehouses. Need to run. We don't do stories like freight in consolidating shuffling it and sending it back out. Ideally twenty four hours the infrastructure. It's a really crappy business running a warehouse. I mean it's kinda like you rent a box. You hire some blue collar workers and you try to make a big on the spread their therefore there's this software there's like no investment in it and especially not for what we need which is cross docking. There's a fair amount of software. For pick and pack for e commerce fulfillment. But when you're just running these consolidation network. We didn't see it by run ourselves. We're able to shave three days off transit time on a l l less than container load shipment and again transit time is working capital fight cut three days on a twenty day journey at a pretty material impact on the working capital of our customers and then we built software and now we have third parties running that software. And i'm hoping not to run a lot of warehouses that much rather have anybody can rent a warehouse hire some workers and we give them a playbook software and customers that's my preferred model for interacting with assets like build software for the asset owners. That makes them better at their job. I'm sure that building this business has involved a lot of travel a lot of conversations a lot of different cultures etc. I think you speak like five different languages. one lessons. Have you learned about building a business that requires global coordination. What are the key things that you think other entrepreneurs will encounter and maybe you can save them some time or or make them aware of landmines. Will you just have to go out there and talk to people. You're not smart enough. Speak languages because i have fun in language classes and like messing around with people and not. Because i'm like so smart. I spent a lot of time a lot of hard work on it. But you gotta go out and talk to the customers and vendors and the ecosystem and mt to the real world is not following your logic you get a bunch of super logical genius in a room in a whiteboard and like i promise. You won't figure out how the world works. Because it's not structured that way you'll come at things with these very naive and dogmatic stances that will make you everyone allergic to talking to you in working with you. Because you're you think you're so smart and you have all the api's but like nobody wants to use that. So god to go out there and talk to people i forgot. Okay how does it work. Is it worked. What's your problems really. Ask questions empathetic listener and then come back with solutions. That hopefully solve the most important problems that you discover. I think that's what stood flex for the part that we didn't see ourselves as like this software company. That is just going to build these protocols and everyone's going to follow suit. I think we build it and they will come is not true instead. We saw houses a customer company. We're here to solve customer problems. Let's go whatever. Solution is required. And if that means calling truckers like we've called truckers for a couple years until we built software for the truckers to onboard them and now we have a mobile app. We have four thousand truckers that we can dispatch software. We don't have to talk to them. They're just like they're at the port when the containers arrive but for a while we did it by hand and then we learn what needs to be automated. What how does this process worked in. We got credibility with the truckers once. I'm fifty percent of your business like you probably gonna use the software that i build you. We had to get that credibility we did one point. Three billion in gap revenue last year. We have the credibility with the asset owners. Like oh they want a piece to that even the ocean carriers two years ago like i don't wanna work with these folks now they're like. Oh wow you doubled your revenue year over year. Like i need that. What piece of the dna of your culture. How the business works. Would you most like to export and see other businesses adopt. It's probably that it's that willingness to go out and you can get your hands dirty not be so ivory tower. You've got all the answers. Here more cross multidisciplinary thinking more people from tac willing to go out and do sales and how those customer conversations and those vendor conversations more people from sales learning the technology world. I really think that's where huge amounts of values created when you share ideas between disciplines and learn from each other and like go out and have mental models that are broader than just within your own discipline. That's something we tried to see a big fan of generals at a lot of people that know a little bit about everything. They really underrated in the world. There's too many specialists out there. There's two things you mentioned earlier. That i'd love to get your take on. One is kobe. I guess generally speaking the other is the us navy. Patrolling supply lines in the ocean of peter's hannah as a major concern where the us is in a privileged position because relatively small percentage is important of what matters to us. But if you're much more connected higher import country like this could be a disaster. How do you think about this. Global supply chain issues in light of covid and in light of the policing of the oceans. What's draws the spectrum of what might happen. I love heads. Willingness to make a prediction which all the time on including like super specific link. The price of copiers going up. I promise you need to go back to all these things like. He does which i love. I think what he gets wrong. It's not a zero sum game just because the us does relatively better as the world falls apart but we still go down. That's not a win like it's better to support the system even if it benefits other people more than us that sum game mindset. i disagree with. I wouldn't want to debate him because he's really smart and accent disagree with that premise. From the start of his argument on covert is really interesting. I think global pandemic is going to hit everywhere. Nobody can predict how plays out the second and third order effects are so strong that nobody could have predicted. A bunch of things that happened after covid hit so for example the fact that china is the most resilient and manufacturing is the best in china the place where it started is like who could have predicted that that it would actually benefit chinese production. Where the pandemic i. Nobody said that. In the beginning everyone like china's screwed Zero economists predicted that kovic would lead to a thirty percent increase in us. Import volumes of products are volumes. Mike container will not flex boards. Were doubled over your nationwide the voyager up thirty percent. That's freaking crazy. In hindsight we can find a reason for it. We're all ben. Franklin rational human can find a reason for anything. They wanna do ex post. It's like oh yeah of course if you lock humans in their apartments and they can't go outside and spend money on restaurants and travel and services. They're going to buy more stuff. Because you need your dopamine make sense in hindsight but nobody predicted that imports would surge in the stock market. Go up. that's one conclusion. I think we can draw like hey. Let's stop believing so much in the expert forecasts and then from a supply chain standpoint. I think it will all go back to normal in a year or so like we talked to people who lived through sars in early two thousands in hong kong yet eighteen months of utter panic and people thinking the world is coming to an end and and then after eighteen months. It was like everyone forgot that happening. I kind of think that's what will play out once. Vaccines are ruled out. I'm not downplaying cove at all but like once vaccines are out and i do think life will go back to normal. But there's a long term secular shift here. There's a couple. I i've already mentioned which is supply. Chains are much more granular. You're going to be wanting to ship. Smaller quantities of shifts more downstream locations to get closer sort of like edge cashing in the internet terms like get your products close to the end consumer and then as more products you therefore. You need a lot more data. Those are for sure going to happen. And that's worldwide not just in developed markets. Second is you are recognizing it's not even aside from the pandemic but there's all kinds of disruptions that can happen. There's a black swan everyday in the world of earthquake or natural disaster. Political uncertainty having a single source for any given product is a real risk. That i think is now more front and center for people because of covid where your supply chain shut down for a couple of weeks or months and you couldn't get product that's a longer term trend. It was already happening. Because of labor costs in china going up but you're gonna have more and more diversification on the supply side of where to locate your factories. Some it'll be moving closer. I think latin america will have a lot more production than it has mexico and other central american countries. That are close to the us market but southeast asia's going to be a big beneficiary of trained and that's a longer term trend. I don't think is maybe it's more on people's minds because a kobe but only driven by covid. There was a really interesting story in the early days about you testing demand. I think with like a website. That wasn't yet necessarily tied to the actual service but a great way says like sort of a bat signal to see if something was valuable picky. Tell that story briefly and just talk more. Generally about poking and prodding around potential demand like the idea of geniuses and a whiteboard do not a business make tell that story. I loved it. Well i think there's a myth that entrepreneurs these crazy risk-takers and i'm not i. Embrace uncertainty to agree. That normal people would find really unhealthy. Psychologically but i'm not a risk taker. I think there's a little bit difference. They're like. I don't want to do something and commit unless i'm fairly certain that there will be something good on the other end. Like i'm not gonna go all in on my hunch. Let's put out some experiments and see how the world reacts and then double down the things that are winning a double down again and again. That's my approached entrepreneurship. Let's try a lotta stop. I've tried so many failed businesses that you will never hear about because they were just stupid ideas but some stupid ideas really take off and the world's much more irrational than you think logical thinkers really overrated like you need people are willing to try crazy stop because the logical idea everyone else already thought of. It's already exposed whereas the illogical irrational one a startup customs brokerage this highly regulated. Pretty irrational. so yeah i built a site. I used to be pretty good at like getting sites to rank highly. Go google changes and i haven't stayed up with space but i would get online sign ups. I was getting three hundred companies to sign up for my sight before we had the capabilities to do the job just to see if that company existed. Would people sign up. I got foxconn signing up. Saudi aramco signed up for my company. I do anything i was like. Oh my god. I hadn't heard of saudi aramco to be honest like fifteen years ago. Twelve years ago i didn't know about them and i was like sis sided affect what he's company in the world so they're not customers of ours. We don't ship oil but it was like a sign that wait a minute what i thought i was building. The original idea that had i was testing was like hey for amazon merchants and ebay sellers turbo tax importing. Then i saw these mega corporation sign up. I'm like oh. There's a demand here in the enterprise that i never knew about something we do. Well it's export is. Let's try things. Let's let's have like let at thousand flowers bloom and see which ones are actually going to grow into tall trees and then pour water on those but the hard part is killing the the experiments that aren't working. What have you learned about the two sides of that. 'cause i love the idea in concept to experiment and double down but requires too hard things experimentation and then killing three things killing the ones that don't work and doubling down in terms of process management of letting flowers bloom. What have you learned about doing that effectively. You can develop these ideas from a theoretical standpoint and the theory that you're working off here is darwin's theory of evolution. Sort of diversify selected. An amplify is the algorithm of evolution. And that makes a lot of sense but the select part natural selection meets killing the losers that is not going to happen on its own came out ever met wonderful myopic like i love darwinian theory. Let's apply it in business and we'll get this very creative company if you don't build processes for the kill part and the select part you know. What are we actually going to do. You will end up with everybody. Running every direction in no alignment in your organization. What that looks like is a bureaucracy. Where like nobody can get anything done. And nobody works well together and had to learn that the hard way as we scale that you really as a business if you wanna maintain that creativity you do need to provide a vision. So that people know. Hey we're going in this direction. All the experiments need to aligned with that tourism frameworks for like. What are we going to focus on now provides focus and direction allow experimentation but like create guardrail so that people aren't going off and doing their own crazy things so it's more process than i was comfortable with. In the beginning i always saw processes like the sign of a bureaucratic boring corporation but bureaucracy can either come from to process too many rules and reporting obligations in managers down micromanaging but just as often it comes from a lack of process that leads to nobody can get anything done. It's kind of like some aspects of government. I assume is like it's less. There's too many rules just like nobody knows who's in charge and can't do anything getting that balance. Right is the key. And i do think that that's similar to evolution pleads right at the edge of order and chaos where a lot of creativity happens. You're china like keep your company right on that line. I love the idea of the standardization of the container. The protocol concept idea of lucien. What other models have been valuable to you as you think about building this business that might also be helpful to other entrepreneurs. Good understanding of history's probably one. That super underrated in the technology world. Especially right now like everybody thinks that we're crazy different time and nothing like this has ever happened before these specs and capital markets in l. This is like actually go look at history and this happened every single time there was a new technology invented although like always going back to the canals and then the railroads and then the telegraph and the telephone always happens. I don't want a bobble per se but those increased asset valuation. They can last for like twenty or twenty five years but then there's always a technology that comes along and so how do you reinvent yourself. for example. The railroad's huge bubbles that railroad vessels very very early days made a lot of money and then after that not much there. Railroad guys invented the telegraph. And they didn't think it was useful. They only used it to improve their own operations amazon. Show genius like this because they invented. Aws and then realize like oh it's useful for other people. I don't know if as knew that analogy going into it or not. But i mean i think there's some good mental models from history that are it's not a mathematical model is just like oh patterns that repeat and you should be aware of them and not act like none of this has ever happened before i also think that entrepreneurs underrate capital allocation. And how important it is to not waste money and to really think about what every dollar of cash you have a lot of choices of what to do with it. You can pay your employees more. You can give it to your customers. You can pay your vendors more. You can pay dividend. You can do retained earnings. You can use it for charity. You have lots of options for every dollar and be really conscious about where those dollars should flow. And what's the optimal use that in an and there's ways to align all of those stakeholders on some level or sort of adversaries because they all compete for the dollar. But i think the ticket to get in them. All line is probably in equity and retained earnings like lower. Your salary give you more equity. Use that cash to reinvest in compound generate wealth and i've at least aligned my employees shareholders in his way. What's been the hardest earned lesson. I guess for capital allocation your primary job. I guess person running the business. But i'll just opened up to the whole business. The hardest earned lesson in the flex per journey so far one of my darkest hours actually came from a fundraising challenge. Flex sport has raised a lot of money. And we've always been looked from the outside is like oh we're really fundraising i've actually had failed utterly in fundraising in our series b. Round i had an investor. Tell us that he was gonna invest. An investor shall go nameless in this forum. But tell us he was going to give us a term sheet on monday. It was like a thursday for fifty on five hundred million. Which at the time would have been amazing terms and we were like alice awesome. I should have just said yes. And no doubt like made him give him a document and inside it. I thought i could do better. Maybe i'll get a better terms out there called up the top of the world and was like. Hey i got this offer like we wanna talk was not prepared was not fundraising thinking. I would just charm some people into investing no data room. Nope dak like nothing. I've really figured out what happened. But he never made the term sheet. I think he found out that i was shopping. It and got fended or something so he never showed up now. I'm gonna fundraise without planning to be in one at a pitch a lot of investors as fast as i could and they all passed or gave me offers over way too low at so there's a couple of one. We got bailed out by peter thiel who had done our series a round. He stepped up and gave us better terms than anybody who giving us didn't need to. We could master terms. I would've taken anybody. Give us better terms. So having an investor who believes in you got balaji. Who's like aligned. Spend more time with them. Get to know your investors. Make sure therefore you don't play games with investors like be prepared really good lessons the other. One is look at her intuitive. Is that damore. Investors you invite to a fundraise to a pitch the lower the prices. I think counterintuitive but it makes sense if it was an auction that was free market classical free markets more industrials you'll find an outlier. That's willing to pay more. But that ignores the fact that there are feedback loops in what's called gossip between investors which leads to regression to the mean so the more people you invite the more likely you are to end at an average price instead of an out liar. The best fundraise. I did probably was with softbank where they invested a billion dollars and i only had one investor in that conversation said of trying to run this process and so i learned that lesson the hard way like one of like tree investors really as partners and make sure your values are aligned. And that they're really stoked and emotionally connected to your business and not in some kind of an auction. We don't live in a free market economic growth and believing that you do. It will cost you a lot of pain in a positive sense. What is most exceptional. About peter and masan. I just think that they're radical contrarian takers who don't really care that much people say about them or at least they pretty good at letting on like they don't care they have their own unique views of the world and they're willing to make bold bets on that they got skin in the game they're not just like thinkers who make predictions and then they'll do anything about it which is like there's too many people like that and the world. They're willing to stand up. I don't agree with them on everything. Certainly but i respect the fact that they're willing to put their name out there and take risks under their own name. This impedes case. I think moscow has got the returns over on the long the actually do really well as agent but he won't topped. Irs founders. That look at me. It's just remarkable. I'm privileged to be part of it as we step back and look at this amazing enormous yet. It's still pay of that. You've you've been operating in if you were lifted out a flex port for some reason and you could build flex board. What other part of this ecosystem would you attack. Where do you think of. There's the most opportunity to build great businesses to improve the system. The one that strikes me as a huge potential. We have a good business in this area but has massive potential. It'd be really game. Changing industry at least is cargo insurance. And it's an ancient industry. The romans invented cargo insurance thousands of years ago. Cargo insurance today does not underwrite the risk that they take. What does it insurance company. That doesn't underwrite risk like. Isn't that the point looking at the rest. They don't they don't have time or money is just too expensive to analyze the transactions and look at what's shipping and whereas shipping shipping. What time of year like all these data attributes that are relevant so it costs the same to ensure a shipment of something super breakable as does ensure this steel rods it's just a percentage of the invoice value. Because if you were to take the shipment and look at the documents and analyze by the time you pay the analysts the difference between the two would go away so they just instead. They charge a high price as i think. There's a huge potential there for as we structure all this data and applied machine learning to go like build a smarter model cargo today. We don't today. We just make margin off cargo insurance and add it to the products and we use an underwriter and they take the risk. But i think in the future as we build more data sets here. You're going to be able to do really interesting stuff. In what looks like a very broken english and then prototype that. So here's an. Api we can provide cargo and shipping. The thing is as you give us these data attributes and we can underwrite the risk and provide you a good rate going back to where we started with this idea of the visa or mastercard protocol concept that you're creating this set of standards that allow for less friction in a system if other entrepreneurs to tackle a protocol like problem by which i mean create those standards and then proliferate them through the system. What have you learned there about. What's important for standard creation itself. What makes for a good standard for standards. You got to get people to use it and so it's really a hard problem like a cold star. Get a network lit up. I mean i think. The people doing crypto right. Now are the ones trying to figure out how to do this. Can you create a network that rewards the early participants in rewards by reality. That's not a pyramid scheme in some way. Like how do you build that network. Our approach is quite different which was go a business in the business and get big almost fifteen billion dollars worth of merchandise that we ship last year as a one billion gap revenue for the business. Now you're in a position to start throwing your weight around a little bit and maybe influence the standards even there. I'm like i don't know if people will adopt one of the sanders. We'd like to create is for ports for airports. There codes the three digit codes. Every airport has a code imports. There's no codes the shanghai port. Actually there's two ports in their three hours drive away from each other. They're both called shanghai port and there's no there's no term universally agreed upon against international maritime organization the un or some regulatory bodies should create that. I don't want sit around waiting for them. And like maybe we could create that standard and get everyone to agree to it so that would be like the lowest hanging fruit. I mean kind of a big difference. If you go to the wrong court now you have to drive. Three hours sucks for the truck driver. Was that space. I really would love to create a standard. But i'm not claiming i know how to do it. How do i get really diverse set of stakeholders with different interests to agree on something. That's just like obviously we should all just agree on the language for this. I'm not trying to make money off the standard of just like avoid stupid mistakes so it might even be thinking about it a little bit wrong that like standard standardization is about designing some elegant thing. Just like the shipping container not perfectly designed. It's more just getting people to agree that that is the thing. That's more a marketing problem. That's the key in all these international standards setting bodies. My friend chairs the commission setting standards for hydropower and so he spends all of his time flying around the world that we did pre covid going to meetings trying to get everyone to agree. I was like oh my god. it's so bureaucratic. Would it be better if some big company to said like we're awesome like us our standard. It's right and people will be like. Yeah look at it. it's right. I'll use it and i i'm more of a free markets guy than a government committee because i've seen what happened with shipping container. What have we not talked about that. You care a lot about in the world or are spent a lot of your time learning about. I think there's a huge opportunity for these systems to be used for ways. That are not obvious to help. The world in disaster relief humanitarian logistics even nonprofit organizations that decent pretty interesting work some of waste a lot of money but some of them do really good work. They get treated by the current. These old companies called freight forwarders. They get treated as like a prophets one because they're rookies and they don't know what they're doing easy way to take advantage of make extra money to. They're trying too hard things in life. You make money doing things not easy. Thanks and they're trying to ship things into a crisis zone into a disaster. Just hit a war going on. That's a really interesting. Here's people that are doing super important. Work for humanity getting ripped off like worse than the rest of us which are already getting ripped off adding. that's a really interesting fertile ground for innovation and we have a group called flex dot org that was actually born out of the syrian refugee crisis. When i was reading new york times article about this. And i was like man. This is fucked up like couldn't we send some merchandise to help these people in need like they're living in refugee camps. Their homes have been bombed out. Like what can we do here. And i just naively was like we have an agent network so we had these companies all over the world that run our software. Wait a company in syria in aleppo and i just emailed it local agent there that represented flexible even though we'd never shipped anything connected with them and i said hey. We want a shipping container to this refugee camp in aleppo. I forget where it was exactly. And he's do you have the destination address and he didn't ask. Are you sure there's a war going on. I was like oh we didn't have doing that. Because there's all kinds of considerations like is it really go to the rebels or the al-qaeda we didn't end up doing it. We shipped to refugee camps in turkey and jordan instead but it was like this eye opening thing like oh you could just do something. You don't have to sit around waiting for governments to solve these problems and the fact that he wrote back like what's the destination address blew my mind and actually was frustrating. Flex dot org is like. Oh we have these capabilities. We can do things that are kind of superpowers. I think a lotta companies. Probably have that if they go look and you'll find that it's good for business as well which you shouldn't apologize for because it'll make you want to do more of it. What have you learned about creating synchronicity inside your business. So that everyone understands what the priorities are and the complex web. You're managing release the next and final question which is like if you think about flex for ten or fifteen years from now and continue to be successful marching towards that vision. How do you balance that. Like create near-term synchronous. So people know what to do but also oriented towards something interesting and exciting. I am learning so fast and furiously about this. Because i think it's one of the most important challenges that faces company. I gotta get product and once you do. You really need to figure out what's the balance between short and long term thinking. Somebody's will really good at this zealand. Musk where he calls his shot and says we're going to mars and this year. We're going to do this next year that next year. That in like eventually we're going to go into the galaxy and explodes like that's long-term thinking but with like really good sequencing our version of that we're going to build that network described. We're any company can sell anything. Any human in any anywhere in. The world has all connects together all the logistics and trade service providers or here financial capital markets are all connected in anybody can go over there. Okay what's the sequence this year. We're going to automate ocean by ninety percent yesterday. We launched our order management products that you can place orders to any factory through the system and so it all has to tie that state. I sort of synthesize this from a process. Amazon calls up one opie to planning one and two they do it twice a year where they have teams right down what they're gonna do for the next. Actually they do like a five year plan but then updated every six months and we kind of combine that with the salesforce calls it v. to mom and that's their planning process and we synthesize those added a bunch of dna and we call it charters. Every team reds their charter. It's probably a little bit too heavyweight today still but it's designed to get every single team to like document. Here's what we're going to do how it aligns to the company vision and mission. Here's the other teams that we depend on your the risks that we think we're gonna face. Here's the talent that we're going to need along the way and then get everybody now. There's one hundred and three those and they're publish. Everybody can read them and now you can see what everyone's working on. There's a lot of value in that. Also because i think in companies. Everybody believes that their team is the only team. That's working really hard when you look and go. Oh crap like everybody's working hard. I think that gets a morale-boosting everybody gets inspired to go perform and support the team. It's an evolving process. We got a little bit better this year than last i think amazon is really well. We're not at their level but we want to keep iterating on that process. What are you most excited about for. The future just open ended question. Well i mean. I think that i want to live in a world where everybody has access to opportunity in texas. We can just live forever and be healthy and some of this amazing stuff. Gino mixing stuff. That i don't understand like thank goodness for all those people. I hate that. I'm getting older. And more wrinkled every year. Well look at old photos of the families of. I'm like so. I know i don't know anything about that. The healthcare is the most important aspect of the frontiers that i wanna see pushed. I think it was that cantor that introduced us another person building a fascinating protocol business. And ever since. I've just really enjoyed learning about flex port and learning from you. I so appreciate your time today. I the same closing question for everybody which is to ask. What is the kind of thing that anyone's ever done for you. Obviously my kind of thing for me is my mother. Took care of the new infant and seeing how much work goes into keeping this baby alive and remembering that happened to me too. And i'm so blessed honestly it's a good way good lens to look around the world and you see people struggling out there in the world remember that. Wow there was a moment when they were a little baby and they wouldn't be here if someone hadn't really cared for them. And i think it's a good moment to have some empathy and recognize. The human struggle is real so awesome ryan. Thanks so much for your time. Today had a blast. Okay thank you to find. 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fedex teague shaughnessy asset management tikos patrick shaughnessy Patrick o'shaughnessy ryan peterson ryan peterson ryan amazon volvo
Justin Singer - How Regulation Unlocks Opportunity - [Founders Field Guide, EP.2]

Invest Like the Best

1:02:32 hr | 10 months ago

Justin Singer - How Regulation Unlocks Opportunity - [Founders Field Guide, EP.2]

"This episode of Founders Feel God is brought to you by Microsoft for startups. Microsoft for startups Global Program dedicated to helping enterprise ready to startups successfully scaled their companies. The program has been around for a couple of years, but I recently became intrigued when former invest like the best guest. Jeff. Ma took over Microsoft for startups provides companies access to technology including azure cloud and get hub coupled with a streamlined path to selling alongside Microsoft in their global partner ecosystem. Microsoft startup says it very compelling approach to working with startups and driving. Their long-term business value if you're a founder running a B. Two B. Company targeting the enterprise, you should definitely check them out at startups dot. Microsoft Dot Com to hear more about the program. Stay tuned at the end of the episode to hear from me and current program member abnormal security. This episode is also brought to you by Venta does your startup me to? Sock to report to close big deals or do you already have a sock to report and want to make it easier to maintain Vantaa has built software that makes it easier to get renew your sock to with vantage continuous monitoring solution. You avoid hosting auditors on site and taking screen shots to prove that you're compliant. So you can focus on building, Your Business Fanta. Partners with audit firms who file shocked to report directly inside Advanta at a fraction of the normal cost hundreds of companies including more than one hundred Y combinator businesses are leveraging vantage today to streamline compliance and focus on building their businesses founders. Still Guide Lizard can redeem a one thousand dollar off coupon advantage dot com forward slash patrick that's advantage dot com forward slash Patrick. Alone. Welcome. Everyone I'm Patrick o'shaughnessy and this is founders field. Founders field guide is a series of conversations with founders, CEOS and operator spilling Greek businesses. I believe we are all builders in our own way in this series is dedicated stories and lessons from builders of all types you can find more episodes at investor field guide, DOT COM. Patrick o'shaughnessy if the CEO of Shaughnessy Asset Management All opinions expressed Patrick and podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as basis for investment decisions, clients, Shaughnessy asset management, may maintain positions in the securities discussed in this podcast. Today is Justin, Singer founder and CEO of caliber foods and stillwater brands to leading companies in the cannabis industry. We start our conversation with a fascinating discussion on how regulation creates or destroys business and investing opportunities, and then go on to discuss the INS and outs of the cannabis industry. In detail, you'll be able to tell quickly how high quality justin is a thinker and operator, and you'll learn a ton about this nation business. Please enjoy our conversation. suggested. I thought that an interesting place to begin our conversation is with your prior life and this interesting view you have around changes in regulation creating market opportunities you could highlight what you mean by that relative to say new technologies creating opportunities in the early stage space or in the nascent equity space. Wise regulations. So important wonder some of your favorite examples of that I am a little odd in that I've got the classical business and legal education sort of the antithesis of what the last fifteen years have driven people. Towards, but it's actually given me. I think a much more holistic view of where markets come from. That's not inside out from a technology perspective. It's much more outside in like what else is involved in creating this market that started the initial interest was in the mid two, thousand and two thousand and I was in law school and I was looking at telecom market. So there is all the spectrum auctions going on. There was where did the property rights in the advertising time reside are owned by the content owner are they? Owned by cable provider or are they owned by somebody else? These are all big questions and they all determined both the quality of what was going to be able to what the axes of competition were and what the ultimate growth potential the market was. So you put that altogether at in a little mix of time spent in early stage seed stage venture at I ventures, and the synthesis of all that believe the best venture opportunities are where you have the overlap of massive extent demand known demand and some sort of regulatory. Unlocking event. So my favorite examples I mentioned things with Telekom, the broadband spectrum auctions back in the eighties to nineties those really opened up a whole marketplace where lots of fortunes were made lots of economic activity. You look at the version of capital gains, tax rate versus ordinary income, and you saw the explosion funds industry that comes after that. Another one that I really like is the reorganization turnaround industry where with the passage of the bankruptcy laws suddenly able to build all sorts of industry whether it was high yield debt or. Whatever it might be, but it was built on top of this platform of certainty where everybody knew how things were going to function in different scenarios. Same thing can be said more closer to my industry supplements, which for better for worse exploded after the passage of the dietary supplement, health, education. Act, to Shea back in ninety three, basically every massive market they look at you can trace to. Some sort of regulatory and locking event, and lest we ignore what's going on today I think we just saw in the last couple of months lots of people saying you wouldn't have the modern Internet without section to thirty of the Communications Decency Act. Well, I don't know that that's quite the argument favor that people make it out to be. It is an argument, an admission that regulations matter. Does it follow that VC's or I guess all investors should have an analyst just tracking new regulatory changes and serve trying to match those against demand. I don't know if you can do it with an analyst like I think it behooves VC's to actually pay attention to the whole picture I'm bear on things like autonomous cars and it's not because I don't believe the technology possible because I don't think the insurance questions answerable and I think the legal questions are answerable around it. That's not because I have some special understanding of the laws around this. It's just I have seen laws matter. Not at the margins they matter at the core technology alone never creates a market there has to be some enshrinement of the competition of that technology of the ways that you wanted to go in the law, and that's the platform which companies can stand and fight each other and develop activities. Do you need a dedicated personnel because it's also sometimes hard to predict Priori which technological changes or which legal changes are going to lead to massive shifts section thirty as like a very strange history the section that has remainder is the least important part of the communications. Decency Act was struck down. Do a lawsuit with Belfort's actually a really fun little history there. Can you describe that history? I'm unfamiliar with this entire area. So what is section two thirty wise important. What's the story there with the caveats that I have not refresh my memory on this stuff in a long time. So I might get some of these details wrong and I encourage everybody to go look it up and fat me on this but there were basically three different. Parts of the communications. Decency Act is passed during the Clinton era and the idea is the Internet is coming up we need to preserve decency. We need to watch out for porn all of the bad stuff, and that was really the thrust of the communications decency act more of like a more realistic view of how do we prevent things that might be dangerous to children from getting online as part of that there was this threat of case. Law that had been coming up though is distinguishing between the publisher in the platform trying to figure out also, there's also debates around like whether it's an interactive website or read only website law in general is always trying to make analogies to prior technologies. In prior cases, the Internet was no different especially age of BBC message boards, but would ultimately happened is then I think it was Yahoo Stocks Jordan Belfort of Wall Street's people from his firm. Were pumping up penny stocks on the forums, doing pump and dump with them and Yahu got sued as part of it that they were the publishers and therefore had liability for this and the rolling ultimately came down was no publisher can't be held responsible least. They aren't strictly liable for the content on the platform. There's more nuance around it than just that it abroad level that is it's and that sort of became the basis for things like. For US generated content for facebook for twitter that there was a leaf that there was this broad exception where they couldn't be held liable for the content posted on their platform and that unlocked lot of activity around UGC I think without that term without that clause surviving and remaining surviving clause all this because all of the decency parts of the CD were all struck down on constitutional I. Many reasons. Then you would have a very different Internet's I would argue about but I know many people would argue differently. Is kind of a coupled with this idea of regulatory change being important is just the basic idea of rule sets to begin with a loved expand a bit more on that. You know use clever examples from like half a block together how soccer came together and how this relates to what we think of as free markets. So talk about kind of. The relationship between rules, laws and free markets as a lawyer like I've just been taught. There's no such thing as a free market you want a free market go to Russia. Whoever's the biggest gone winds? That's a free market. If you want the rule of law if you want the bundle of rights for property rights that is infringing on the true free. Market, but it was also creating a shared platform of understanding from which people can transact. These were the same insights that underlie the original stock exchanges. Somebody was there to put down and build trust on their common laws how you create contracts that could be exchanged. The example that you mentioned about football thing that I always like to say twenty two guys. Beating the shit out of each other in a field doesn't we suddenly become the super bowl ever choirs rules that requires regulations, requires contracts. All these things have to be commonly agreed to the early days of Football College football in the late eighteen hundreds people dying quake constantly there's no rule book. It just became a free for all enough players enough kids. That somebody said okay. Let's put some rules in place here. What is I down actually mean what is a catch actually mean how many downs are there? Once you got the shared set of rules than the play all became much more constrained around those rules wasn't just a free for all where whoever was live at the end was the winner you actually had to abide by certain things and those rules have to be tweets over time. People learn to exploit them. This is not some system where there's a perfect set of rules there never is that suddenly things are all going to work in a healthy way you can create competition through rules. My favorite modern example of this is f. one racing where every couple of years they changed the rules around the build of the cars because if you leave the rules in place for too long, the cars get too fast they get. Teams that are able to exploit certain things about it. Also able to pull away you get this fundamental inequality but if you change the rules in very them up a bit, then suddenly everybody is looking at this new jumble and they're kind of on a level playing field all over again, you get a lot more competition out of that you get a lot more innovation activity. You're not just trying focusing on spending ninety, five percent of the effort to get the last five percent of the way there you're spending all your time getting that I ninety, five percent all. Over again, and that's where economic activity innovation really lies in the opportunity to create things out of whole cloth. But you still need some shared basis of what is right what is wrong? How are we going to interact with each other? How are we going to exchange things? Wonderful Book it's called reinventing the bizarre Stanford economist from around like two thousand, seventeen, thousand, eight, the talks about just the limits of markets they can be used they can be misused, but you have to make a conscious decision about how you use them if you want to get a economic activity result. Other any other interesting angles on the regulatory changes that have happened recently before we move onto the cannabis space for the majority of our conversation that you've washed with interest in this could be say in the last five years crypto and blockchain are looking for the same thing. They're desperately trying to get the Fed to declare them store value. I don't follow the space nearly as closely anymore every time you hear blockchain here, shitty database. They also clearly recognized that some sort of government sanction is required for this to be what they all believe it can be the obvious one is Uber. Car shares this whole industry arose because we weren't enforcing laws around taxis and how they worked around employment. Demand contractor you look at Uber I don't see technological innovation or left unstuck logical innovation although there is some like the distributed dispatch technological innovation. But fundamentally that whole business that entire when I say that business multibillion dollar behemoth of business that it is the capital horde that it is is built around a use of independent contractors at a scale that has never been done before men that is built on on a legal issue. You see now ab five is out there in California and they're claiming that it's going to kill the business clearly laws matter. They would not have been able to build that business in the way that they did if they were required to employ the full time driver's. Got To build a very different business that was very favorable bolts who their capital because of that independent contractor relationship and interpretation that was at odds with the pre existing definition of what contractor was. Let's move on to your area of interest and operations specifically today in the cannabis space. I don't know that I've ever done a full episode on this topic I don't think. I have. So I'd love you to begin by maybe your origin story why you got interested imagining a lot of perceived opportunity is the potential for regulatory change but talk through your initial interest in them we'll get into everything you've learned since it's a story I. Think Lot of investors would recognize themselves I got interested in the space towards. The end of two, thousand, thirteen, I was teaching entrepreneurship. I was kicking around town doing strategy operations, work variety startups, and I was looking for what to do next and as part of that, I was kind of interesting getting back into investing but I didn't necessarily want to go back into venture. I. Wanted to broader mandates. I have always kind of felt allergic to the silencing of technology as its own sector was companies that put themselves up Technology Migrate You'RE RIGHT CG company that uses technology just like every other TV. Using technology and being technology to different things. So I was looking for something broader than that. 'cause I I love technology. I've been deep in it, but I see it as a tool to affect other things not as an end in itself and part of that process of pitching myself to funds was developing bitches on market places and market spaces than I. thought the funds invested into the spaces and I was really interested in were under banked and cannabis with. In Washington on the verge of legalizing, which they didn't January twenty fourteen and I kept in glass out of the room nobody was taking me seriously like I got a lot of stone jokes but I kept taking it really seriously I'm a big fan of the early days of venture back in like the Don Valentine days everything was unstructured. There are no clear deal terms. There's no standard sheets there was no anything just the lack of structure. Was the opportunity I'm like a big believer that once there's a vault guy something all of the real opportunity is gone. There's been evolved guide for venture for fifteen years. Now, there was no vault guide to cannabis is all brand new and was changing rapidly and that was really attractive and the fact nobody could have built up expertise in this already because it hadn't existed was a real attractive thing to me. So started looking at the space. I in a search vehicle format, we were thinking about it as a fund manager, which was my background in line with that was looking at different companies to invest in we're trying to be safe by investing more on the technology side trying to avoid plant touching operations dealing with all the legal complexities of touching the plants given state level laws was a big concern and a couple things happened is more or less all the same time I. We saw this race to potency going on with edibles wherever is trying to shove much THC as possible into the smallest container. Possible. We also made the decision that like, Hey, if we're going to be in cannabis, let's be in cannabis. Why are we nibbling around the edges? Let's take this full risk Michigan take a risk, just do it, and then the third thing that happened was my grandmother asked me for a pop Ronnie and those three things. All happened within a week of each other and what was really interesting with my grandmother is the she didn't want to get high. She just wanted to feel better and I couldn't offer her anything that would make her feel better had this one brown is hundred milligrams that cut him up into twenty pieces. I individual bag need half a morsel and wait two hours scared the hell out of her shoes never gonna try even offered her joint. And she was like, no, I'm not a marijuana user self identity was a big part of the. So we started looking at this as an opportunity and in terms of functional foods these are compounds that we know have effect. There's no question about it. Well, that's usually the biggest question with any new foods or supplement is, does it do anything in this obvious THC does something? How can you put it into formats that are mass acceptable that? Don't change people's identity and that are consistent enough that they can feel comfortable using it anytime during the day and that we can feel comfortable investing and building our brand against because we know that experience is going to be the same from day to day. That's we oriented ourselves very much as food company focused on cannabinoid rather than it cannabis company playing with food, and it's been like that ever since you said before we started recording that. In the early days and maybe still today this industry is filled with a lot of bullshitters I'd love to hear your take on sort of what the evolution has been like of the quality of the industry participants. Before we get into some of the kind of market sizing stuff which I find fascinating I don't want to denigrate the early participants in the industry. Anyway I don't think they were more full of ship than today's participants as participants are. But they are also full of Shit. It's not even intentional most of it is just. Ignorance or just arrogance gotten a lot of people who are like I'm well aware of how this market works. That's great. I've been here six years I've been studying everyday my wife and I don't even know that I know a thing about it yet good for you I'm proud of you. So in the early days had a lot of people who were renegades they were doing something that was quite strictly illegal when we. Joined the industry in twenty fourteen I like to joke that we were taking handcuff risk at that point we were but not nearly to the extent that people were a couple years before us, you had to really be comfortable operating without any sort of business controls operating fully cash don't worry about accounting just flying by the seat of your pants operating that business and I think when that all went legal a couple of things. Came pouring in and they looked at the marketplace and they treated the way they normally look at marketplace their new to let me see what the leaders are in like to invest money in them. Well. They forgot that it doesn't really work the largest players in an illegal market who have been given. The color of law are still the same people they were before they were given the color of law. They just were people who are willing to take risks that nobody else was willing to take criminal risks and nobody else's only Dick. Those are not generally the traits associated with building a responsible business that has cost controls, good accounting practices, governance, good project management but they were characteristics of the early markets. It was really interesting early days back at the beginning of twenty fourteen went to what was. Then probably like the world's largest marijuana conference, which was held at the Airport Holiday Inn Express Logan Airport in Boston and it was me and a room with thirty is fifteen of them were stoned out of their mind talking about the great shatter and flower that they were growing another five of them were lawyers and doctors understood what this could do and we're really interested, and then the rest of them were real estate guys who owned a bunch of warehouses that really wanted to get grows in them. So they get that really good cannabis IRA and everyone was shooting for in those early days. It's obviously changed dramatically I think up until last year at least or up until this year, he had a lot of people who still thought. This was all just going to be easy I graduated from Grad School rain to the teeth the great recession two, thousand, nine, I had to advanced degrees and no work experience. So I got a very clear taste of what things look like in a down market and I think there are a lot of people in this industry now, who have no conception of what a down market is at the whole promise of marijuana and imagination that is just suddenly going to legal and everything is GonNa Change I. Now these things are complex. The retail system is complex, the distribution system complex, the production systems all have to be brought up individually. There is a lot of people up in the early days who thought they could be I and be the Warren Buffett of we'd never mind none of them even knew what Warren Buffett did they just going to integrate everything I'm going to take peace from everything and it's going to be fantastic. Yeah. But then you never do anything well, and everything is expensive and none of the accounting actually works and what if the market changes? It's just There are a lot of these hopes and dreams. The didn't bare. Any relationship to how the world has ever worked in reality. I would love to walk through the industry a little bit for the initiated myself included I think of as sort of supply chain and value chain. What is sort of the end to end industry look like what are the major stops along the way, and then we'll get into caliber and stillwater. There's two things we got to differentiate. One is the CD industry versus the teach industry. Those are wholly different industries with. Wholly, different infrastructures and wholly different regulatory structures. Let's start talking about the THC industry because that's the one that runs tried to nationalize you though it is federally illegal and when you look at the THC industry, you're really looking at fifty different industries. Each state has its own set of laws and has its own market structures. Someday, there is just going to be an absolute glut of economic research papers on the natural experiments. Of, new markets with different market structures in the context of marijuana, which products they create in which behaviors they incentivize. So I talked to Colorado directly in a couple of other but in Colorado at least there's a three tiered system that's based on the same model. As alcohol a cultivators you've got processors and you've got retail. There's a couple of other that come up. But broadly speaking, you've got tears, you got the. People grow the pot. You got the people, extract the pot and make the products. Then you've got the people who sell it there is no like distribution infrastructure. There is no co-manufacturing construction. This was a big learning for us in the early days when we first came to Colorado and said, we WANNA, launch microdots t product we talked to people who are in CPG and they were like, Oh, you've gotta go find yourself. Well. Come in aren't legal allowed to manufacture marijuana in Colorado. To Go and get licensed to be marijuana manufacturer, and you can't manufacture anything else to get that license you have to attach to real estate well, that real estate's based on whatever the city ordinances are might have to be thousand feet back from. Imaginable, whether it's schoolyard to halfway house to open space that might one day be zoned residential. Then you have to find a building that doesn't have a bank note on it because at the bank has a mortgage on it, they're gonNA veto the lease. So you've gotta find a wholly-owned building that meets all the setbacks and is in a city or county too. Narrowly state that legalizes it's the state that allows for legal reasons, cities and counties that legalize. So you've gotta find it in a city or county that has legalized has rules that you can actually live with. So that's all part of getting the license huge. Then you've got to start producing your stuff. From the beginning we do not want to cultivate, we looked at cultivation as a commodity you do really well in the early days when the prices are high demand is high supplies low and everyone will just buy out anything on the shelves experts date on that markets mature, and you could make a lot of money as a retailer but you also. have to understand the most customers in this market are either tourists are highly price elastic. So it's really hard market to make that in. We were more interesting brandon goods because we felt like it was going to be much more generalize -able beyond one states we felt like that was really the linchpin between what we viewed raw-material just they can avenue eight. And a finished good product that actually had a consistent experience around it and really been the locus of our investment already ever since as just understanding how to qualify a good cabinet. What does that actually mean the raw material? These are things we've got a ton of food scientists now offer major companies and like to say they're very good at qualifying agricultural. Materials, they have learned how to do that in the large food and cannabis has its quirks. Fundamentally you're qualifying an agricultural commodity trying to convert it into something that is useful for processing, and then you're trying to actually manufacture it, and there's a really interesting side conversation to be had about things that held the cannabis industry back. One of them is the. US over the course of the last number of decades has evolved to a CO manufacturing infrastructure for consumer goods. So the same it's sort of a store rates. Aws has with technology where you used to have to build everything soup to nuts, manufacturer all yourself, and then the came these people who built the manufacturing infrastructure and you could rent time on. Their lines. So you didn't have to investments well, all the equipment that they had to rent time on was national scale even if the state allowed you to work with them, turning on their lines would produce ten times more inventory than you could ever sell. So there was this mismatch as an aside beyond that to the equipment manufacturers themselves stopped manufacturing small-scale. Equipment it was really hard to just find stuff that could be used in a single state environment. So there was just a lot of complexities to be worked out in this market for it's actually function because everyone was trying to assume like, okay. What I see in CG that's GonNa work in THC, it's like well now there's fifteen reasons why that structure. Doesn't work here. All of the tricks that you've got you've now got to figure out new tricks, none of those work any other interesting backstory or timeline points just in terms of y took. So long for this to happen, the you think are important antecedents took on where we sit today whether that's laws regulatory wars, kind of the social stigma of it. There's scientific excuse for marijuana have been sitting around schedule one for as long as it was this was known when the schedules I came out. There was Schaefer Commission report that immediately recommended rescheduling the Nixon Administration put in a drawer in the early laws all the way back to the stamp, Act Tax Act it was racism against Mexican immigrants the word marijuana prior to the marijuana tax act cannabis tincture marijuana tincture was. One of the top three most used drugs in the country you can go back to the US Pharmacopoeia and find lots of tinctures there. You can find from Bayer Cannabis tincture in them, and then it was decided that this was associated with unwanted Mexican immigrants, and therefore we need to illegalize as much as possible. Then you've got coming up on the controlled Substances Act in the late seventies, there was an interview with. AIDS he stood up admitted we couldn't criminalize being black. We couldn't criminalize being anti ward, but we could criminalize the one thing that they had in common, which is a love of marijuana and that part on crime and tough on crime mentality the racist elements, all of that just hung around for a long time, and then you just had this cohort issue where you've got. A whole generation of political leaders who still believe this is a political third rail despite the fact that it's got sixty seven percent approval among the population large and even fifty one percent approval among Republicans it's just one of the strongest mental models cohort replacement. Some things don't shift until the people who are holding them back are gone and I think this fits that bill very. It's fascinating and so screwed up in. So many ways when you really dive into the history here, it's this sequence of bizarre events that lead to a very large macro outcome. So appreciate those little touch points there. I. Think definitely something for people to go look because it's hard to believe some of this stuff until you read the laws, it's hard to believe it. It's also. It's hard to conceptualize. The concept of a drug is a mental frame and the concept of new illegal drug is a mental frame can't tell you how many conversations I had more in the early days of this company where people be like well, I don't do drugs I'm like you got a nice wine cellar over there man well, no, that's not really a drug I'm like some nice prescription opioids on your cabinet. Well, that's not really my doctor prescribed. I'm like your coffee really enjoying that caffeine right now. These are all trucks they all augment physiology. The question is really what is the safety profile? What is the effect marijuana THC? These are fundamentally no more or less dangerous than caffeine it's interesting to compare how caffeine has been regulated over time versus how marijuana has been regulated over time visit is just a very natural counterfactual. That is fascinating about what is accepted, what is rejected, and what that does to two things that have a very similar safety profile. If anything marijuana safety profile THC safety profile is better than Caffeine's. Raises an interesting question of degree. So I think the impact of smoking a joint or something at least in my experience a little bit more impactful than a cup of coffee. But I think one of the things you've learned is that ethic you mentioned understanding the actual molecule better and Sorta dosing and what that range might do to people say a bit about how that figures into the business plan the products answer to how you build the brand. I basically throw out almost all research done before twenty sixteen throughout all research done around SM- inhalable marijuana because we just don't know all joints are not the same. Every joint is different. Every person is different. The amount that you're actually consuming is unknown edibles are actually started our first opportunity to control that inputs and reduce the variable there to something that what came out on the other end was actually observable and useful. We do a lot of work at our company with some academic partners on studying the pharmacokinetics of our products. We WanNa know how much THC is actually absorbed into. The bloodstream in different formats, how much CBD's actually gets into your body? How much do you take a pill but how much shows up in your blood and it turns out that everybody is different it's wild person person variance in terms of who absorbs what and how much even in waterside overseas water insoluble formats is crazy. Some people just can't get high some people don't absorb CBD other people can only get high through edibles which absorbed through different pathways than inhalable inhales, and this is all great science that should have been done thirty years ago, but has been delayed until now. So look. At a lot of the old studies, I'm just like I don't know what to draw of that is because you've there's a question of magnitude I think it's almost criminal to ever talk about direction of effect without talking about magnitude of effect, and this is in pretty much any circumstance. There are absolutely risks with THC never going to play that down but the magnitude of those risks have been wildly overblown and we are learning more and more about that. especially different dose levels thc kind of three different drugs want a sub five milligram dose for most people it's like a light and. The Olympic perfectly fine people can function operate no problem whatsoever five to ten or five to fifteen. You're starting to get real stones. You're getting high for most people although changes again, like different people have different tunnels at least with thc once you start getting above fifty, it's a psychedelic experience. Almost it's not one that most people care repeats but the for you can really start discussing what's the effect of marijuana? The question has as many multitudes. What's the effect of computers? There's a lot of nuances be baked into their before you can start answering that question with any sort of specificity that's. What's the most interesting difference between the CBD Industry in the industry? What are the relative sizes I could even wager close guests as to how revenue basis or something what the difference between the two US I've seen good numbers the legal thc industry I think sitting like ten to twenty billion range today. The illegal industry is sitting in the sixty to seventy billion dollar range for THC. In MRS IN AMERICA CD I've seen estimates that this year you're talking like two to four billion I. Think are probably a little bit high it's really hard to tell CBD has just unregulated THC is actually more regulated in CBD right now thc like, yeah, the FDA won't. Touch it. But at least the states are paying attention to it before products on the shelves in well-regulated states like Colorado it has to go through cannabinoid testing, which is imperfect science that is developing but at least it's something. So you at least know what you are taking to a greater degree than you used to. CBD. Now there's none of that companies are self-regulating but self-regulation isn't a thing self-regulation is just asking for trouble. There's no incentive to actually abide by the rules when I lobby on this issue I, keep saying the returns I'm lying or far greater right now than the returns on doing the right thing and that's a regulatory fault that is. Something that regulators can change the answers by putting in place regulation. How much do you think is left to be unlocked in on what timeline? So it sounds. So it's still early days when I asked, what are the top three variables that matter for the future here you said regulation regulation regulation. So what does that mean and look like almost all of it is left to be locked when you think about like I said, the THC market right now it's fifty individual states that operate all lines soups and not supply chains more or less the national industrial food supplement and beverage supply. Shane is in the US is probably the most robust in the world. The. Marijuana supply chain looks nothing like that and could benefit holy from that. This is to scale structure that has been put in place yet there's a breadth of use that has been put in place yet. There's no reason why a lot of products can have one to two milligrams of THC as not a intoxicating dotes there's no reason to treat. That's the way that we do the ten milligrams stuff. Yeah. That should be treated like alcohol. That's great. It should be I, think the CBI we got we know so little we know that it has bioactive fact we know that I mean it was proved as prescription drug it clearly as bioactive effects got good. Properties, it's God's good anti anxiety properties, good anti inflammation properties, but we don't know at what levels it has those in four which people in for what conditions this sort of thing that only really comes through research and experience and just putting the markets and structuring the market so that you can continue to collect good data especially as regulator, and so you can make good decisions and how to build for this forty. CD. The tinctures that are the most popular part of the CB world-renowned. CAD Onepointoh. Was All these pictures that would go everywhere well. The best research we have suggest those things are six percent bioavailable, ninety, four percent of what you consume is getting excreted out without entering your bloodstream. It's one of the people don't have a good experience that product it's also basically intermediate good nobody runs out and says, you know my favorite thing in the world is to do is to drop raw crude oil on my tongue with an eyedropper that's not a consumer product. There's also sets of claims that have to be developed around but that takes time in research once you get past the teach the canals in general this is a category of ingredients think people make. Claims when they say one hundred and thirteen identified cannabinoid all have bioactive the fact yet maybe to some degree, but the real question is going to be which ones of those can be produced in an economically efficient way and brought to market with a safety profile that matches what we as a society are comfortable with and sold for profit. The answer to all of that is probably going to be not I think I'd be happy with three to five additional. Follow on can happen in the next decade that would come up. There is a set of materials that are the most fascinating bioactive that anybody on my team has come across I've got people who spent the last twenty five years at eminent Mars, working their functional ingredients, divisions, and wave and horizon organic. These are food scientists who have been paying attention to neutral to bioactive ingredient functional ingredients. This is the most exciting space of new science, any of them ever seen. Can you talk a bit about the kind of business and investing angles here? So one interesting question is does some of the opportunity exists because it's so fragmented and the big brands big CPG brands can't deploy their scale and their marketing advantage to just go win the space right now, talk about that transition period and sort of where you think the pockets of potential value are for entrepreneurs and investors. So there's two things that I think are holding back. The big brands one is you're right federally illegality is holding the back anybody who has existing. Business Line to protect can't afford to take the risk of operating this. We've said from the beginning that one of our big benefits is that coke isn't sold on the same shelves as we are or not solving some shells as they are sucks that we can't sell on their shelves, but it's great that they can't sell ours dispensaries are unique environment aubrey much more like jewelry stores than CVs bud tenders drive seventy percent of the sales of new product sales because people come in and they know they want experience, they don't know which product to get. So, this is all opportunity that is available because the big players aren't coming able to spend time on so that you can succeed at a small scale and really make it work. The other thing is the lack of federal legality just cuts all the advantages out from those big players. Those guys have all built up infrastructures that are designed to serve massive markets. If you told, Coke, I need you to produce enough soda to serve one person a day. They're like, great. We do that five times a day. No problem. If I might great I need you to produce enough coke to serve hundred thousand people there like Shit. I don't know that I've equipment I can turn on and turn off without losing all my money. That's too large scale they also don't Know like that thing that I want produce what's the right formula for it? How do you get to the right formula? You have to start small and work your way up companies not that I think that has been a real advantage to the marketplace just all of the things that make it hard are the things that keep coke and Pepsi out in things that keep innovation and small operators and opportunity in at some point they're going to come in and that'll be a different. World but in the meantime is long as you have the right understanding of what the opportunity said is, which has to take into account with the demand side looks like where you can ship to truly what the market is and you build your production platform to match that. Then you've gotta opportunity if you over build relative the opportunity, you could get into trouble real real quick. What do you think is the competitive frontier for your businesses consumer brands versus others? Is it equality is? The brand itself is it relationships with bud tenders never heard that term that's hilarious. What is the competitive frontier? Where will this battle be won or lost again it depends on timing. It's very easy for a lot of investors who've gotten used just investing DDC brands on Instagram is friend of my calls at like Qvc for millennials where they just have platforms they spin up a brand, slap it onto a commodity product and make some money off facebook ads. No other profitable vomited lives. We're not there yet a brand without consistency is just a logo. You actually have to produce a consistent product and that is actually really hard specialize in term can avenue it's water soluble. The reason why we do that so that they'd be placed into water based food systems and as well. So low fat food systems and we've also discovered that there is a much better absorption profile. So people actually get what they have bought into their. Bloodstream to do that, consistently, it's taken years of our investment and I think when people go to fast with too much money they go in the wrong direction I. Think you saw this with constellation had this whole thing when canvas two point Oh came down where they're like, oh, like can liners the aluminum can liners were t h c? So we have to delay launch well yeah. That's because you treated a two million dollar problem like two. Billion dollar problem that was a solved problem. Already, the CAN liners and it's solvable if you have a small line and good food scientists who can operate flexibly. But again, there's new science here. What is the shelf stability working in acid versus base will abass breakdown CD? The answer is, yes. Do you need a high s environment for it to actually live in? How long does that see stick around does degrade below the label claim these Are All like the structured parts of the food supplement supply chain. It has to be verified before they can be scaled and I think a lot of people were just especially if you're trying to do brands, you want to go straight to scale because you want the cheapest way to get their word and infrastructure phase in this industry you've got to be in it for that. You've got understand what you're getting into some day will brands went. In when you've commodity infrastructure that everybody has access to that's the only way to differentiate. But today quality and capabilities are how I think you differentiate yourselves. You actually have to build the platforms on which you operate. You don't get to go out to just rent somebody else's. What are your thoughts on sort of where this all goes from here? So if the first part of this was the handcuff risk, the second part is sort of the state by state period of time, and maybe the third piece is some sort of federal unifying. What is it time for something like that and when will we look back on this and just think was a crazy period of transition. So on Thc I think you could see a lot of movements next year depending on the outcome the election obviously marijuana reform in social justice reform and criminal justice reform all tied very closely and for many obvious and deserve reasons CBD, you had Senate Majority Leader McConnell legalizing the production Of Hemp at the end of the twentieth Farmville by it's FDA has been slow to actually accept responsibility for the derivatives of Hemp that legalize namely CB FDA's claim to three to five year time line I. Think it's wild for a food public health regulator to just ignore a market where twenty to forty million people a day are consuming a product totally unregulated because they don't have enough information now you regulate the market. Can you improve regulations over time? You don't look for perfect in the meantime consumers to twist in the wind. So that goes back to my point of like you need regulators who want to regulate and I don't think we have that right now. I, think hopefully, we will have that by this time next year and if you have regulators who are dedicated to. The concept of public health who are dedicated to imposing the will of Congress and enshrining that's in administrative policy. You could have CB regulation. Next year, you could clear up the banking issues around THC next year you can get thc probably starting decriminalization, but heading towards legalization with next twenty, four months. These are all things that could have been set any time in. The last four years. But one thing that I do believe is if thc and CD of manage to make this much progress throughout the administration's attorney general sessions and bill bar the two most anti marijuana people I could imagine God. I can only imagine what happens when there's somebody who's making the life's work to destroy it so we could be looking back on. This three years from now I think with wonder I kind of hope that the next president who every might be would embrace marijuana in a similar way to how President Obama embraced gay marriage maybe was circumspect that the election but then he got it across the finish line once he was in office and I think that's totally implausible analogy that can happen here. Can. You walk us through the business itself in sort of what it looks like in terms of almost like an income statement walk through what kind gross margins are we talking in a business like this? How to sales and marketing figure in what are other notable key aspects of business that determine its long-term kind of margin potential again, it's different each stage, the supply chain. So I can really only speak to my point as a products manufacturer. The margins are quite good. You're talking thirty to forty percent even a-, and the key thing is we don't have a huge salesforce only got three, hundred thirty stores to sell to. We got a salesforce three. This is on our THC business side. So that's still water brands are THC business, it operates. Serve three hundred sixty dispensaries covering a population of around eight million total population state population around million we self distribute to them through a mix of couriers and our sales people directly dropping off. There's not a lot of advertising to be done. So I don't think people fully appreciate the Google and facebook won't take money from CD or THC companies. If you've seen those ads than they were placed their against public policy and usually through some sort of work around that was probably enabled by the sales team at those. Companies, but it's frowned upon by the legal team. So it's not like you can spend your burn a hole north performance marketing. Even if you wanted to, I mean the way you do it is you have to, if you want put an ad on Instagram I, you have to go out and buy like an affiliate's placements and get an article written on some third party sites, and then you have to have them by an ad against that article that links to your website. The transaction costs neoclassical economic sensor just massive. In the space and yet still thirty five percents been. So wanting a lot, we really pay a lot of attention to operational control. We pay a lot of attention to emergency pay a lot of attention to good process because we believe that if we can learn to function in an environment as fucked up as this, the headwinds are only receding. So it's just removing from advanced level as we get towards clear federally galaxy, you're retreating towards and more of an easy mode men no play just more and more opportunities. Open up for us. But for now, you're just facing problems everywhere you look everything takes five times longer if not ten times longer, it takes three vendors to find one who can do the job. Each one of those vendors takes two months to figure out what they know anything. It is a blanket rule in myspace space for my staff. Don't believe people when they tell you things it was a blanket rule for me as an investor, but it's especially a blanket rule for me here and it's not because people are. Dying I think people are just they're optimism they can't distinguish between optimism sales and lying. So as seen like rafter after people come through with just huge plans that never made any sense never materialized. Thank you back to that founding story I'll of the POT Brownie story as to the origin insider something what after that would you classify sort of the first big break for the business? So if you've had any step change improvement since the prospects of the business, what was the first big break that stands out in your memory? After we decided to become a food company, we wanted to produce a product of my grandmother ninety year old seniors and the product came up with is called stillwater. T was tune half milligrams of THC, and it was explicitly designed not to get you stone. It was supposed to replicate the feeling you'd. Get from taking three deep breaths and have of that last for a couple of hours and we went out to sell US dispensaries and were met with a collective T.F. We had one by tender is like did I take three hundred milligrams for breakfast? Why are you pitching me a two and a half milligram product to which the responses I man you've gotta problem but second this product isn't for you. This product is for other people some would get it. We would get people would give it to their mom but tenders and her mom or the grandmother would love it, and then they would become real advocates for it it. Never, really took off and it turned out because you have to account for what your retail channel is and the people walking into dispensaries just weren't that interested in the low dose products we couldn't market to try and bring in more people and the dispensers themselves and really have much interest in going outside that core customer base and they were making money and they didn't do any work. Everybody loves making money off studio work. So we couldn't get the target customer that we built this product around to even get in front of us to even try to make the sale and that was a big learning for us. It's sort. Of like you can't fight the Fed you can come in with the mark in, want to say have all these big ideas for how things should work? Why aren't these products merchandised? Why are they all behind glass? Why am I listening to a bud tender as if he's a pharmacist, why can't we advertise talk about the things that we're doing but then there's like the market as it is and you've got to figure out a way to sell into that. Fortunately, we had on the back end. Nice little innovation story where to produce the water soluble component of the teas. We were basically creating these crepes of slurry like an. New Type feeling texture, and then breaking them up by hand, and we were dumping the granules into t sticks. T stick was our form factor. It looks like a stick pack with of perforations functions a teabag, but is part of that we had to have granules of a certain size. So all the grain was smaller, the fines we're basically throwing out. Well, our yield was turning out to be like fifty percent of our THC which are core input there and That was fine with a a half milligram product. But when we realized we had introduced a product that would get bud tenders excited. So we made a ten milligram t we realized that man you can't get by with fifty percent yield on the ten milligram product just getting destroyed on margin. So we looked at a couple different things we could do whether we could try and find a different way to gripe ultimately decided was, hey, this powder parts the water soluble. Piece was really the most interesting piece when we package that up into packets and sell it as done product that became ripple ripple is like a little stick pack odorless liable flavourless clean label, soluble thc. CD mixes drop straight into a beverage and dissolves instantly, and that was the product that came out of those two things to go. The need for product would get excited the need for a process or a use of the waste so that it didn't destroy margins. And suddenly that what was before waste became our growth engine that was the product that took off everyone got really excited about eighty that you can make anything an edible and then they got really sight even further because we started discovering that people are giving these anecdotal reports that they were getting high faster with ripple than they would when they were taking other edibles and we believe them but we couldn't prove it until we went out and actually did the studies. What a fascinating turn of events really cool story to look back on the book and our conversation with another couple of questions just bigger picture kind of harkening. Back to your background as an investor first and then wrap up. So my first question is you mentioned studying under Tim Wu what specifically you learned from Tim. What made him special what you take away from your time learning from him I don't want to oversell my relationship with him. I don't think he would know me from Adam at this point, but he did have the best class I took and he was my major writing professor. But the big thing from him was just that market structures matter. That was what he was really talking about back. Then I think it's still what he's talking about today. These things don't just exist vacuum markets don't come out of a vacuum they're not naturally occurring. There's nothing natural about them. They are created by man therefore, they need to be created with intention if you hope to get out of them what you expect. You also mentioned that you're intrigued by Jim China's idea that this is sort of a golden era for fraud I'd love to hear why that idea is interesting to you and kind of what it means to you. That just feels like sort of violently true. At this point, there is absolutely no penalty for lying bullshitting. At this point, we are rewarding the bullshitters from top to bottom and. That's fine I guess I think there is a belief that you need founders who almost bullshit themselves to create companies out of nothing. But I think that that's a form of idolatry that I think is just straight up wrong. There's absolutely no reason founders of not different from other people may be more tolerant of uncertainty. Some of them are good businessmen. Some of them are bad business people. They are also humans. They are leaders of humans and I think actually putting together an organization where everybody is treated as a human where everybody is not asked to participate in a cult where they're not asked to put the company over themselves where they just like this a job I need you to be good. At it and then I need you to go home and enjoy your family. That's a much healthier way of doing business and I don't think you would see any reduction in good in innovation that actually has societal benefits off of that if anything you'd see the exact opposite I think most innovation these days is geared towards things that can really raise the value of equity but not necessarily be standard of living of all the employees within the company. Yeah I hate this notion that founders are aliens who are just really good at some sort of thing most of the time they're actually atrocious human beings who are just being carried by competent people within their organization while they're being treated like children internally. If you had to re enter that world and be backing founders actively, how do you avoid that problem? What would your advice be to investors who are primarily making bets on people to avoid that type of person? So you have to structure its Jerry and I talk about this all the time and I am fully on board with him that we're both on board with Connor and Gary King that there's no such thing as intuitive investing when it comes to people, those are complex open systems. If you tell yourself, I just like the cut of his JIB, they turn out to be great. That's look good for you. That was not something that is repeatable. But what you can do is you can create structures decision making structures that try and look for land mines we those out you can try and raise the floor of whoever you hire. Don't think it's possible. To hire perfect person what perfect means different in the context of an organization, a team time. But I do think you can at least construct a hiring process to probe for things like integrity to probe for things like a willingness to play games at the truth to probe for just the difference between somebody who can describe things for somebody who can actually do things I think you focus on those and just mart has this great smart hiring thing yeah. The book is fine. His PhD thesis as much more interesting about how you actually setup decision structures for unstructured decisions. My best resource for this something, I think a lot about two is the CIA. As internal, library on making structure decision making in unstructured situations. As good as it gets the you think about what an investor is doing. They are trying to predict inherently unpredictable complex system, which is itself impossible to predict a point out gum but you can at least start predicting ranges of outcomes if you structure thinking well, and you can avoid falling in love with a specific outcome, given that the same facts might also align with a multitude of other. Outcomes. These are just things that I think are really important. I also think it's super important. Always play the counterfactual 's anytime anybody I'm mateen is like when you guys did this, that was so smart as like, yeah, that was smart but let me tell you about the three other things we wanted to do before we landed on that one that was stupid that could have worked and we could have been going in a totally different direction and tell the. Story about you just heard the story about what happened with ripple that story could have gone in a bunch of different directions. We get a double down on low dose DECI- we spend more money on performance marketing maybe that would have worked I can't say that it would but I think it's really dangerous to get into the mindset. It was always going to be this way and it was always going to be this way because I'm so good bullshit I. Don't care how good you are. The world is complex. Luck is massive massive factor. The best thing that you can do is put yourself in a position to have better larger options than you had before as long as you keep on doing that eventually, you're gonNA, find the option that you can really lean into at say that a lot with this company, this company is large lever that I ever hope to hold and it got that way because we just. Start with very small lever and kept putting ourselves in a position to God and find things to add onto that lever. We couldn't pick exactly which one was going to be the thing but at least we had the opportunity to go after them in the Cannabis Bay specifically what do you not understand well, today that you wish you did cultivation is fascinating to me I. Know I don't understand it. I. Know Enough of it to know that it's complicated I. Think that everywhere you look in the cannabis supply chain it's easy for to look simple especially when you start scaling it up, things get very variant very quickly just because you understand something the way it operates at one scale doesn't imply that you understand how will operated another scale. That's one that is always scary news just trying to understand what's the next model that's going to work for thinking about this industry. I knew a guy wants who got his PhD. In philosophy of friction and he described it to me as the way that friction works at a molecular level is different than the way it works at an inch levels different. The way it works at a mile level. The philosophy is Wendy. You Change Your model for what works something that has describes the molecular level, and now you've got somebody that describes step up if you try and take the molecular model and apply it to the inch model you're not. GonNa get anything predictive and the models I have for marijuana. Are they just Colorado? Specific? We're GONNA find out soon we're going into Michigan next year is this as unique of the market as I believe it to be or are there lessons this market that are transferable to other states each state truly unique from top to bottom and everything has to be relearn. We don't know yet and that's both scary and wildly exciting. That's what keeps a new and fun. Well Justin I've learned a ton today I like I really didn't know anything about the space coming in and now do so I really appreciate your time. My closing question for everybody is to ask for the kindest thing that anyone's ever done for them. I will tell you at least in my professional career. kindest thing that anyone has ever done in my professional career was Roger paying me out of his own pockets to be an intern it I A and they were friends and family company which got me out of a job in San Francisco that I hated, which got me back to new. York with my wife or at that point my girlfriend now wife which led to me having a kid a dog in a company and all just because he was willing to expend not much money to get somebody who he thought was smart and could help the fund. Fantastic could easily bands but he did it and man and my grateful it was kind. Fantastic. Well, Justin thanks again for your time today I've learned a ton and I hope to send such. Thank you appreciate it. This episode was brought to you by Microsoft, for startups Microsoft for startups global program dedicated to helping enterprise ready BB startups successfully scaled their companies. In our five part miniseries. We were talking to Evan Riser CEO, of Admiral Security about his experience with Microsoft startups. In this week's episode with Evan. Talk. About. Technology. Shifts and picking a cloud provider. What has changed about companies sort of clouded option I would count us and our business in the same category of like slowly, and then suddenly you know we had to adopt this sort of thing. So maybe just describe what exactly because it sounds like a technology platform shift that often makes new companies possible. What exactly has changed and wise a company like yours position. Well, for that yet I think two things one is just how enterprises work. Then the second is, what are the new platforms that allow small teams do a lot with very little. So they in former category like the the general shift is. Enterprises it stack moving into the cloud and the prevalence of migratory five is just an example of that. So that enables all this it and security deeds be available in the crowd and therefore accessible Api's, and so we wanted to build our product ten years ago would need a fundamentally different architecture that wouldn't allow us to get as much data at the same level of detail in deploys quickly and I think with the with the rise of infrastructure and cloud computing, and even more specifically some of the higher level services like azure cognitive services. Those are tools that allow relatively small engineering science team to go build. These world glass enterprise ready applications you very quickly. So you just started in two, thousand, eighteen. So you're you're young company even though you're moving quickly I'm curious what the experience was like at the beginning as you thought about what tools to deploy this is one of the more interesting things for me. Now, because the toolkit available to founders say eight years ago is very different from what's available today you can do a lot less building of commodities stuff or stop it's not your core competency. So how did you think about that? How did you address the problem of what stack of Third Party partners are we? Going to use to build this company on top of we arguments, mistakes, Some areas were very thoughtful wants for us. Thoughtful when we started right we knew just like the speed to market a was going to be very important for us. So we started off by just using the or familiar with right. We didn't do Lotteries Urs WanNA areas, one example inside cotton infrastructure when it to things like cloud infrastructure, it's not really just a technologist it's really a business decision and the reasons why we decide to invest on Azure I think this to on the technology side we had to have the most secure. Of Privacy Centric Clapham to bill on top. Of. The the second thing is clearly for a business and we the technology platform that will need lots to spend more time focusing on customer problems not on rebuilding commodity technology. So being able to use higher level services like AI and machine learning computer vision getting that out of the box just allows it up to do a lot more faster. Of course, I, realize the irony of me being a enterprise technology CEO saying it wasn't a technologist vision but I really think the reason we ultimately decide. To invest in the azure platform was really around some of the the business benefits glide came down to just what is most valuable to the company for companies like us we currently work with maybe three or four percents abortion five hundred. So the biggest challenge for us as a Harris, the other ninety, five percents, we wanted to reduce the cost required rush to go and market ends acquire customers into their scrape programs like the Azure co-ceo program, which enables Microsoft sellers to go sellers from Russia. and. Help with us to help solve customer problems. I think the other thing that was really important on the business side was we wanted to increase our success with customers by lining their strategy. So a lot of CIO today are interested in consolidating architecture into the Microsoft ecosystem they want fewer and fewer point solutions independent and they want one interconnected ecosystem that that works well. So the ability to enable our customers too busy investment microsystem to buyer solution gets as your consumption credits as part of. That to reward them for their Microsoft ecosystem investment. That was another key piece. Big thing for us is that we realized that conner infrastructure was much more businesses and in the past I would have offloaded that to maybe the engineering team and had them kind of side. But for us, we brought to the board and he said Hey we think that all in this actually more important for the business, we get a lot of benefits for both the company and for our customers by investing Microsoft overall. To find more episodes or sign up for our weekly summary visit investor field guide dot com. Thanks for listening to founders field, Guy.

marijuana cannabis Colorado facebook Microsoft I ventures Patrick o'shaughnessy US Vantaa Advanta founder Venta Shaughnessy Jeff Telekom CB
Ali Hamed  An Update on Private Credit - [Invest Like the Best, EP.172]

Invest Like the Best

44:46 min | 1 year ago

Ali Hamed An Update on Private Credit - [Invest Like the Best, EP.172]

"This episode is brought to you by coffin. I've become very interested in the best software tools in investing and when I asked twitter for the best Bloomberg Alternative. The overwhelming winner was an excellent new product called Coif and it's a web based platform that you analyze stocks. Etf's mutual funds and other asset classes in one place. I've been using everyday to track. What's going on in the market and I think if you try it you will to. Cohen has a ton of high quality data powerful functionality and clean interface. The best part is that it's free you can sign up at. Www DOT CO DOT com. That's K. O. Y. F. I. N. DOT COM Hello and welcome everyone. I'm Patrick Shaughnessy. And this is invest like the best. This show is an open ended exploration of markets ideas methods stories and strategies. That will help you better invest. Both your time and your money. You can learn more staff to date that. Investor FIELD GUIDE DOT COM. Patrick o'shaughnessy is the CEO of Shaughnessy Asset Management. All opinions expressed by Patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes. Only and should not be relied upon as basis for investment decisions clients of Shaughnessy Asset Management May maintain positions in the securities discussed in this podcast. I guess guest is popular past guest. Ali Hamad who joins US FOR AN UPDATE ON PRIVATE CREDIT? We discussed what has happened. So far what parts of the market frozen and where opportunities may lie we also talk about how the world has shifted digitally since the beginning of the Kobe pandemic. Please enjoy my conversation with my friend. Ali Muhammad Ali. I've been doing a lot of these updates on specific areas of the market in the Kobe. Era Haven't done private credit yet. I've been really excited to talk to you about not just private credit but sort of all UC in ecosystem that you operate in. Maybe you could begin by giving me a sort of state of the Union. What are you focused on right now? What's been surprising? Or unsurprising about the world of private credit and how it's reacted to Cova thus far sure so I think first reaction is everyone sort of froze for at least the first thirty days. I mean the problem is no one under OCHO pandemic and no model matters anymore assigned. Yeah we're having a conversation or investment committee meeting this morning we were having genuine conversation of what over fifty percent of your heart city rent and then I look out my window and I'm looking all these buildings like all it's truly insane and so I think that the number one difficulty in transactions closing our that there's such a variance of apple. Come that people don't really know what safety is anymore. And so I think the first thing that started to happen is anything that was a short duration assets started happy at worked out quickly. A lot of people say well. The short duration my asset less correlated the market. I am because if I buy something. That's long duration. Like I don't know it's been happening. Your three. By by sending at sixty days and duration like a bowl or surgery merchant cash advances can probably figure out what's going to happen sixty days from now in this case. The world changed so dramatically. So fast that if you have an asset that's due in sixty days you're dealing with it now because maturity coming up and if you had a five year loan out to somebody you know you can. Defer payment for a few months ensure three sixty payments may not come in over the life of asset. You'RE GONNA be okay if sixty or thirteen day. Seventy Day asset. You're probably not taking phone for anything else. And also a lot of people. Their funds weren't set up to do trades as quickly as they occurred. I think a lot of stuff that happened. In March you really had to have a certain fund structure or a certain level of discretion to go make certain trades because it trades went away quickly so there a combination of people freezing if they didn't have to do anything the short duration or assets the faster. You're trying to move and the other two things that we started to see. I was basically people spelling. Uncertainty wasn't really distressed in distress. You kind of have a saying and the thing didn't go as also supposed to Gal and so you can buy cheap in a high yield exchange all the work you're GONNA do try to set but in this case basically people are just giving us a bag of stuff and they were like. Hey here's a bag and I don't really know what's in the bag. The bag seemed okay. I don't know how to bag is GonNa do and a pandemic you want the bag also. It's really cheap and find certainty. Didn't feel very good. I think a lot of people said let's just wait. Let's in our hands look folks on a portfolio and let's de risks and not. Let's go find a million things to do. I think that's GONNA come. Miss could end up being selfish. Look on my God could end up being like a pinnacle moment. I career of the type of stuff that we're about to get to do but there was a total shutdown anything that didn't need to be focused on immediately. Can you give me an example of what a bag of uncertainty looks like? So let's imagine you were looking at a fund that was making small business loans. That is a big bag of uncertainty. What will you do? I don't know seems like restaurants is not going to help restaurants a lot because restaurants don't need any anyway of shutdown maybe they do have more resiliency and then what is it a fault. Rake GonNA BE IS GOING TO BE. Ten is going to be thirty. Percent is going to be a hundred percent. Were looking at stuff. Dah is not really left. Bird even senior teases Not Above fifty percent chance. That are training discounts. This kind of crazy and also things haven't behaved like you might expect them to you. So the subprime I got on the call with a guy who was originally in super super deep subprime. Consumer loans and his company is doing well. But they're not profitable and is investors are trying to figure out. Should he keep origene this environment am I? I think that I got on the phone. I said I bet you. Your book hasn't seen any issues yet is like shocked. They had already seen that because it was just weird subprime consumer really hasn't seen a huge tick up into salt yet because a maybe just got laid off or be. Maybe they're not going out of house. They're not spending a lot of money or see. Maybe they're not paying their rent but they're paying their other loans because they're watching the news and seen had on rent right now just so many like saint near prime is probably going to have more variance subprime super primes knows. I mean I think a lot of people are going to their loan. Tapes and looking occupation of their borrowers super important to know what percentage we're GONNA ask Allie right now all kinds of stuff. Let's talk about what the important levers are for you in private credit so private credit sort of more of a niche asset class. Everyone's quite familiar with what's happened in the public. Credit markets with fed intervention investment grade and in high yield may be more awareness of. What's happened there but talk about sort of the important things that you're watching in the private credit markets generally speaking and where and how sort of what you guys deviate from. Say like the Beta of private credit if such a thing where to exist so I think one unique thing about private credit or especially lending in general is the diversity of the assets and without means as each asset is serviced or originated by a company with a bit more unique domain expertise normal. So let's imagine you're looking at a traditional asset in public markets and some servicer of home. Lots I think a lot of people are like looking at the servicers and wondering what you're GonNa go bank really trade in that space. I don't WanNa over imply that I'm an expert. I know in my world the I think people are looking at is the originators services. They work with that. Make sure that the assets to be like their secured by are getting paid back and when you're in a world that's as mainstream is ready or commercial real estate. There's a lot of services a lot of originators and so one originator goes bankrupt because we're now in a tough economic time and they're the bottom stack or they can't operate okay. Go find another backup service or and they can go servicer and you're paying your home loan. You don't really care who you're paying back in specialty lending a lot more domain expertise in each of these each of the lenders one of the things that you I've even talked about is when we look at sedan seen assets. One of the things that's most important to us is that the assets aren't hard actually service. We're looking for things for this. Automatic repayment with a repayment comes from someone other than the borrower. And because at times like this. If you're lending money through an originator and part of the originators core competency is their ability to go get the loans. They come back all of a sudden. You've actually taken implied corporate credit. And you have all these sort of technical startups and large originators. That aren't operating profit. Still rely on venture capital funded. And if you're lender lending through one of those. I think the first thing you're doing is working with your original or see if they're going to stay in business or figuring out ways that you can help them standpoint S. so as an example some of the things that these people are probably doing early on is line waving the repayment penalties. Because they want just the money to come back another thing they might be doing is lowering their advanced rate. Hey if you can raise. More equity is taking swings. I think they're saying you can raise more equity even a really cheap price. I'll lower my advance rate in exchange for a lower rate of return. So I think people are basically doing a lot of blocking and tackling with the partners they work with on a day-to-day basis services assets as sort of a first order. Because those are things that are breaking I. What are the scary scenarios for you in the private credit world is it basically? Just a wave of defaults. You've already mentioned this types of assets and we've talked about before the types of assets you're learning against are quite diverse produce pay for example people are still eating fruits and produce so. Maybe that one's doing well but is there systemic big systemic risk in the private credit world as much as there might be in the public credit world. We don't know yet. One of the arguments against it again and my point are the acids and private credit are a little bit more diverse. How many other people are finding it? Same Produce Right now not a lot. Then I think a lot of it's just really unpredictable and some people are GonNa get left holding a bag that navy desert you like. There's things that we did. That were totally skillful and are genuine and as other things that we're lucky so in terms of skill yeah like we underwrote to the fact that people are going to eat kershaw produce and we all still under road to the fact that stays incredible operator so even when I wake up and I look at the Wall Street Journal and it says Oh Man. Ferrostaal produces being thrown out and dumps. It turns out that I is really good at helping. Farmers redirect privilege to non-hostile auspey Talbot type buyers and into retail grocery. Get to sleep at night and a lot of our operators have been able to adjust quickly it turns out a lot of what we stance is tech enabled assets and. I could have never dreamed that the reason we're going to go to a recession is because people were going to be at home. Using their technology assets deals in many ways there's people who again were financing really high quality real estate assets hospitality assets. That is not that they were smarter. Dahmer taking more leverage than seemed appropriate. I certainly didn't have sales and revenue of hospitality. Going down ninety percent any model. I ever bill so I think you are gonNA see surprising. People get blown up because it was just such a odd event. I don't think it's going to be systemic. Do you think there's going to be enough people ready? And now that I have gained a bunch of my friends. You have lending signs asking if they need capital. I know that a bunch of my friends who running pigmy asking viney topical. So there's definitely people see on the sidelines and I also think that things that are going to get purchased I are going to be. Things are perceived as less risky and again think people are generally wrist off right now so the thing that I'm most afraid of is going out and bidding on something. That looks really safe. Because I think that he's GonNa be so much capital sledding to those things in the short term just like you saw that in public markets kind of people try to slice as the flight of things that they thought. Were hide faulty. They weren't really like taking a swing at riskier assets. I think you're GonNa see the same thing happened in private i. It's just that everything happened. Product happens in slow motion because they're private transactions and the other reasons slow motion occurring is default. Just take time lots of times. Default triggers are not. Hey if you have one monthly cohort that trips Performance Covenant? Fault on you instead of things. Like if you have two or three cohorts in a row or if you have a Corley cohort or if you break. A borrowing base in barring basis can be fixed because a servicer or originator puts cash back into the. Stv that you're running against so a lot of the things that required all just take sixty to ninety days and we're still within that five sixty day window and and all happens and you gotta find about it. Your lawyer sounds like an angry email and their Laura Ingraham aback student and I think wrong. It just couldn't take time and finally one more for a nice thing about private. Credit is short of thought clarity. Because we're not dealing with March markets dealing quitter be needs. We're not dealing with senior lenders. One of the things that I've always said about being a senior lender your junior under your juicy nerve returns ensure give losses the Kerr the loss of the courage you and outsize way but the more scary thing about being junior lender. Is You have a senior. Who's really your boss. And they make decisions because of other things happening their portfolio. Do you have a senior lender in your senior lenders? Some bank that has a bunch of other issues going on. You might be screwed. Not because of anything you did. But because they're just trying to solve an issue and you to pay them back and so you can't work something out with your borrower and whether it makes sense for everybody so there's all these exchanges happening and they're just take the time to talk just to put some points of calibration out there for people you sent me to really interesting data points. One from the MANHEIM auctions index and one from ally financial. Maybe just share those kind of not the specific data points of you. Don't have them top of mind but sort of the general trends that those data points point to where we sit there. You have to ask yourself. How bad is this going to be free? Even goalposts of what? You're going to be willing to do the things I sent overt Mannheim's posting I think it's eleven point eight percent down in terms of car prices and that's despite the fact that people aren't really trying to sell US cars to put that into perspective in the last National Crisis Car prices down auction about five and a half percent at most this is quote unquote twice as bad Alex. Nanteuil seventy five percent of their four times. Nancy Antar into ferment. Twenty something percent of the consumer loans Sherman and all. That means you just don't know what's going on in there and kind of back. The planet mentioned you're buying uncertainty. It doesn't mean at twenty percent in April have defaulted on ally loans. It just means that you have no idea what's going on and if you go to our website kind of easy it says hey you have an issue. Would you WANNA be on to ferment? Not Making hard. But it's definitely a blocks and then the other thing that we don't probably the easiest indicator of looking at what's going to happen. Humor credit is just unemployment. The numbers everyone listening to this already knows that the numbers are six million. People unemployed were at levels that? I've never seen before and I don't think most people have seen into question is not really. How do they get more like? How long do they stay that high and again that's all in this spirit of it's going to take a long time for transactions to start happening again. It's just going to take time for people to actually go back into their models and drop base-case and drop the bear case. I think one of the things that people always used to in lending say okay. We'll underwrite to a two times loss ratio and what that means is things have to get twice as bad as your base case. Rita lose income and often. What's called four times as bad before people lose principle or whatever the numbers are in this case you might genuinely have to under this like ten times loss coverage and no borrower capital who need to is GonNa take capital at the advance rates and the conservative levels at a lender would have to lend out right now. The eight hundred pound gorilla in all this is the government and they're fairly swift fiscal monetary response to a lot of what's going on and I would say very high apparent appetite for more of that sort of support. Do you think that investors are properly discounting that government participation in prices? Another way of asking the question is you said there's just so much uncertainty and especially in consumer you know unemployment's a key number but if a lot of people are unemployed with fantastic unemployment benefits. Does that change the picture? Does that mean maybe the stuff that's trading at crazy low discounts to are crazy high yields might actually be attractive. Because there's this kind of backstop that we've never really seen before. I haven't seen that yet because I don't think anyone is ready to underwrite to it until they actually see the results. I think what you're seen instead is also instead of people looking to the way they're solving uncertainty is not by price in their loans higher yields and instead the way they're solving for Asia's adjusting to advance rates. Joe If you're going to advance lend money to somebody yet just ten percent at night and you percent advanced rate instead doing at fifteen percent but is sixty percent advance rate. You're not saying I'm going to give you the government's going to continue support these people and so I wanNA keep it at ninety percent but just lent you now at twenty two percent because the world's changed I think either people are not doing anything and are GONNA wait for the results come in or they're just adjusting their advance rates to levels where you get wildly wrong. It's hard to lose money. Can you define advance rate for those? That don't know what that meant to. Let's imagine you have one hundred dollars of less. Imagine Patrick you're going to go out and make one hundred dollars loans and you're asking me to give you debt. Capital Finance does loans. If I give you eighty dollars against one hundred dollars alone. That's an eight dance right. Which means you're fronting the first twenty percent losses and so it's basically just our way of talking. How much leverage service I would say the innovation. The quicker things that are happening to the market are lesson my world but more at the originators that we back world. So I'll give you an example of the company called stem that we work with and stemmed finances streaming revenues for musicians. A lot of them have their tourist cancelled and so a stem is getting the opportunity to work with artists that they may not have already worked with Anson Anson and so they're reducing risk by working with really high quality partners and this could be like a huge moment for them there's other businesses there's ecosystems that are doing incredibly well the Amazon ecosystem the youtube ecosystem the SNAPCHAT ECOSYSTEM. These are businesses that usage is up and add revenue really isn't as are down as you'd think partly because for social and for these digital assets ads are being told from TV and instead of going on to Google for example because Gupta cheaper way to do it easier to measure higher are Hawaii. And you're actually starting to see these businesses finance media assets at better than ever prices because traditional media companies need cash and are willing to sell those media assets. And so you're getting again to with large media companies. That would have never taken a phone call for expensive capital before where the asset itself isn't performing badly because people are still at home watching and advertisers still need to reach people and they can't reach sports fan for example to espn right now than you either medium to do it in for media company. It's bankers aren't going to give it any credit for snapchat account for Free Youtube account for an instagram account. There's no way they're looking at the balance sheet and saying. Wow that Youtube Library has value. And so these businesses there's like a mismatch and understanding and does really are originators or seeing the biggest immediate impact and the other questions to ask themselves. Do they pull back origination? One of the things. That's going to happen and already to happen is origination. Demand has gone up because thanks are going to be less. Traditional lenders are GonNa be Lending Lass and so these newcomers who do new types of financing where the world's at that's complicated. I don't want to really figure it out. Now's the time you are trying to figure out how to get a new type of financing and so we're seeing their demand go way up and the question is do they pull back completely. Because who knows what. The world's going is the losses they would incur by toy back completely and making origination fees greater than the losses they would incur. They saw harder faults as a model. You have to run. What do I think the worst case scenario is what losses what I incur in that default rate scenario? And how does that compare to the loss of revenue I would incur if I do nothing? Some of them are hey. Is this a tiny? We take market share one of the things that I think all under should be doing. If you'RE GONNA stand in the market you call every bar or that you've ever talked to. Who said no to your loan because of price and ask if they want alone right now if you still believe their high quality credit. So there's a lot of blocking and tackling decision. They're making at their level. That are goes bids are transacting. Faster contracted my world. We do some that up as saying a focus on quality your credit worthiness not on rate of return is really the smart play here. Meaning same rate of return but up your quality versus your rates of return higher. That's absolutely one piece of it is probably the biggest piece of it. Which is our number one. Advice is don't pull back completely being more conservative if you have twice the level of demand maybe don't make twice the amount of loans and instead keep making the same amount of loans but just increase your pricing. Because if you charge higher prices you can incur greater losses because the fees that you're charging the rate your charging will cover some losses and lend the people or finance people are higher quality credits. Then used to be able to get because your command entire so. Yeah so we're basically just saying there will be a time to go toggle on risk again but for now if you can make the stem out loans you were making before but it lasts rest. Go for the other thing is. We're looking for diversification in really tough times to lend. Maybe it's just me. I cared less about diversification and I cared more about five higher quality credits and so in our credit books for some of our portfolio companies. Do they have the option to breach a concentration limit but we felt like the answer was financing a higher quality credit. We would say yeah. You should go do that. Because we didn't really want Beta exposure credit markets at the time because everything was overvalued. Now you aren't willing to take that same concentration risk because again sacking or things are breaking in ways that we could never imagined and so there's all kinds sort of de risking things that you can do in the short term. The other thing though is we're trying to discourage companies from chasing assets that are going to see low defaults next three to six months. There is going to be certain things that appear that seem like wow. They made it through the pandemic their default rates in pick up. And I bet you've asked the person at all private credit investors going to be chasing. And then you're GONNA have a bubble there of received higher quality assets whereas the stuff that used to be uncertain and did get hit even if it ends up being a better place in a long term is GonNa get completely ignored for awhile so step one is sort of defense and quality and everything you just described her re underwriting things. Maybe don't stop it. Don't double focus on bringing your average quality alone up once that phases done. What areas are pockets? Do you think will then represent the biggest upside opportunity and the answer may just be. We don't know yet. But what are the areas that you're at least thinking about or considering that as uncertainty declines might represent places to look that? Aki doesn't seem to hard for US. To figure out a couple of initial action so last year and the year before we used to underwrite acid that we thought were really great. And at the last minute some. Jv investor. Who doesn't do a lot of private credit would come in and just take the deal from us at three hundred basis points before they ever shut up. The first thing we're going is going back to all those lenders who probably how unstable capital basis because the lenders were borrowing from weren't a stables. They thought they were and I think a lot of it's going back to. What does the stuff that we always liked and just increase in the price that we're willing to offer them and go pick up coupons that we've always wished we had and that'll be a really good opportunity but more importantly there is a new economy? That was already getting created in this space. Just hit the gas on it so for example ECOMMERCE with obviously taking market share from physical retail. This forever made BECO- faster and a lot of people who aren't shopping on Amazon and shop. Five which is crazy. This is many people still weren't now. That's how the and everything and the Amazon economy is going to do. Incredibly incredibly well. The third party so Amazon are going to do well and on. Top of that. E commerce generally has so much more variable costs than physical retail. One of the interesting things people used to look at these technical mascots and say wow. They're newer so they must be riskier. I think now they're going to say wait. These technical of assets have more variable costs to they're more dynamic in changing market environments. They're actually less risky than physical retail. Which is sort of an interesting dynamic. It used to be the beginning ECOMMERCE company. You're borrowing at a higher rate of return in a physical retail store. That will never happen again. This spotify ecosystem is going to be really interesting. People are still at home watching spotify e Stop Chat Cock. Instagram ecosystems are going to be interesting. If you're an sports advertiser for example and I kind of alluded to this earlier and you need to reach sports fan. If you're Nike you still got to sell shoes. But no one's washing ESPN or CBS. Or Fox. Sports right and so. How do you go reach those sports audiences? You've always been getting hit by INSTAGRAM snapchat. And by the council on the top ones you may have been motivated. You might have allocated an experimental amount of your budget to those new platforms and those handles. Now that's how you reach. People and those businesses are going you forever be viewed as Google is a cheaper higher. Roi Way to reach audiences. And I don't think that's ever going to change the youtube economy. An economy was already quite large events to become a permanent part of the American workforce gig workers. It used to you. They'd your gig worker. You had less stable employment you now have quote unquote more flexible employment. You might not be unemployed and if there's less work on Uber You may have start working Princeton car and so I think that bats Luethi occupation can be might actually make you a better credit restaurant or worse credit risks and to. There's a lot of economies that we already marching towards that suddenly became what the economy now is and a lot of things that used to be perceived as oh that's tech enable. That's new new means risky. That might require a higher cost of capital are now wait. That's tech enable even during ten damage which is going to be everyone's future investor conversation forever now. Even during their sustainable. Even when things are unpredictable they can talk all up and down the costs. They're less risky. And I think that was an interesting shift. I don't hear more you and we've talked so much about the youtube economy such a fascinating ecosystem maybe starting there with Youtube but also just the other online ecosystems that you think are most interesting and maybe surprisingly interesting as a result of this everyone home online all day. Start with Youtube. What have you seen so far whether the usage or advertising or other things going on inside that ecosystem that is compelling or interesting yes to this extent so basically when you see an ad play on a youtube video. Fifty percent of revenue actually goes to the person who made the video not to youtube itself so they split the revenues it and certain categories. You wouldn't really want to buy the assets cheap sort of an odd place viral videos. You have no idea how much money does longer make videos inappropriate content advertisers. Try to avoid and Youtube is having its own identity crisis of like what is it really trying to be how much government and says I to have etcetera but is the second biggest in the world. Not Really Niche five feature of capable or if. It's not the teacher of cables. Buy Car with Detroit. Cable is and it's how people are doing their homework. It's how people are learning how to do things right now. And a lot of categories. You can actually price the assets and how much revenue library that is due and Youtube. It basically. If you're looking at this is just YouTube. If you're looking at any facebook instagram snapchat looking at any of these digital content assets. The handful of toggles the first is views so right now views across most of them are up as low as twenty percents high one percent up because people are home watching. Cpm's which is the cost. Advertisers are willing to pay for view. Might be down fifty percent but that means advertising slot the views are up twice and CPM's down half and you end up kind of Landis Damn place you were before and then on top of that in this story which is one of the things that sort of interesting in do at home queuing. I were watching Hulu last night. And when you look at the commercials who usually pay a subscription you have and so maybe I'm showing cheap I am. It has ninety seconds around the commercials. They weren't able to fill those ads spots. Wow that is like sort of an interesting thing. The other thing that was interesting about these digital assets is a lot of them work on exchanges and to the way the Google ad exchange works your target. Not that I know. Have any relationship with target name but which is why using them as my example target may decide that they want to spend three million dollars a month on Youtube advertising as they do is they go to the Google Exchange. They type in right. Now we're willing to spend three million dollars a month on women between the age of twenty eight and thirty six who live in and XYZ states and we're not willing to pay any more than X. amount for thousand impressions is a real exchange. So every time somebody visits so google page their information center the exchange and then if a target was blowing by bid on them and add pops up the interesting thing about these exchanges. Is there some of the stock market? You actually get real time sentiment on how these retailers and how these advertisers are willing to spend as we've seen CPM's decrease in back up sort of even in the last week. The first couple of weeks of April sort of GNARLY. Last week I actually sort of bottomed out and we're actually starting to see an increase in revenues over the last week or so and so there's actually been a great stabilization of these tech naval assets. That don't rely on US reopen the economy and don't rely on people walk into the store and people who knew about them but maybe had never taken a class on youtube or had never released followed your favorite sports team on an instagram account. For the first I'm redoing that and they're not gonNA stop. What about parts of the of the sort of digital world that aren't advertising based so you mentioned maybe e commerce something that you see interesting trends in put some more meat around the Non Media Properties advertising driven part of? What's interesting digitally I? I'm being careful to only say things allowed to assay but there's ecosystems in ecommerce tremendously well so one of the things that people don't appreciate sort of diversity of how each industry is doing so for example the luxury is going to struggle luxury brands. Even if they're on ecommerce they can't lower the prices even if they wanted to devalue the brand quality sued is doing very well but it depends on the category ensued. If it's perishable is actually a new more sustainable well one of the reasons curse pages doing so well is because you can't horde grapes but you can hoard corn so it's all these little nuances that matter one of the things that we've sort of come to admire is at third party ecosystem. Arthur PRICE SALARY. Augusta's on Amazon. So people don't really appreciate it. But two-thirds e commerce revenue on Amazon is done by small businesses that sell through Amazon. Kick the number something like one hundred fifty billion dollars of revenue per year. Right now is being done by those people. And it's an economy that people really sort of ignore and these are small businesses. This is a huge part of the economy and these are small businesses that are taking market share from physical retail. And there's going to be brand affinity and we're GONNA get used to those products and they're probably gonNA become loyal shoppers of those products. The Shah Faezeh systems been tremendously. Well these are people who are still selling products online. When they used to advertise on facebook they used to compete against every other brand. But since one dollars have pulled back. It's actually a higher R. Y. For them than it's ever been to be advertising and they're going to be able to take market share from physical retail brands that shouldn't and can't be advertising right now and again people have brand affinity and these are probably going to be a relationship that just don't come back immediately so there are a lot of these permanent shots happening and again it goes back to. It's almost wild thing that you've commerce has ever thought of his more risky than traditional small business when it turned out in this environment doing at least for now tremendously better than anyone I've ever imagined. What have you seen so far? In the early stage venture capital world specifically around the types of deals that have continued to get done and at what prices venture capital has actually reacted way faster than private credit which seems counter intuitive. You might think oh in private. Credit THINGS ARE BREAKING RATES. Must be hi. How the HECK ARE MERGING CASH DANCE? Doing payday loans doing again that we do sort of punitive. Mca or payday. But how are all these sort of? High Risk Assets. They must be breaking like crazy ever. All the dynamics I mentioned earlier in call. It really is sort of moving in slow motion right now. Venture capital on the other hand is moving really fast and the reason is venture capital companies by default are always running out of money and when they raise capital. It's not because they're choosing market timing because raise money. Eighteen months ago. They have six to twelve months of runway last. And there's no board member on the planet. Right now telling an entrepreneur. Oh yeah things are definitely going to be better in a few months if you can raise your going out and raising now if you don't have to do you're going to lower your burn. We have seen across all eventually across. All startups are having a lot in the lay offs and a lot of people are trying to hunker down and see if they can push their fundraise off to the fall or winter or next year. But there's a good amount of companies that it's not that they're bad just they had a raise and so the valuations were seeing right now are probably about fifty to seventy percent down of companies that are raging last month this month. That will start to come back probably in the next sixty days but they're gonNA stay down for a while in so much of the thing is. There's a handful of dynamics have venture capital funds. The first is initially all. These capitalists went on twitter until they were open for business. Screw the tourists. We don't really care about markets the thing that's important to us how you're GONNA do in the next five to ten years of it's a good. It's good again. We're still open and I remember talking to a bunch of my friends myspace. Not The guys. The problem was not. The market's down the problem. Is that a lot of people got sick. Some people died. We all had to go home. We stopped doing anything. That's going to affect everybody and then there is a huge influx of bread drowns and to VC's had a hard time doing new deals because they had a handful of the companies their portfolio if they are hospitality company Alive Events Company. Their shells went down by got either ninety to one hundred percent and so you might have had a company that previously had twelve months of runway. There never just became their gross. Burn or maybe away rounded Grossberg just became their net for have two months of runway. And so all the attention went to solving those problems and the attention went to. How do I help? My portfolio companies mitigate burn tremendously. So we can push out for a while and is neces- I the second order is. Then everyone went through their fund and said how much drive how to do. I have left and how much I dry powder white need to us to lead inside. Arounds into my existing portfolio companies and venture capital usually a series do series ideals series. Be Looser fee deals across from with growth deals and there's some sort of allegation of some third party firm investing one of your portfolio companies to create a new outside valuation. Many firms. Don't care about that. Many firms do but no matter what funds were looking themselves realizing that they were GonNa have to allocate much smarter than they thought they were going to need to to lead insider deals which means there's going to be less opportunity to do deals and so just less names are going to get printed and so again in the short term valuations. I we're seeing two times three times. Revenues TASSELS. We have an egg a company's growing really fast a never seen that before for perspective. What would that multiple in December infinity if you are a series a? Company growing one hundred percent year over year as a SAST business twenty times revenue was not crazy dirty time even dependent on the operator depending on the fine depended on the growth growth was being valued at such insane premium. One of those things. I was talking to people. As if you're growing one hundred percent year over year you could do any size around from any firm. If you're growing eighty to one hundred percent near rear you can figure out how to get around Dumbo. Be Hard anything below eighty percent just really hard and now the question people are asking is. Can you get the profitability with this round up? You need to and if not. Can you get your profitability with one more round? So again I would say venture capital for the last sixty to ninety days was actually probably the best environment I had never seen in terms of the attractiveness of the deals being done for perspective. Irr's or something. Yeah in the conversation. I mean the conversation having with people so I think we did about sore deals which is a lot faster trusting that period and this is what I'm seeing in the market and I would kind of list data points of I wouldn't mean the company brought them sort of characteristic of accompanying evaluation. Say This is what I've seen. This is what I'm willing to do. And there definitely was some feedback from entrepreneurs and operators. That was hey like. There's no way we're going to close roundabout valuation and I look. I hope you don't and there's a good chance you're not going to but opportunity costs right now is so high and you can only underwrite so many deals at once that this is the bar I would need to dig in and potentially due diligence and close a transaction. One of the mistakes a lot of operators made is pre cogan signaling was a single is always important. But signalling was maybe two important. Where if you are often down round two ambassadors and then something was wrong and so a lot of operators did during cove is said GonNa Reopen are round and the reality. That just wasn't enough to get around cleared and so then it became his awkward dynamic where they reopened the last round to quote on investor-friendly and then that didn't work and so then they had to go back to people and say wow we couldn't even closer last round now doubt the operators who actually had the best time. We're the ones who said we're not GONNA put a price on it. We have no idea where the world is. You have no idea what the market is. They are completely humble about it by all. The investors had no idea what valuations. They should be giving either. I remember. There was one deal that we were looking at where. Vc The operator but really experienced and neither wanted to throw a price. I because no one knew what to do and no one wanted to insult the other parties and but they were humbled out Basilica. Everybody gather bids. And then we're going to see where the market is and we're going to raise it. Whatever the markets but the whole reopen the round or posturing or acting like. Hey this isn't going to affect me. I think that really damaged people outside of the see. What else do you think has been the wildest? You mentioned junior debt earlier as an area. That's really interesting. I'd love to hear about the price. Disparities say within a single company between junior and senior debt. And whether or not you think that's going to become a fertile area of opportunity on the long side Yep probably in the next three months or so. Senior debt is a good position. Bnb during control. And you're not really for seller because as long as you're has liquidity when I think a lot of people so far it seems like most people are doing a good job making sure they quantity which has surprised in a positive way about. You don't really need to react to anyone else. Instead you're reacting to the date of your portfolio of course you want someone to make interest payments I mean by the data. The portfolios are actually looking at the data tape and look at every single payment. That's making sure things are going okay. And if they're not going okay. That's all the negotiations and everything. I told you about starting to come into play which is now going to spend the next sixty to ninety days trying to figure out a workout plan with the originator with the asset book. To make sure that you don't get yourself into a knee jerk reaction where you try something you try to transfer the service you know the assets to quickly anything like that basically solution-oriented but if you're the junior guy you're not in control you have a senior linebacker. The senior lenders shots because if there is a default alone book they can call it a fall. You're the junior and you just have to basically act appropriately whoever's on top of you and so those are the places where we've now seen a couple of people trying to gather positions and we're starting to see those ten twenty percent discounts. It's huge and the gang are still buying uncertainty and not only. Are you buying uncertainty on loan book? You're also by uncertainty on. How the senior Lenders Act and unless you nervous senior lender really well and you know they're positioning. What else is going on with their lives. It's hard to kind of by their behavioral uncertainty. What are the big trends? Are you thinking about but that's personally investing wise areas that you're not involved in that you'd like to be which we joked before about how we both have felt this not regret but this funny feeling like Jeez. I wish I had done a little bit in real estate. And now maybe thankful that we haven't what are some big seismic changes in your thinking personally or professionally? Two months into this the biggest wine that I think that we're going to spend the next five to ten years. On is the new idea of what a small businesses and small businesses not a dry cleaner or drugstore and a our portfolio company. Clear Bank. Incredible jobs run are staying. What this small business economy looks like. Really it's online. I have no idea what's going to go in the bottom of buildings but unless the government does something that makes it feel a lot better to own commercial real estate or lease commercial real estate or physical retailer or so minimum amount of cash. It's a mystery to me so but we do feel convinced by is just Amazon. Price ecosystem is not going away. The youtube ecosystem is not going away. This spotify ecosystem is not going away so we do plan on financing. Small businesses are idea but the small businesses is is completely different. And I don't think we're going to have to get too much more creative than that until I'm in a different stage in my life. We there's so much to chop in the market was the market just grew by like one hundred percent and we were almost one of the only lenders that space to begin with and now we actually have our own proprietary data that we've been working off of for a few years and all of a sudden that's like the whole economy and it turns out that was less frisky and whatever else was doing so. I don't really need to do a lot more. Does that then mean? Basically those listening to interesting strategies would be figure out how to build business online or enable others that do that or is that second category already totally captured by Shop Affi- and Amazon is shopping APP. Store voice thought would continue to be like an interesting place for investment opportunities so I do think servicing. Those companies will be interesting. I don't know whether it's staffing whether it's warehouse management whether it's there's GonNa be stocks. I don't think we're going to figure that out for a few years because I don't think that we're really lean. We used to be known for being creative investors. The whole world just came to us. I don't have to be creative out for a long time. I can just doing as do in the market just exploded in so you. I'm sure there's GonNa be people who are trying to invest in that and the ticks shovels and Begosh for just going through this seismic shift of offline to online that we are already going through but now clearly that's where the entire world's going to be and so yes. There's always stuff that gets built around that but I would stay. Were leaning away from creativity for at least actually years old fascinating change from. I think literally our first podcast conversation was called creative investing. And it's funny to see the world have probably come to that the categories. You're interested in much faster. Maybe even you anticipated it used to be a novel idea that Youtube was gonNA take take market share from traditional cable. It used to be a novel idea that an instagram account could be a commercial activity and it used to be a novel thought that shop high was going to end up creating an entire economy atop to that and I think that became less and less controversial and now it's just the norm while he as always I really appreciate your time till unique categories though he covered again today and we'll have to keep checking in as things progress and good luck to you. Thank you so much for having Patrick. Hey Everyone Patrick your again to find more episodes of invest like the best go to investor field guides dot com forward slash podcast. If you're a book lover you can also sign up for my book. Club INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum. Right away and then three to suggestions of new books every month you can also follow me on twitter at Patrick. Underscore Osieck S. H. E. G. If you enjoy the show please leave a quick review for us on I tunes which will help. More people discover invest like the best. Thanks so much for listening

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James Reinhart  Lessons in Process Power  [Founders Field Guide, EP. 32]

Invest Like the Best

52:47 min | 2 months ago

James Reinhart Lessons in Process Power [Founders Field Guide, EP. 32]

"This episode of founders field guide is brought to you by dell technologies. This month is small. Businessmen dell technologies and windows are celebrating. You're unstoppable drive. Save up to forty five percent on powerful pcs with windows. Ten pro to work from anywhere plus top monitors docs for the ultimate business setup. All with easy financing options through dell financial services speak to a dell technologies adviser. Who can help you find the right business. Tech server storage and cloud solutions at eight. Seven seven ask dell. That's eight. Seven seven asked del for small businessmen savings as you listen to founders field guide and learn from the best founders and operators about building great businesses. Make sure you have the best tools to help grow your business today. This episode of founders field guide is brought to you by eight sleep. Eight sleeps new pod. Pro cover is the easiest and fastest way to sleep at your perfect temperature. It pairs dynamic cooling and heating with biometric tracking to offer the most advanced solution on the market simply. Add the pod cover to your current mattress and start sleeping as cool as fifty five degrees or as hot as one hundred and ten degrees. It also split your bed in half so your partner can choose a totally different temperature. I was so impressed. After using eight. Sleep that i became an investor to embrace the future of sleep. And get one hundred fifty dollars off your new mattress go to eat sleep dot com slash patrick or use the code. Patrick hello and welcome everyone. I'm patrick shaughnessy and this is field. Guide founders field. Guide is a series of conversations with founders. Ceos and operators building greek businesses. I believe we are all builders in our own way in. This series is dedicated to stories and lessons. From builders of all types founders. Field guide is part of the colossus family. Podcasts and you can access all of our podcasts including edited transcripts shouts resources to keep learning at join colossus dot com. Patrick o'shaughnessy is the ceo of a shaughnessy asset management. All opinions expressed by patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management this podcast for informational purposes only and should not be relied upon as a basis for investment decisions clients of shaughnessy asset management may maintain positions and the securities discussed in this podcast. I guess today is james reinhart founder and ceo of threat up an online thrift marketplace threats. Online store is distinct in how company touches every product processing every piece of clothing at their own facilities instead of focusing solely on being a marketplace connecting buyers and sellers. We talk about the competitive advantages of building processing plants from the ground up. How james turned threat up from having negative gross margins to very strong economics and the future of retail more broadly. I hope you enjoy this. Great conversation with james reinhardt. James so i think the best place to begin. Our conversation is for you. To level set the audience by describing what threat does specifically just paint us a quick picture of the business. Because i think many won't be familiar some marketplace for secondhand clothing. So we kind of do two things one is. We help consumers buy and sell high quality secondhand clothing. Just women kids today through manage marketplace. I e we touch all the goods so you can send us the threat up in our clean out. Kit will process all that stuff but it online and then sell it to buyers what we think. Is this incredible. Resell experience online. This thing to do is we're starting to destroy brands. We have a platform called repeal service. Is we now work with more than a dozen brands walmart. Reformation gap companies abercrombie and fitch throwback from my childhood were power next generation resell experiences for them. So this gonna things you do quarter marketplace and sales service. Talk a little bit about how you came to this market this idea twelve years ago. Yes so the true founding story is i was in business school at the time since late. Two thousand eight. And i was a teacher in an educator before that which leaves linked to business school and i had no money and i went to try and sell my clothes at the local consignment store on mass adding cambridge. Second time around. They wouldn't take them. They said just do luxury. And i could you not i was like holding j. crew cashmere sweater Has got to be worth. Some are so that went home that day with the same stuff i brought with me and i thought man. I've got a thoughtful both that aware of other people have this problem line. There's gotta be a better way and now it's really like kicked off. I remember going to school the next day asking my classmates anybody listen. We're planning on closing your causes. Don't you wear and nobody ever said. I wear more than fifty percent. Everything i don't know a third. And then i would say like what are you gonna do with all that shit. And they're like i don't know eventually just give it away. That was really like what got me. Fired up what did other people think of the idea started. I think generally people were really kind. They said to me. Oh that sounds like a good idea for other people which is code for like. That's a terrible idea. I think generally people thought while james's smart he must be onto something but consistently the feedback was honesty. How this is gonna work. Who buys us clothing. Nobody does this. I got a lot of resistance. But i can't believing that there was a big opportunity there because seventy percent of what people buy been ansel man. There's a lot of great stuff out there. That's ending up in a landfill so i just kept going on that thread. What was it like in the early days. Getting your first customers. This sounds like we talked a little bit. About the difficulties of selling low priced goods on the internet. I love to rip that threat apartment. Understand it because it seems like the lessons you've learned might be very broadly applicable. I had this thesis from the very beginning that to build like really big long term twenty five fifty or businesses. You have to do incredibly hard things. Because i think if you do easy things other people can come into your market. Thanks the strategy of starting with low price. Good obviously like a big amazon fan. I remember being based on saying we started with books because if we could sell books on the internet for seven eight nine bucks we could sell anything on the internet. And i was like man i could sell like ten dollars pieces of clothing and at the time we just launched with kids up. Eight dollar pizza kids calling on like a figure out how to make that. Were i get all kinds of stuff. I was obsessed with this idea of solving the hardest problem at the beginning and just getting conviction. Because if i had done that thing and i get that going be very to compete with us. My co founders. Chris and over time. We were just obsessed with working that hard problem and so we started with just like a classic marketplace we just connected buyers and sellers ebay style. It took about eighteen months. We were slow learners about eighteen months to figure out that the real opportunity was not connecting buyers and sellers but like a first principles approach to reinventing how people bought and sold secondhand. Ebay was famously. We don't touch that. I'll never forget at the time. I just kept telling anybody. Listen but would you rather be amazon or ebay. Amazon approach was we'll touch stuff. We'll do the really hard thing and that will put us on this new trajectory when we pivoted the business really focusing on ingesting all that stuff. The philosophy was man. Let's do the really hard thing. They may not work but if we get to. Were going to be massive. That was kind of early days around thinking about low price goods in the work involved. I mean this was a negative margin business for years trying to convince investors. Yeah we'll get there. Can you talk us through the evolution of the gross margin so what made it negative gross margin to begin. I'm just fascinated by like what the line items were in how it progressed as he scaled in the beginning had this thesis around supply so the idea was people. Send us their stuff. Jake my j. crew sweater right which we don't do men's today which of course the irony is not lost on me that we've not yet solved my problem but take this j. crew sweater. Somebody bought for hundred twenty bucks right off one hundred twenty bucks new cashmere sweater in a retail context. We would price it for twenty five bucks and in the beginning. We gave the customer twelve or thirteen dollars that we gave him half of what we saw for. And then it costs us ten or twelve bucks. The process the item then. It costs us you bucks in overhead logistics and like that is run out of dollars but then we had so much people sending us stuff. We could not get people to stop sending us stuff. We still can't stop sending stuff what we realized. It's not really about the money. You're not going to get rich selling your used clothing. What people really wanted was. They wanted convenience. They wanted this effortless way to do this annoying job in their life. Which is i got a whole bunch of crap. In my closet aware anymore we started to change the payout rates that we give people so in that twenty five dollars sweater or we used to give you twelve or fifteen bucks how to give nine. We'll find with that okay. You're still not getting rich will give you six. We just started tease out. Where was the value creation happening in the marketplace. What we started to really appreciate that buyers regenerating tremendous value because they were getting a cashmere sweater. Twenty five bucks a brand name kashmir sway over twenty bucks in sellers You've solved a really big problem for me. I now don't have a closet full of clothes. I don't wear. I actually liked opening my closet and finding things that i like. Not all the crap that i don't like so he just started to like really tweak. The value proposition so that's gradually proved the margins on the outside. The second piece is we opened operations. We started processing goods. You no playbook for this. Everything is a snowflake. everything's a single skew. there's no barcode on a shirt you're wearing. It's not as though you just scan something like oh. This is a banana republic. Buttoned-down retail forty four nine strike. You have to create that data operations just got smarter and smarter about how he did this. My co-founder chris. Probably one of the smartest guys i know. We built the whole operation in the beginning on the iphone. Eleven two thousand twelve. We ran our whole first distribution center. Like one hundred thousand square feet on the iphone ipod touch because the hardest thing at the time was getting photos of stuff on the internet without buying really expensive cameras and hardwiring everything together and chris was like well. Why don't we just use the camera on the iphone will take pictures and upload it and then we'll do some date on ipod touch and we'll connect that data in the back end and that's like chris a couple of guys built in a weekend you the image of Grab this was. We had all these ipod touches on all these iphones hardest. Prominent time with keegan Charge barely evacuated. Suck with this great photo of this shoebox chargers people just running in their plugging in iphones. Economic new iphone ops innovation. How do we process the goods and then payouts and obviously we didn't know anything about pricing about self throws maybe that jacob sweater shipments so that twenty eight dollars and not twenty five c get smarter about willingness to pay. That's the margin sip it more about the hounding of making it more convenient for the person that sounds like really what they wanna do is just get rid of their stuff. Not just throw it out. The dollar amount doesn't really matter. So what does that look likely what became more and more convenient. How did you think about that as star. You have a bike. We bought a bike for eight hundred bucks or nine hundred bucks. You don't use that anymore. You go to sell it on time. Craigslist or something like that or or ebay or even today facebook marketplace. You can get two hundred bucks for that bike. It actually seems worth it to take a photo of your by and be like it's schwinn two thousand eighteen and it's got twelve years and you can describe the by because you're going to get two hundred bucks for it. Takes an hour to do all that. You're cool take that same analysis and do it for yourself for twelve bucks. Oh okay well now. This is a big waste of my time. Because i value my time more than i value of return on this twelve dollars. What we identified was that for more expensive things. It makes sense to sell them on your own. But when have individual units that are twelve fifteen twenty dollars the actual right organizing principle is to get rid of them in bulk so when we invented the threat up. Clean out kit east. This was holds a laundry basket where to stop the average bagged. Twenty five eight senate into the idea was well if you could pile like of stuff in there and threat up with picking up at your house comes with prepaid label to take it anywhere. Do anything all the sudden. Those twenty five items might turn into fifty seventy five hundred bucks and then you're like oh okay the roi on my time across twenty five items makes a lot of sense. And so i think people started to be like wow historically. I've just given the stuff away. And i found it annoying to do now. Threat of sends me a bag with prepaid label on it. I send it. And then i just leave it wherever my mail gets sick. Leave and pick it up your house and people like wanna seems like pretty easy show anyway. That's kind of how it got started. It was all about stripping out the friction on us vice. I'd talk you through like the working capital. And all of this. So i'm presuming. You don't pay the person who's sitting in the clothes until you need to eat off to finance it with working capital. Just talk me through what you've learned about working capital inventory in this part of the business. Now run a business. The high sixties low seventies gross margin so from negatives that seventy roughly and the working capital piece of this is yes when people send us their stuff we put it online and then it's on consignment. We don't have to pay you until it sells and the way works. And we're very transparent seller around essence. You send us items we sell your items. We then wait. Fourteen days to make sure your items. Don't get returned and then we just put the money in your account we say. Hey we sold your j. crew. Cashmere sweaters can beat on j. crew. All jake cashmere sweater you earn five dollars for it and it goes into your threat of account. You're not going out to dinner on five bucks. What ends up happening is people just let loose items cell and that money accumulate so take a little slush fund women i would just let it accumulate in my little slush fund. And then i get so point. And i buy new handbag and the effect of that obvious. All those dollars are sitting in working capital. The working capital is negative by immune. Inform out that's kinda secret weapon at a business and then people tend to not appreciate how good the gross margins are but also they i get working capital. That's a fascinating model. I really love it. How much of the dollars. In a seller's account do they typically spend on the platform versus taking off the platform anywhere from probably fifteen percent expand on the platform to twenty five or thirty over the years. Some people think like oh that should be higher but one thing that we've been really religious about is we don't incentivize you to spend on the platform we say like. Oh we'll give you ten percent or twenty percent more because i think it creates these unnatural platform lock ins make people feel like it's not really cash and if you think about like the human dynamics of that if you're going to spend it on threat up you're already gonna spend on giving you an extra ten percents just taking money out of our pocket and if you're going to spend it on threat up chances are give you ten percent more isn't gonna push you over the edge actually think you're destroying margin when you do that. Historically people done what's been interesting is now consumers are cashing out with our partners. So as i mentioned our resale as a service can power retailers so now when you go to cash out your earnings say your fifty bucks. There's a whole bunch of places where you can get more money. So one of the most popular ones is rent. The runway which is become like. Oh i have fifty dollars in threat of credit. But i could get fifty five or sixty dollars or sixty five dollars at rent the runway because our brand partners are now paying you more. Talk me through the evolution of the operations peace so you decided to do the hard thing by keeping the physical goods yourself building warehouses etc. What are the first warehouse. Look like how has that evolved. What did you learn about when to invest in capex and new technology. Not just the one warehouse with iphones and an ipod touches. Talk me through what you've learned about that evolution on the side we got started in our first disability in twenty eleven than into twenty twelve and this was way out of my comfort zone. We didn't know anything about us in a classic way. What we did was we. We need find the smartest person we can find to help us solve this problem so we went out and hired somebody named john. Boris still chief systems officer today in. John spent seven years at netflix. Helping build out there. Dvd business building out their facilities in prior between netflix. And when he came to threat up he at spacex actually working on replicating a rocket program. John had this incredible wealth of experience around. How do you scale operations in the beginning. It john. show yours how we're going to build out the first facility which was in california right close to our office in san leandro to be close to it and it was one hundred twenty thousand square feet very very manual. We migrated off the iphone. We built custom stations around how we do for taga fy and then it was just john and his team just their big brains. How do we aggregate this whole process. Every single activity that we do in the value chain. And how do we do it better. How do we save money. How do we do it faster. We just became obsessed with all the individual pieces in the value chain. Give an example when we started using the iphone is taking the photos. We weren't taking any photos on mannequins at the time everything was a wage flat photo. Gotta take photos on mannequins. Because that's how women want to shop. They wanna see it on a form. We started taking photos on a mannequin. And then john realized that processes slow. You have a person who is putting items on the main mccain in then you have a different person taking a photo. We built a new process to essentially continuous flow of taking photos. So then all. We started bill to take photos. Much faster put them on an economic faster. The problem with that was that then we were like destroying mannequins left and right because no mannequins that are built at that time were built to have thousands of photos taken on them. Every day. the mannequin is designed bespoke photo. Shoot so then we had to like figure out how to make your own man against and so we started working to develop our own mannequin. They were custom molds of fiberglass. We could build that. Were light that we can repaint mutation. Ten thousand votes on day on a mannequin panic. It starts to look a little worse for wear. So how can we finish the mannequins. And i remember walking into the district. Centre one day and like a mannequin. Graveyard we were throwing out so many man again. It was like a horror film arms and bodies and heads everywhere and then we figured out like okay. Well how do we improve the lighting. So we built new reflective lading shields that allowed us to take a photo and then cut that photo out of its background so that it will just amazing online. That's where we were in san leandro and then we got the process to a point where it made some sense start automating which took probably three years or so running the business dane day out getting the process to a point where john team and the board and i felt we should start to build some steel in this building and build some structure. We started to a bunch of the processes in the facility because we felt like we really understood them in. John's flosse was consistent with everything that i've ever been told which is much easier to tell a person to do things differently than it is to tell a machine to do things differently so when we got to our next. We started to build these carousel systems. So now today. We run some of the largest carousel and conveyor systems in the world. We think of the largest in the world though. That's a hard thing to prove. But our facility today in atlanta which are newest which is dc oh six holds three and a half million items on hangers in dynamic storage but imagine to plus or so football fields full of carousels in conveyors then put two football fields on top in two football fields on top not gives you a sense of what the atlanta facility looks like and the woman working on now is could be bigger than that one. Would it be fair to reframe some of that knowing when to transition to machine from a person as you sort of need to prove the method with humans and unsalable way for some acceptably long period of time and then once zero variance or low variance only then build a new machine or a new machine driven process. I think that's right. Yeah and i think the time to prove out that you've got it right. It was variable on the process right. Now we're actually transitioning to a next generation photo studio where even automated a big part of the last photo studio. We had strong. roi and fishing cap. Beck's build. We had like a new breakthrough now until like the next generation. Those photo studios in the lighting strategies. It's a constant ablution. But i think the first big step from manual to some level of automation to be the biggest one but there is a continuous curve of pat. We make this more automated right now. We're on photo matching technology that will allow us to take any garment and see. Have we ever seen that garment before. Getting every item on threat. Ups snowflake where we've processed more than one hundred million unique items so we've seen a lot of product so when we see that dress from reformation and it's whatever the design of that drafted that comes in the door and one of our clean out gets and we start to look at it as there's something we can do on it with using a and using our camera technology to oh we've already seen that reformation dress and these are its characteristics and that helps us reduce all the rest of the inbound processing overtime amused amazing example after example of process power. And there's that great. What's the name of the book. I think it's called innovation stacking from one of the founders of square where they talk about. It's not one thing. It's like a hundred things in their path dependent. And you don't figure them out until you get to the roadblock and then you just solve a problem integrated on it and there's like no replicating that it's such an interesting operational story. We really rely on. I've been obsessed in the very beginning around. How do you build competitive advantage sustainable competitive advantage over time to your point about the hundred things is. It's not that we do people will say like what's two things that you guys do amazing and i said it's like the wrong question. The question is what are the hundred things that we do. That are each a little bit amazing. And because it's the classic michael border famous book. He's like competitive and gets built. Like compounding the unique activities that you do and so if you do three things uniquely well when a competitor has a ninety percent chance of copy each of them. It's point nine times point nine times point nine. That's the probability that they can copy you. If you do a hundred things that are unique and valuable defensible. It's point nine to one hundred. We really live by that idea of. How do we wide in the moat with all of the unique activities. That we do i think. That's the way the ops team is just wired. We haven't talked a ton about the buyer side of the equation. We've talked a lot about sellers in the convenience you provided them talk through that journey and that set of learnings. What would have been the difficult hurdles that you've had to clear to make make people aware that you exist in the first place and then the strong repeat customers the second hand market the thrift market was always bigger than people saying every time i like hell bibo they recognize. There actually is a few thrift stores in my town and a few consignment stores in my town and it turns out there. Twenty five thousand drifting consignment stores in the us. So that's a lot of stores. So there's a lot of volume offline going through secondhand the way we've approached the buyer in the beginning was was. How do we take the person who might be shopping. Secondhand offline and bring them online was very much the net flicks approach while. How do we take the guy at blockbuster. Put them in our. Dvd's by mail system so we had the same a lot of netflix dna at threat with a number of executives who were executives there in the beginning there was very much of the. How do we get the buyer from offline and online what evolved in twenty fifteen twenty sixteen through. Some of our survey were was these. Were not people who were shopping. Thrift off line now had found brought up. These are people who shopping off price or shopping. Discount retail who now like. Oh well now. I can just by secondhand than it's even cheaper and i feel good about it so it's really evolved in our customer acquisition journey and our customer make up is is. It used to be the person about used and it was buying used and bringing them online and now as people would never bought used before but who really see value proposition. that sort of integration happened in twenty two thousand sixteen. And i think what's happened since is what you're seeing with. Young people gen z and millennials. And they're buying behaviors their attention to climate change conscious. Consumerism has just rapidly accelerated this such that. You're seeing young people buying secondhand pretty astonishing rates. It's something like half of gen. z or forty percent. Agenda and forty percent of millennials have bought a secondhand. He's a clothing item in the last year. Really profound acceleration in interest. So i think there's a bunch of big tailwinds for us in the consumer market as far as like engaging them. I think the thing that people love about coming to threat up is there's always something new every day in your size and it's fun you go to the website. We don't take ourselves too seriously. Designed to be sort of the fun direct slightly reverend brand but anytime a woman wants to find a new dress or a new pair of shoes or sweater you go to sped up. There are millions of items for you to browse every day. Were refreshing that catalog. You think about the traditional retail environment w compete against they might change collections. Six or eight times a year or even like a fast fashion retailer might be twelve times a year or changing the assortment in the store quote unquote every day. I was reminded this story from one of our customers. Who's a teacher. And i remember. Just good. I was a teacher or brought up. She said oh. Always check threat of inbetween. My periods to mike lasts have like five minutes. And i know you guys are always listening new stuff every hour. I have my set of filters that. I have set up and refreshed and i add stuff to my cart all day long. That's the type of behavior that we see drives engagement. It reminds me to my favorite little concepts. One was the story of how business insider the website was successful. Which was nothing more complicated than at the time when it launched wall street journal in new york times only updated their websites once a day they just updated the more often and the second is amazing. Concept abound the internet if you make information readable to the internet that artistic doorman otherwise like uber and airbnb the popular examples in your case secondhand clothing magical things to start happening. I just such a neat combination of ideas in such a simple category. That people probably overlook. Most investors probably. I'm curious actually had this problem. I guess is many investors. Certainly in the vc world. Probably don't buy a lot of secondhand clothing. And i'm curious if that was an issue for you early on and what it was like raising money and how you did that in a pretty unique category. That's caught less sexy at in the early stages. I'm sure sexy now with the numbers. Look it was super hard in the early days because this is changed a lot not far enough yet but certainly a lot more women investors today than there were ten years ago. You can imagine what it's like to walk into a venture capital firm full of forty fifty year old men and tell them that you're selling used women's clothes on the internet for fifteen dollars. A may not have ever bought used clothing before so there have no concept of that and then be to our unit economics conversation. It's like there's just extended disbelief round like well. How could this ever work. And then there's just like a lack of awareness around not there's the personal behavior but just how big the market is and so it was really challenging. But what i have found over the years raising money in our first investor was from trinity ventures partition the costs. You now the chair of my orange wonderful woman. She just sorta got it right away. It wasn't just because she a woman and then a mom she was just like a really savvy investor around where consumer trends were headed. So what's happened over. The many years of fundraising is people. Sort of a funny thing. I've spent time with a bunch of esters recently and they had this moment when i'm telling the story here's what we built. Here's why it matters like you can literally see their eyes light up. I get this. And they start to relate to their experience of cleaning out their closet and then of these folks investors now you have kids daughters who are shopping secondhand in ways that they never imagined. I love that comment. Books like miami with investors. I totally get s. My daughter like she only shops at thrift shops. Okay well how much would you like to invest. So it's really changed a lot in the last five years but it was definitely challenging in the beginning. But i think it's made us today as i reflect back over the past ten years. It's made us just a much more resilient company with really high conviction of like where we're trying to go and what we're trying to build because i think there's that period was it fifteen sixteen where that's when it really start where everybody's raising money and that trend continued and i think founders who start off where their series a. is done at like a forty million pre narrates ten million bucks. I'd only they know what it's like to really grind through that hardship. And i think our team having run through the grinder multiple times over the last ten years has put us in this position. Wear literally nothing gets us down. We relish the hard things. We put more chips on our shoulder every time. And i think that that resilience you have to of live through it. I don't think it can be taught intellectually each be resilient now you either learn to be resilient or not and you really don't know if you have that resilience in that staying power but a long-term until you're like repeatedly tested got the business out of the recession. He was really hard to raise money. Two thousand ten. But i think we're better company or at twelve years a long journey and it always looks so rosy at the end when the numbers are stacked football field automated ourselves working like a charm and what was the most psychologically difficult period for you especially doing something that is sort of contrarian and different and takes a long time to build just psychologically was there an episode that stands out of the most difficult as that resilience built up. I think everything really came to a head in late. Two thousand eighteen where we were out to raise some money and we had a couple of term sheets they basically got retreated at the end and now is really hard because we had put so much time and effort and still to this day really like those investors but those deals basically fell through and i remember being like this might not work. We might run out of money. Keep the coffers full to do the investments that you wanna may side remember that period being really really hard the end of eighteen and we totally got ruined and ultimately came out on the other side in nineteen with a strong investor syndicate. But that kind of six month period in between where as a founder like as this all been for naught. Kinda think like dark. But i think it's the resilience built over the prior eight years where i was sort of like all right. Well gotta get up tomorrow. Big boy pants on and go back to work. It sounds like you've studied the classic competitive advantage literature. You mentioned going to business school. How do you think about as leader about capital allocation and getting better at that time inside the business around here familiar with eric. Reece's not the lead story but startup way which is a second book but in that i think that book had some real influence on me because he started to talk about as your business grows up you start to think about capital allocation and you start thinking about innovation. How do you think about giving dollars to run. Experiments within the organization in he talks a lot about metered funding. What is metered funding. Look like the way we think about capital allocation. These days is is very much in a meter funding approach. Which is can we invest these dollars this capital in take an example like in a new notifications platform up. What's like okay. Well what are we going to do with it. Well we're going to build a whole new system of notifications across push and email and onsite and physical mail and like big landforms engage or casper. Okay well what the cost what are. The milestones are waypoints. That's going to help us understand. Are we meeting those objectives such that we want to continue to fund that investment. Let's probably closest to the sort of philosophical way that i think it which is around metered funding. We are definitely not a shot company. We don't bet the company on anything we don't take flyers were constantly to use the basis and we're constantly planting seedlings were constantly doing new things and seeing how they might generate good strong outcomes and watch how much money we're giving them in. Are we really clear on the milestones in the feedback. Loops i think eric. Recent is book has a think phrases abandoned or persevere. Point do we keep going with this notification thing or is it time to be like we tried. It probably should just keep doing what we were doing before. Let's talk a little bit about the industry in which you operate so clothing as it sounds obvious like it's a big thing. Walk us through a survey of the clothing landscape. What would be surprising to people. About where close get made the businesses behind them the impact that they have on the world anything that you find especially surprising or interesting about clothing writ large and then we'll map that back onto what you do today and kind of what you plan to do in the future. It's going back one hundred years the first department store fields in chicago and it was the first time that they were bringing the sort of mom and pop or individual italia a into a big department store. So it wasn't that you went to the bootmaker a hat maker or the shirt maker. You came to a place where you could get all these things in one. Big department store like multi-floor experience that really dominated the growth of retail for the next fifty sixty seventy years. And then you had the growth of individual branded retail where example that today be the gap companies. You had gap and banana republic and were relatively the same age right. It was like the heyday of eighties and the nineties. The gap khakis campaign. You had like a lot of these individual brands in what will be considered your store formats of the last twenty twenty five years and then what happens. Is the department stores in. You have random retail all of a sudden. They're sort of this inventory that they can't sell because they bought wrong or something happened so in the eighties. You actually see the rise of what i think has been the biggest structural change in retail ever. Which has since the advent of the department store which is off. Price guys tj maxx. It started in the mid eighties. They start small and they build this compelling store format of discount retail and off price retail fast forward. And then you start to see in the early mid two thousand two thousand six. You have the founding of guilt. It's hard to be that fifteen years ago but if a guilt and rule allah flash sale companies which were the rage for awhile. Which were how do i take the off price model and do that online through flash elsewhere map. And you kind of get through that. I've learned from department store brands retail off price flash sale. There's obviously a bunch of steps in between covering one hundred years of retail. But you get to the point. Where benefits really direct to consumer. Okay now i'm going to cut out the middleman on ever lane and i'm going to go straight to the consumer. Now you're in a position today where you have this great flowering of Sumer brands it's easier than ever. Frankly to starter brand harder than ever. I think to scale brand given the competition what all of this has been. Incumbent upon is improvements in how clothing gets made and the supply chains around the world the cost of manufacture. Quoting pretty much has gone down every year for like thirty years. It's cheaper than ever to produce stuff and the cost that that's having on the planet is meaningful and i don't think consumers really appreciate. How bad fashion is the planet today. It accounts for eight percent. Though global greenhouse gas emissions it takes hundreds of gallons of water to produce a single t shirt. So i think we're in a world today where that starting to become more visible to the consumer citing young people in particular have really shined a light on this and i think the fast fashion world has been put on notice around. This and i use fast fashion. Not in ancient am forever twenty one forever twenty one whose file for bankruptcy not just them but any manufacturer retailer is producing clothing that they can sell report by bucks because that has a real cost on the planet. Until i've been really concerned around where's ultimately going to take us that if you look at the data from the ellen macarthur foundation which does a bunch of work in sustainability around this by twenty fifty. We just keep doing what we're doing. The fashion industry is gonna count for twenty five percent of global greenhouse gas emissions five percent. And it's a big number on the issue is like really by all these brands that are making all this stuff so if you take that backdrop of proliferation rise of this stuff lowering cost of manufacturing increasing impact on the environment etc that backdrop of the retail space. How do you think about your own future and your own roadmap from here. It seems like you have almost like a costco like devotion to iterating on one thing that you do extremely well is it fair to extrapolate that. You're just going to continue to do those hundred things really well. And stay in this specifics. Obviously going to men's and there's other places to go. How do you think about your future from a business standpoint but also against the backdrop that you just laid out for us. We're a mission driven company from the very beginning. There has to be a better way where my change a lot of time is what do we want the world to look like ten fifteen twenty years from now and i think we want the fashion industry to continue on this much more sustainable circular path. I'm not sure that we can get the fashion brands of the world to produce stuff more sustainably whether that means using water or environmentally friendly dies or the types of wool. The sustainable will they use. They're coming around to the idea that we need to start to treat these resources more carefully and i think a lot of incredible work being on there especially by great new emerging brands. All birds was a good example. Rossi's is a good example. Everyone's a good example. I think our job is to get the fashion industry off. The linear path in the linear path. Is we make stuff. We sell it to you as best we can. We discount stuff we can't sell to you. You wear it and then you put it in. A landfill dot has banned the path the fashion industry for a very long time. What that means is that seventy percent of what people stop wearing and giveaway ends up in a landfill seventy percent. It's just crazy and the thing that i'm obsessed about is okay. Let's break that pack. Let's go from yeah. Let's produce stuff. I think we should produce less than we need to produce much stuff as we produced today. Let's produce stuff in a more sustainable way. Let's have brands sell it but said themselves in a way where the margins get better not worse because discounting and markdowns and everything else which is crushed the fashion industry for ten years. So let's stop doing that. But people aware it and then when people don't wearing it let's loop it back and i think we're right up. Sits in that is really in a powerful place. Okay you're dominant thing. Let us take it back. Let's put back online for somebody else to buy. And we live in a better or circular future. Is there anything else that we missed. That's interesting about the supply chain in this space. You mentioned the unfortunate byproduct of eight percent of greenhouse emissions or gases coming from this space. What else have you learned. That's most surprising or interesting about. I'm thinking all the way down until like the raw materials that might go into clothing. Give us a little bit of extra meat on that bone around what that looks like. And how you think might get better. There already is a lot of great work being done in textile material recycling the same ways that we made tons of progress in recycling plastic recycling glass. These types of things. I think fashion has been a little late to that game. But i think i think it's catching up is working on. By a number of companies to take any piece of clothing and break it down to its constituent parts strip out the cotton and strip out the polyester about medal. and signing you're gonna see rule breakers over the next few years around garment recycling. And i think the biggest challenge is we need to get to a point in the fashion industry where producing clothing from recyclable materials is the scene cost or potentially lower than it is to produce from new materials because i think the margins in the fashion industry writ large amazing every brand would love to be more sustainable but they have to pay twenty five percent more for ganic cotton or twenty five percent more for recycled. The math just doesn't work everything in these industries. It needs to be driven by the fundamental economics. So my hope. Is that a lot of the innovations being done in. Recycling will help us get there and i think the development of materials that are made to be recycled. I think adidas was doing this very very well of thinking the full cycle of their products. I just signed up on the running company dasher. Cool guys like. I don't have any pairs of their shoes. I love what they're doing. But i just signed up for their think. It's called the site crown. Or i can't even remember what it was but it's like a shoe subscription in the ideas that the shoe literally every single part of the shoe can be broken down recycled and made into a new shoe. And i think you're going to start to see things like that. Come to marketing ways. That i think we'll lose us for vasan space. I mean so big something you wear every day. Don't think too much about fascinating to hear the issues. I think the other final topic that we'll cover. That is unique and interesting about threat up. And how you run. The business with your partners is the nature of work itself for your employees. Had a really popular episode dustin moskovitz at asana couple weeks ago i was amazed by how much inbound i got of people frustrated by interested in what work looks like. Even though we've all gone remote. Which i think the reason why people are questioning this in the first place. We haven't changed that much in a very long time of the five day. Workweek nine to five blah blah blah. What you're thinking here. Why do you care about this topic. And what have you done about. How much time do we have all sorts of things when i think about why people work. Why do we work zoom way up like well. What is the point. You start to think hard about like the type of culture that you want wanted the company the type of people that you And i think the the shared values of a workforce of a culture of the company are really really important. And i think the commentary right now around future of remote were distributed workforce's. I'm very much in the. We all need to go back to the office camp. Because i just think that atomization dehumanisation that happens when everybody sitting alone at their houses i think can be really destructive especially with given the amount of time that people will spend at work sitting behind their computers and i think in the short term people will think it's fine. I think over the long term. I think he just another way race down the fabric that binds us together. I think the office is like another place for you to like meet interesting and unique and different evil and i think not having that space. I actually think it's really bad for like the body politic. Just bad for the country. I think it's bad for us. Citizens do not have places where we collaborate. It feels like a dystopian future when we're all just sitting at home reading our own news. Strict reading our own news gets delivered to us talking to the same people in our circles. And so i just think it's another step breakdown so i'm like not a big fan of the distributed forever workforce our culture in the beginning we. We really tried to be innovative around. How do we help. People do their best work about five years ago. Six years ago now we started with a. Let's create this thing called beggar days. I remember reading the concept of a maker of a maker in an organization at somebody who make stuff designers engineers. Don't spend their time in meetings. It's really like independent work. And i thought well shit. I'm the c o. I do a lot of that too. I have to do a lot of seeking and a lot of independent work. I spent a lot of my days and baker. how do we then create constructs in an office environment where people have dedicated time to do work. Real hard work came up with the idea of. We're going to create this nacre day phenomenon some days. We're going to be on wednesdays. Monday and tuesday were normal office days. Thursday friday normal upstairs but on wednesday it was a maker day and the idea of the maker day was that there could be no standing meetings. The idea was that this would be the time for you to head down and solve the hardest problems confronting the business or work on developing plans for your team that requires three four. Six seven eight hours of heads downtime. That went so well over the next couple of years that couple years later we were getting feedback from the company week persistently were hearing men. I am so productive on maker day. But i get so much done. I do my best work. I just had more maker daytime but we can solve bad so if that's the thing that plays want to do their best work. Let's go to make your days so we moved to a schedule where monday wednesday friday was in person meetings at the office. In tuesday's thursdays were maker days and the switch on that was also remembered as you didn't need to come into the office. You should go wherever like you do. Your best were and some. That is the dna of from me as the founder. Because when i was in college. I always do my best work in the coffee shops the love sitting in a coffee shop full of people writing or reading or studying or thinking and that was always like my safe place to get stuff done. Do my best work the idea of the makers as being like you kind of work from anywhere you want to come in the office rate. You wanna stay at home great. You wanna go to a cafe. Great and i think that carried us pretty far around building this construct around baker days of meeting days. The added as we added an early sabbatical policy. Once you've been at dreaded for three years you get two months sabbatical we pay you and the idea was. We need people to constantly be refreshed in recharged warnings. I loved about being a teacher when i was in. My twenties was the summers off to travel. I wife and i got to travel. All kinds of amazing stuff came back to school year in your like fired up and i thought well why is the business world. I can't we have some similar contract. We built sabbaticals into threat up and the only thing we asked you on your sabbatical was that you liked. Didn't sit around and do nothing. You had to do something meaningful. Like go travel go do something gets the pistons firing your brain expands the universe for all of us and so part of this about when you came back is you get a little fifteen minute. Slide show q. And a. with the team we who went to the great barrier reach going to scuba diving like repair the great barrier reef man. That is awesome the last thing we did very recent which is the beginning of the year. We moved to a four day workweek. Which i spent a lotta time thinking about the manage thinking about we came to the decision bat. People do their best were when they're fresh and they're recharged they're like fired up about coming into work. There's something about the three day weekend. We've all experienced it. Where having that extra day you come back into the office your man. It was great to have monday. It was great to have friday. You're kinda ready to hit it hard again if you just had that extra day recharge so we're experimenting. Now we're in the middle. It's a six month. Experiment will kind of review it in june so far the feedback is really positive. I think we're going to build a cycle of four days on three days off. It's gonna create superior output overtime when a fascinating progression of new things to be tried. It's cool how your theme is reassessing. Large important things that people have slipped into the background and not thought too much about right at twenty. Five thousand thrift stores workweek. It's neat first. Principles approach to building a business. What you most excited about the future just period. When i think about the future like the best day for like our country. I think they're ahead of us. I have an enormous sense of optimism about where we're headed. I took such great pride. Live images of mars coming back. We can still do like amazing stuff. Some pretty like inspired around where technology is taking us. there's going to be pitfalls and we're gonna make mistakes and they'll be negative derivative outcomes of the progress analogy starling satellite internet the ability to deliver internet all over the world to rural places. That don't get it today. There's such incredible progress being made so many parts of life that i really do think the future is pretty bright. But i think it's gonna require entrepreneurs and politicians in elected officials and work more collaboratively. And i think that's the rubber right. Does the thing that i'm like. We need to get back to a more civil collaborative politics ending. Government has a role to play in second hand. I talking to some of the other day if you think about the real acceleration in solar and electric batteries and things like that. It was when government started to create subsidies. We really want the fashion industry to stop the cycle. That it's on and we want people to make better decisions like what's the role of government incentives to do that. So you know. I'm spending a lot of time. Thinking about what that looks like overtime with the carbon tax equivalent in the fashion industry wants us. Fashion companies have to really internalize the fact that seventy percent of stuff ends landfill. Things change. i asked same closing question of everybody of loved talking about your businesses so unique and my favorite themes in business are applied. Here especially fun for me. Since i hadn't really experienced the products. I love hearing about it for the first time the last question i asked everybody is to ask. What is the kindest thing that anyone's ever done for you. All the things that my mom did where she would always give me the confidence. That i could do anything. There were all these failures in child. Childhood life formative years. Every time that i would like mess up she would just be like doering. Mom be like get yourself back up. You're going to be good. You can kind of do anything you want. And i think if you're an entrepreneur you're always ask entrepreneurs where resilience comes from. I don't think it calms necessarily from any one thing. But i think having somebody who no matter what always picks you back up. I think that's probably the kindest thing and it's probably kindness over over many moments in my life. That's probably the best thing. Fantastic is so much fun. James so great to meet you in this format. Thanks so much for your time. Yeah likewise thanks patrick. This episode of founders field. God was brought to you by dell technologies dealt. Technologies in windows can help you upgrade your business. Tech with these small businessmen specials save up to forty five percent on. Pc's with windows ten pro plus business docs monitors and more work anywhere with windows. Ten pro cordell technologies advisor at eight. Seven seven addow. That's eight seven seven. Ask del you can also check out the lincoln. Our show notes to see deals that dell has today. Thanks for listening if you enjoyed this episode. Checkout join colossus dot com there. You'll find every episode of this podcast complete with transcripts show notes and resources to keep learning you can also sign up for our newsletter colossus weekly where we condensed episodes to the big ideas quotations and more as well as share the best content. We find on the internet every week

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How COVID-19 Impacts Startups and Venture Capital with Ali Hamed and Brent Beshore

Venture Stories

50:54 min | 1 year ago

How COVID-19 Impacts Startups and Venture Capital with Ali Hamed and Brent Beshore

"Hey everybody it's co founder. Partner village global aid network driven venture firm and this is metro stories a podcast covering topics related to tech business with world leading experts. Everybody we're now accepting applications for network catalyst accelerator program founders in. Our Program have gone on to raise money from LUX SPARK A sixteen Z. Slow First Round Susa homebrew Maveron obvious and affects signifier and many more learn more at apply at village global dot V. C. Slash network catalyst. Everybody welcome back to another episode adventure stories by village global here today rejoined by two very special guests back by popular demand. All Co venture and Brent be shore of Permanent Equity Brent Permanent Equity is new brand. Yeah UNPACK IT. A little bit for us. Well after I came on your show I mean my brain was so tarnished that I had had to rebrand. So No it's It's something we We rebranded Let's see here Eight weeks ago six weeks ago. Something like that. I don't know times I don't know what data's right now. So but we wanted to get a brand that More closely matched. What we're doing and to be frank. I was tired of having people. Ask Me if we were based in Spain or you know if if it was Edvin tour dot E. S. or whatever the whatever. The flavor of the day was or emails getting rejected from servers. Because it looked like we were spammers. So yeah so we got permanent equity thank goodness for the foresight of Patrick o'shaughnessy who When I first started talking to him cash three and a half four years ago now About permit equity using the term permit equity. He was like I really like that. And then you know He about a month later said Oh by the way. I bought the domain I think this is GonNa be a thing and I was like. Oh that's cool. Whatever and then I went to him You know I don't know four or five months ago and said Hey. Do you mind me coming back from you so anyway. Yes we're we're permit equity Same same company. Same Location. Same philosophy new name Cool Hill I've been trying to buy co-venture dot com for years and the the guy who owns it is represented by attorney in Canada. And for whatever reason they just won't come to the table I'm like I'm like a pretty motivated buyer. Let's have the conversation. Will I know they're listening to this song excited for them to come to the table and Brennan excited to put put permanent equity on the map in this market? I think the price is definitely depressed. A bit yes. They are listening. You're hedging already. That's fantastic okay. That's a great segue in this market alley. You wrote a blog post the other week talking. About what the market means for each? Vc industry why don't we you know what does it mean? I how should be sees be responding to it. And what does what B.'s believe about what the future holds was market determined? How they should out. They should act as a result so I think the first reaction was an adventure community. Broadly like okay. The market's down. Why does that affect us? You know we're long-term thinkers and this is GonNa last temporary period of time but if you're invested in a company should have a five to ten year view anyway. So who cares and my comment back was the problem is not that. The market's down. The problem is the reason markets down and the reason. The market's down 'cause like everyone got sick. Some people died had to go home and they stopped buying stuff in. That's pretty bad you know what the stock market's down but that's not the problem. The problem is demands down into the idea that like this isn't going to affect venture capital. I thought was fairly naive. You know I think a lot of venture capitalists took it as an opportunity to like market themselves on twitter. Which whatever that's fine he'll do all the time but I do think it was a little. Bit misleading the entrepreneurs and so now just like everything on twitter. It's like two different polar opposites so the Omega. You know if you're if you're investing now like that's crazy because we're all on hold and whatever and is the other can't which is like if you're slowing down your investment pace now you're just a tourist and you clearly don't have a long term view and the answer somewhere in the middle. The answer is everyone in the portfolio. Who has a lot of portfolio investments? And I use the word. Everyone and it's harder to find absolutes. Inevitably someone's going to come up with counter example. Most people who have enough investments Have a company. That's totally fucked right now. And you know. The company may have lost ninety percent of sales. It was a company that may be was doing. You know a million dollars revenue a month. We had a net burn of two hundred thousand dollars a month. They had enough runway for eighteen months and now they have four months of runway or three months a runway and they're not really sure if those deals come back at all until they run out of cash so VC's have to spend most of their time for least a few weeks figuring how to create bridge browns or solutions or layoffs to those companies and on top of that because there's less demand right now. Top line growth is going to slow down. Usually third-party financing's happen. Because of seven hundred percent or more year over year growth some sort of new inflection point is reached and many of these companies are not gonna hit that inflection point this year which means evaluation may not be able to go out which means that they're they're funds are going to have to do inside around for that which means that. I have to go back and say how much am I reserve capital do I have which means they can print less new names so yes less. New Deals will happen. Doesn't mean no new deals are going to happen. No that's not true. We closed the deal on March fourteenth. Close another beyond March thirty first. We'll probably do two more deals in April but the opportunity cost of new dollars is low and the last thing is i. Think a lot of entrepreneurs in normal times view it that if they do it down round. It's very scary for the market. You know visas really loved pattern recognition partly because they're generalists and partly because they don't really know a lot you know. Aside from people who focus on certain vertical generally venture capital is a venture capital is done by journalists who looked at pattern recognition to the side of deals. Probably good and I'd like to see a seed round and then a series I and then a series b. with reasonable growth in between and we've all come up with these insane terms to kind of make things fit within that we have seen extensions now and like series A. Extensions that way you know. It fits perfect story. A lot of entrepreneurs have adapted to that and so when they go out they need emergency financing. What they're doing is they're reopening their last round or they're trying to they're trying to avoid down route because they know historically that's been really bad. I've now seen a handful of entrepreneurs tried to do that and see all of their best prospects of investors. Just write back and take the meeting. Hey sorry not for us. Because the market has adjusted in entrepreneurs. I think haven't either gotten rational advice of. We don't know too optimistic vice looking at twitter and seeing everybody say oh our doors are still open. It's business as usual and I think that's probably damaging people we have seen people raise rounds exactly like they were going to before writing. That's minority not the majority because there's more risk in the market now so I'm just talked a ton but that's sort of this summer quick question for you What how do you? How do you see opportunity costs in venture capital survey impacting? You know the evaluations of these companies is it is there sort of echo as other assets drop in valuation and sort of rising attractiveness depending on what you believe to be true about the world. How does that? How should somebody think about the opportunity? Cost of impacting today. Shins so I think you know in other asset classes is probably easier to measure so right so like in credit markets spreads went up by seven hundred basis points and so then you know in our credit fund which we manage. We now know that if we used to retarget an extra turn now it's X. Plus N I dunno and is but if you're one of our limited partners and he used to be thrilled about whatever return we are getting and you were comparing that to like liquid. Abs or liquid high yield And you needed some premium because we're illiquid You would then say well if I used to be happy with that but I can get a better return on my other portfolio. And that's what I compare you to. You need now need a higher richer. And you're GonNa see that all of our competitors and credit or given the same thing and on top that. I know that after two three more months defaults will start to occur. They haven't yet and when that happens if I invested dollar today that means I have one less dodge invest tomorrow when you have gone up in Venture. There is sort of that opportunity. Cost and new. Casa capitalists actuated but. That's the short term. Fact is because today I can do bridge rounds into really high quality companies at really low valuations that. I never used to get to do before you know. It used to be that if I was seen some company in a reasonably large base that was growing and growing one hundred percent year over year and it was doing seven figures a top line revenue. There is no way that that deal wasn't going to get a bit up by handful firms. Now there's so much of that happening. There's so much triage that. I'm getting to do deals that like I am. I can't believe that the lock it does mean that when another company comes to me my opportunity caught like I can still only do a certain amount of deals in my mind. I probably will do more deals in twenty twenty than I do in two thousand twenty two. But you know I'm still you have to be for you have to compete for my attention with another company. I'm getting a bargain on. I think that that's player. Yeah I think that's an interesting point and I think we're seeing that as well as sort of intra industry opportunity cost and then inter industry opportunity at so. What are you seeing in terms of like you know the deal flow is mostly emergency deal flow right now is it. You know your portfolio. Like what are you seeing right now? Yeah Yeah I mean so I if you have a solid company. That's on good footing. You've got a good balance sheet and you know you're not going to market right now to to to sell your coming. There's just no way so. You basically have a pretty nasty selection biased right now of companies that are trying to get sold right and you know we. We opened up something called Safe Harbor. Which at the time looked helpful The the government has ended up. Just just hammering that program because you know our cost capitals way higher than than there's Unfortunately you actually have the competency to deploy it as like the DMV of finance. Have no idea how they expect people to. Spf programs actually deployed the capital. So they would you know. It's in all fairness I look. I've been I I I would. I would agree and I've actually used that exact line In the last month and I was really really worried about it to to the credit of the SBA and the and the banks We are seeing a lot more throughput and liquidity into the system through that program that I ever would have dreamed as a great and so I mean it looked again politics aside about whether or not it should be going through them It is and so the reality is how are they doing? And I'd say to be honest. They're doing doing pretty well. I mean we're we're we're talking to people daily who are gotten their numbers that are then you this. The bank with weight works as you apply to the bank the bank then goes to the SBA and gets guarantee code and As long as conforming loan that guarantee code holds. And so that's kind of your place in line and then you execute on the documents. Have you seen people get the amount that they apply for or how they because we've gotten a couple of people that we've been told the loans GonNa go through but we haven't been given the paperwork and there's two main question to have the first is what kind of consent do you need from your shareholders and your senior lenders if you have debt and the second is sure you got the loan but is it the amount that you thought you were going to get and I don't know if you don't have to answer yet. Yes so so. We're seeing that on the loans that the banks are taking liberties to to basically ask for different amounts of money than than what people are based on what they see in the documents and so this is again where depending on these skill level and the expertise of the bank can have a material effect on the amount but both positive and negative to be honest I mean I think they're trying to get it right. And they feel like they're on the hook for making sure they ask for the right amount of money so. I think there is some complication. There by understanding is that because it's unsecured and because it's one hundred percent guaranteed that you don't need consensus that sort of bypasses consensus of other lenders and so we actually have not seen that. Be a problem in that segment of the market yet. So again in general I mean actually I think that the program is working for what is designed for is actually working way better exceeding my expectations now. The next round just came out Announced yesterday which is this. Sort of the not forgivable loan but so one to twenty five million dollar four times cap on Amount that came out as it was part of the cares act as well but it's an execution of a different part of the cares act. That portion comes with a lot. More strings attached. I think is going to be interesting to see how companies react to that. And you've got another really interesting things so you know all these programs sort of an overlapping mosaic of a advantages and disadvantages have been type. Accompany you have right so that one that came out yesterday is you know it's all based so if you're not making money at least on the basis It really doesn't apply to you and so they're trying to target in some ways. Maybe I'm getting too much credit here but I think they're trying to target certain types of industries with certain types of capital. And I would just ask him. So what are you guys seeing in in VC? I mean is it. I know the Affiliation Rules Held Sto. That's created some some challenges. But but you know what are you? All seeing in the world on P. P. Program. Eric you WanNa go and then I'll go. I think it's too early. In terms of we're seeing startups. Russell is sort of the ethical implications ethical questions. Should they apply it? Is it appropriate for them? I haven't heard any startups Hear back from from that program yet and you. I hear that it's quite a doozy to to to make sense of in to apply in the first place We're we're seeing most of them apply Say Hey we were GONNA fire people if we don't apply and so you know the money's been allocated and we think it's appropriate. My philosophy is a job's a job's a job. If you're trying to save jobs I I mean I. I think that you know. There's an argument to be made about jobs. Should you save is delaying the inevitable? Which I think in some cases it is if there's a material downdraft in in long term demand and we think that the world's changed and sort of a sustainable way then just delaying the inevitable. But I think there are jobs that are you know. You're just running into a solvency issue which I think this does solve and and I think it's it's intended in in those cases to be that so I mean I don't have a problem at all with BC back started supplying for it. If it helps save the jobs that they attended safe. So I've seen some of those sort of moral dilemmas that like. Oh should you really apply if you don't if you don't need the loan? I think anybody who knows that they don't need the loan. Either has a lot of cash or feels that they're smarter than a virus like that takes a lot of confidence to think that you're smarter than knowing how a global pandemic end up and whether or not that audio and I think that if it turns out you apply for the loan and the pandemic is resolved and you didn't need the cash then you should use. The option have the ability to donate the money later to someone who really needed. It would have to ask for forgiveness on it. You could just one percent return the money. Yeah but but like make the decision later when you actually no-shirt because I know if I was an employee of a company and the CEO's like wow as sinus strains and like at a righteousness. I'm not gonNA take money. That was offered to us to keep a safer than we might. Otherwise be I'd be pretty annoyed. You know I think that their businesses are like wildly profitable. So like it's you know. I think I saw a couple of newsletters at maybe a hedge fund that has five employees in a billion dollars. Am sure and apply. Yeah okay I agree with that. But for most of our portfolio and is that like the back companies are backed by you know these ultra-rich GP's who are going to be rich one way. Or another no the capital is being invested by endowments and Pension Funds. And everything like that. And you know. That's the purpose of what this capitals. out there for demand went down. You can now print money without as much risk of inflation as normal because you have so many deflationary factors and the point to Brent's point is jobs a job as a job and you should take capital that the government is provided to us. Try to keep employs. I'm seeing a couple of dynamics in vcu right now. One is on the investing front as Ali mentioned. We're seeing deals other Deals that they tried to get in six months ago a year ago. Couldn't get into now. It's open you know just a little bit higher price or maybe the same price and it's like Oh my God. So there's some deals so it's a good time to investing at the same time you've are saying. Hey wait is going to be a better time to invest three months for now six months from now nine months from now are prices going to go back down significantly that of the that's one question people restaurant addressing you. How much dragged reserve and it relates to the L P front which is if you were fundraising you most likely post and the question is. Are you six three months from now? Six months from now nine months for now is going to be a worse time to fundraise to you to work with. Lp's than it is than it is now it was sort of. You're the devil. You don't know better than w know if the devil is quite quite bad Alliott what what's your take on. Abc's should should hell is west. You know it's The with humility and say that you don't know which is is could end up going three months or six months could come back. It could be so bad that we don't even know so you know we're picking her spots. I'm not going to deploy my whole fund this month but maybe when I see stuff that truly looks. You know unbelievable. Pull the trigger. I'm comfortable being too late than too early. And you know my job is to be a reasonable fiduciary of capital to my. Lt's Anna turns out. Like I didn't pull the trigger fast enough. But continue to have a three investment period in which a majority of the deals come in and valuations of stay lower for a while. I can live with that. I can't live with putting a bunch of capital out now and then four months later all being gone rent curious. How you guys are handling that. And I'm sure you know you're struggling with the same issues and bridges to add to that your question of. What do you believe about the world in six months from now twelve months? Now how does that affect your your work? Yeah I so. I think that we don't know and we are trying to have a high amount of humility. I think the work. We're constantly trying to triangulate and sort of calibrate. What we believe to be true but right now I mean. The the band of outcomes is just so dramatic that we we just honestly you know unless you have long term government committed contracts and even those I mean could be reshuffled I think the risk tolerance is just down a lot and I think rightfully so I mean we haven't really talked about. I mean the virus is one obviously. Heavy risk factor but. I think that it is going to be a more risk on environment regardless and I think that you will see world actors that Maybe have a ulterior motives trying to shake things up even further and trying to destabilize things. Taking advantage of those natural disasters will will still come. I mean we're not it's not like a nature takes pause on that stuff so I think that we're going to be set up. You know sort of more fragile than than we would overall as a system and so I think the all those things we're trying to take into account and at the same time not go into a hole and shut down the entire process. I mean we still have full team We have no intentions to lay off anybody. We want to continue to move forward on on opportunities and we're actively in discussions on a daily basis with with companies But I can tell you that are opportunity. Costs has definitely risen. And I think unlike these C. Which you you're seeing. You know the good deals. Kinda coming back quicker if you look at like a two thousand eight which I think this is materially different in many ways in two thousand but the lower end of the lower middle market really didn't reprise for about eighteen months and deals really didn't start coming online. That were I would say a high quality for probably three years. I mean that is that's brutal to think about right And so I think there is a danger that you you know. If you've been in the mode of fundraising look we. We just completed. A fundraiser of the timing was was fantastic and we have a ten year horizon on that capital. We're in no rush but we're also open to opportunities. I mean I think is how how we we sort of the Pasha were taking. The the issue is becoming. I said earlier selection bias. It's like if you have a great company right now and you don't have to sell for some reason you're just not going to. I mean you're not going to sell. I mean there's just no way and so and the government's providing sir the bridge Capital needs right now and so for us. We're just trying to watch and see and have good conversations. Build good longterm relationships be helpful on been proud of our team that they've really kicked into gear and tried to create content? That's helpful these businesses. How to cost? Cut a how to think about these government programs You know the finance teams calculators. And of course we've got our own fully of nine companies that were actively engaged with on a day-to-day basis and Some are lightly affected in some are more heavily affected. And and and it's rolling to. I mean we've got construction firms that I will have jobs sites. Shut down for a week. We'll have Down for a month For a day it's every every day is kind of a new day in being allowed him. What's not and so? I think that it's A. It's such an uncertain time right now. It is really difficult especially when you're trying to do longer term Majority of outs. It's just really difficult right onto execute on it and that's even without us needing to have a bank involved. I mean we're we're pretty much. I mean I I'd say the only one But in the private equity Probably the only group that doesn't traditionally US bank financing as part of our transactions. I can't even imagine trying to get a deal done right now. Intriguing banks attention to get a deal. Done like it's inconceivable and talked to a a buddy of mine who runs private equity Sort of all private investment for a large endowment and. He said he considered private equity. Be Shut for business and real estate. Be Shut for business. Yeah I I I don't know where. Vc isn't it. Sounds like Mr? Vc's maybe a little less shut. Certainly adding this idea of opportunity costs I think really matters and ultimately owners need to understand the Christ You know what sort of is the opportunity cost price. I mean we've got an AIRBNB taking on mid teens yielding capital. And you've got you know United Airlines taking unlevered planes and having low twenties yield on that debt. I mean it's just got to replace everything down down the market you know in in your World Bryant. It's it's GonNa take longer because companies have more companies have more optionality into there's more negative selection bias right if you need to be purchased. There's something wrong in venture capital. The default is you're going to need to fundraise and just fundraisers go better or worse. But you know Eric know in in our shoes I would say the companies. That are good. Aren't GONNA wait three years to go raise money because they can't very few venture capital companies can but as if they're good and they're raising now it was because something recent happened and they were midway through the race in the end the fundraise all apart and now they have to race and that those are going to be few and far between but the good companies are probably gonNA still to come out in the fall. They're going to put the brakes on it now. They're probably not gonNA even try to raise in the summer and like this fall is going to be really really good time to invest. Probably and you're going to have a ton of deal demand and they're going to have more capital demand and supply and of our us. I would just tear up for September and October November. There's going to be really really busy months but trying to do too much too soon right now just because you read a bunch of blog posts. It said you're supposed to be contrarian and buying the dip probably doesn't make sense and like I can tell you my calendar is pretty empty like if you were to look like usually my days like thirty minutes thirty minutes or eight minutes if you look at mccown or you might think I don't have a job and it. I'm doing that because one our companies have emergencies and I WANNA keep my counter opens. They can call me on my cell phone anytime and then I'm not trying to make myself busy. I know that it will happen. And so anytime Working on I'm watching workout videos. Tian say and I'm drinking Tequila and I'll come back to invest when things get better. Isn't that your normal life holly during our close super close but more countering by that actually is a good question to Ali. How what do you think How do you think coming out the other end of this? What you've learned Doreen just on personal habits like time usage. How do you think your life will look different as a result of this sort of more permanently or do you think it will at all so I have a friend who had this great line is like your keep telling people that like? I can't with that right now just with everything going on. Not that busy you know and and it was pretty funny because what he really meant to be saying. Is You do all the stuff that you get asked to do. You feel guilty doing it and we now all have an excuse to not do stuff and it's like a really believable excuse and it makes it so that we're all kind of actually opting in instead of like getting pulled in sucked into stuff so. I've been only doing things that I actually want to be doing. Having said yes knowing that I had the choice to say. No it really makes me wonder what my ability to say. No in the future will be so. Yeah I guess. Time has brought a lot more time with our portfolio companies and I'm loving it It is really fine. This sort of Get under the Hood Morris of doing everything in twenty minute increments and also finding myself talking to people. I haven't caught up with a while just having time and I was gonna say that's the same thing that I've been experiencing is just Y- having a more open calendar and less sort of busy stuff that I've been doing Has Really opened me up to have deeper conversations and be able to like linger when you should linger and I think not being rushed to go from one thing to the next I really hope that I'm able to keep that. I mean we'll see when when life comes back snaps back. That looks like it. It's definitely given me given me a hope that that maybe I can eliminate some of the hurry from my life that I think that had crept in And also I eat so much better now that I'm not eating out. It's incredible Qianjiang Thirty Diet. You'd be like wait for months ago. I just want her so bad. When you when you have a full calendar every you know every bad meeting too long and every good meeting is too short. Yeah and as I mentioned it does have sort of this hell. Yes or no dynamic of Of of really being. I thought I was going to have to have kids to be able to have an excuse to get out of Get Out of stuff. I've just made it up. I just tell people I have kids but now there's much easier reason but it allows me to to linger a as you mentioned you mentioned earlier. This is different than in two thousand eight. Let's let's a step down there. I'm curious if I was there jurists because you know some people say things like hey. Our ECONOMY WAS. Structurally sound as soon as this gets back to normal. We'll have some sort of recovery. Some people say hey even if our economy was structurally sound you can't just you can't just pause for two months and go back to the way things were before assuming we use the viruses contender or or or doesn't flare up in a way that causes us to separate again and other people say we were actually Our economy was not structurally sound. And something like this was going with a virus or something else was needed or was going to happen to sort of reset. Who is your stats? Yeah I think this this is Made mostly of our own choosing and by the way if you hear screams in the background. No one's dying. It's just a I have three girls under six so I actually have have kids. And the only way he's got a recording in the background actually just like a radio. Exactly different pitches covers as a getting on so like I think i. I made a comment in one of the pieces. That Britain did It feels like a combination of prohibition imminent domain is kind of what we're going through right now and I you know I am not smart enough. I'm not a macro economist You know I I don't know what what Zia phrased Economists were created to make astrology. Look legit by you know I. I'm not smart enough to know sort of all the underlying reasons why something could go wrong. I can tell you that the situation we're in now. We had a pretty good beat across our companies on the economy and economy. Going INTO. A march was fantastic. Things were going well. Demand was fantastic. The labor markets were really really tight. But look stuff was getting done and It's just gone off a cliff. I don't know I don't know what to say. I mean it's not like this is a It's not like people over levered. It's not like there was some contagion. The manmade contagion right that hit the market. I mean this. This feels like we are in a situation that it's it's much closer to natural disaster but it's just a natural disaster that's hitting the world all at the same time and so in terms of the recovery out of it and the. I don't think there's a playbook coming out of this thing I think that there is GonNa be just a material difference in certain types of demand when you having government say standing in front of you saying don't get close to people don't travel You know it's going to take time. If everything will say we create a vaccine and everything returns to normal quote is GonNa take a while for people to this. Earth had that muscle memory You know go back to something closer to what it was four. I also think it has shown that there is a lot more latent risk in the system than a lot of people were seeing and so my guess that savings rates Sort of increase of risk tolerance decreases just in general and I think that will ripple through the economy. I mean if you're if you're a business owner in you say you know I could buy that piece of equipment but I think I'm GONNA buy using set of New Right. I mean that that has you know. I'm GonNa fix stuff that I have. That maybe is not optimal. I'm not going to hire those two extra people that I think I could really expand. Just we'RE GONNA WE'RE GONNA be a little leaner you know. I think those things in general Do have an effect on on the economy. And I think that we're headed. You know my best. Guess is that or we're headed to rolling lockdowns. I think until we have a vaccine And I think those rolling lockdowns will be by geography. I mean the United States is so big. And you can't you can't you know sort of is not a monolith right. I think there's going to be you know rolling lockdowns in large cities or regions. And then until there's a really effective therapeutic until there's vaccine I think that we're in this weird no-man's-land last for eighteen months two years. Maybe even a little bit longer And I think that's the new normal that we're headed for is a sort of in general. Broadly decreased demands just based on those sort of factors you know sort of lowering productivity than higher savings rates. I think will ripple through most everything there are going to be you know. Call it five to ten percent of businesses that get a tailwind were serves largely unaffected by this but I think the vast majority are going to feel it in meaningful ways yet. I think also To that point you're gonNA see a lot. More companies set themselves variable costs. You know as much as they can. So you're seeing the resiliency of ECOMMERCE right now or a physical retail. I think people are going to really decide that they need to store to sell. Stop stuff you know. I think that may never change or that will have changed. Never going away. I agree with you. I don't I don't know that this is like a going back to normal but I do think it's also important. I kind of think about like what if it does you. And just sort of have the playbook for each part you know what if things go really well and have that playbook what if things go really really badly and how that playbook and just lean into the. I don't know factor. That's what we've been out of the all of our companies we have. We've encouraged them that that you know what are plans for. X. Decrease in revenue Y decrease in revenue. What are the trigger points based on? How long this thing goes so that everything's mapped out ahead of time. So you want to think about it. You've already served given it. The calm thought and then coming out the other side of this thing is exact same. It's you know. How could we essentially use this crisis for good to consolidate you know talent that we never thought we'd be able to access to some? You know whatever those may be. I think those things on both ends you know on the way down in on the way back up Look important to build a plan out with the humility that you just don't know yeah the the other you know. Kpi that I think has come out of all of this. Is You know when you're thinking about what you're going to tear back on and come to spending you know what was the value all the stuff that you pay so like one of the. Kpi's that I always. I always tell people like my iphones. The cheapest thing I own because like I paid for it compared to how much I use. It is unbelievable and then like you started thinking like cheese. Spotify Relatives Utility. How cheap is net flicks relative utility? How expensive car relatives utility and he started thinking about this sort of utility verse. Spend you know an especially when you start seeing also parts of the ecosystem that really gets affected so no you start thinking about consumer demand. He even consumer lending subprime people looking at me. Like wow that if rates and subprime we're going to get really high the realities. They've already been really high. You know and and the sad reality is for subprime and deep subprime. Life's a recession. You know and then for super prime. They're probably going to be okay. And it's a bunch of people who are sort of sitting in the apartments and getting delivery and are feeling okay about it Maybe with a deep sense of Gil which is I definitely feel deeply guilty about the what. What's going on in the world and the fact that were killing are safe and everything like that and it but the people that are GonNa really effective people in the middle is the people who are good borrowers. They're good spenders and spend their whole life following the rules even though they're kind of hanging on the edge and they're the ones who are gonna be making sort of significant changes So when you're thinking when when we're also looking at our demand and the revenues and the customers of our portfolio companies you know. The first thing we did is we said. Please send us a list of everything on your customers. Broken down by the industry. They're in like all your customers in the travel hospitality space. That'd be really bad are they. Smb's that'd be really badly financial services institution that wouldn't be so good and then understanding of those which are the middling credits because the good credit standing credits. The Bad Credit Suisse say the bad credits. It's the middling ones that are sort of worrisome to lead. I think it's interesting. Analyze consumer behavior and also enterprise behavior in terms of. Are they going to freeze new business expenses? Are they going to embrace new ones? That are cutting costs in a way that they wouldn't have before an enterprise sale will probably be hit harder than consumer subscriptions Because I don't keep people train off netflixing spotify right now and spotify networks are not going to give you a discount like they. Just don't care enough about you but I know that. Like for all of the enterprise offer that we use. We're getting pretty good. Discounts or portfolio companies getting discounts and people are trying to take care of their existing customers. So we'll see I think. Different companies will be sucked in different ways and anyone who thinks dancer. I am excited to had a predictions. The I think that the the might end up being sort of a long lasting thing is digital community as being much more important than in the past. I think it's been sort of an augmentation of real life community in person community. I think these digital communities that are being formed. I think you'll see a lot more of these form that will enable a level of intimacy and and true community that. Maybe you haven't been there before I'm actually excited about that part You know prior to this. I was not a heavy zoom user. I used them a couple of times and I gotta be honest. I mean I think we might travel less in business just in general I mean. I think it's still signalling mechanism to show that you really really care. And then it's you know relationships important but I think that the actually utility of it. You can bypass a lot of that and use sort of digital tools in a way that could create a lot more a lot higher productivity. I mean I think it has odyssey implications on certain industries but I think in general could be really useful. Thing long-term yeah. I'm a little nervous that how many digital communities are gonNA exist. I remember like I already overwhelmed. With how many telegram groups I was in and like that. Like Crypto telegram groups. We're really mania. And I. I don't really need more channel and I'm already been like there's already like a couple of zoom groups that have now formed. And like you know I they're cool. They're they're really cool but it is a lot of content. The challenge is saying that you can't hang out like I don't know if you guys have experienced this but sounds like hey do you want to zoom later and you're like I'm available but you know I kinda wanted to read at another really hard to get stuff right now in a weird way? Socially just your kids. Yeah no like I was talking to a friend like I was about to say. I have to go and it has to go. I just wanted to go. It's like as I came in like it's GonNa be pretty bad. I'm putting out of stuff to say. Just GonNa go watch. Tv Let's let's let's LP's a little bit. I feel bad for absent friends right now. Who are trying to. We're trying to raise their first venture fund when Goget hit and if you were trying to raise a venture funds Bishop Microphone Twenty Nineteen. That was like the best time. Ever in only microphones got off the ground. But now I mean you know on the dom inside your they were already over allocated to venture to illiquid portion. You know they're getting crushed and you universities. Obviously don't have students. Their students are now realizing paying all this money for zoom calls that they don't even want to be on in the first place parents seeing them you know at home saying hey why are we paying all this money. You are cost reopen the fall. I don't know so that means they need more money for for an L. P. market their shot. If you're trying to raise a fond right now is a really bad idea to call people. You'RE GONNA get a no and you might as well wait a few months and then reopened fundraise because like a maybe later better than a pass. So if you are raising a fund right now is because like yours your special and so. I'm sure that the funds now it's like a another fine if it's a rea- per if you're looking established firm people are going to invest. They'd rather you wait. But they're going to do it because they know they have to. If you're an emerging manager I. I would strongly discourage it. The other thing that's happening especially for endowments or anyone who has down type model or they have buckets is your equity just got crushed. You need to rebalance and so. Let's imagine you one hundred dollars of staff you know of of money and you used to say well I want a certain percentage of inequities you now have all of a sudden like if you had. I don't know forty percent equity thoughts call it. You know how thirty percents equities and so you now need to take the money out of other stuff and put it in equity or if he used to always want sixty percents or above to be liquid and forty percents of the private. If you're liquid book just got mark down but your private market in that. He had to take money out of the private market and put it back in the public market. You're targeting goals so not only are people not wanting to invest because it got hit and there are reticent nervous but it's also that they're having to re bucket into things away from you and you're just too many too many headwinds for no luckily probably markets have a lot of dry powder. But yeah I mean I think also how behavior you think is gonNA is gonNA rebound here and six months to twelve. Months will also affect how handled the dry powder that they currently have. I mean that's one of the things that You know when when this thing all started hitting we call all of our OPEC As and said Hey I just met you know verify. You're still with US right. And we got resoundingly. Hell Yeah and in fact. We have two larger Lp Say hey if you've got stuff that comes up as a result of this you know we'd be willing to put in more that those are the types of LP's that I mean we obviously selected for heavily An officer the long-term vision a lot of the people that we've talked to that are on the side. I mean as always I mean it's it's just shut. I mean there's just no way that they're gonNA be doing new commitments right now. If you think about all the factors why most shot right now is sort of a an echo up the chain of of of why they're being shot you know the same. I mean they're dealing with triage the same as everyone else meeting your you'd better believe. Lp's are being active in the in the folio their GT's trying to help triage understand where you're gonna try to you know. Put your capital. Save some of these companies as well. I think those are discussions. And maybe if you've if you're raising a first time fun and you don't really understand. Those dynamics is going to be hard for you to understand why you reach out there saying. Hey I'm booked up. There's no way in so I think you know again. How risky where where do assets flow in a in a risk environment I think that's interesting question. I think that again I. I'm not smart enough to know that but I think it does have implications of how quickly will some GP's deploy dot knowing that it may be hard to raise no matter what their track record is on the back end of that totally? Let's not spend the next ten minutes. Talking about predictions are cer- certain industries. That were excited to see different different different. Transient acceleration. I've to One is One is a something that excited about another. I'm less excited Of curious about I is education. I invested in Homeschool Company. I invested in Daycare Company. I think you sort of shift from K. To twelve to do something new or shift from university to do something new is. It's wildly expensive. I think is is accelerating quicker because of this and I'm excited to see entrepreneurs create solutions to solve that Song. I'm looking to To invest there and not that it's an university. It's not that bad. It's just that it's it's way too expensive and people taking on too much debt of and so that that space. I'm really excited to see or solutions. I think when space that I that I think has not performed as well as it should have is ripped up is bitcoin. I think you'll be. Hey you know. This should be a flight to safety in these type situations than before saying. Hey Not for these type situations but for others Nations but then it with the Fed printing extra dollars. I think people are sort of understanding. You're learning about geopolitics and how strong the dollar is and how they can effectively get away with it in a way that doesn't seem to impact Bitcoin Bitcoin Preisinger or Brooklyn prospects. And so I wonder what that means for people's Understanding of of on Bitcoin. I'm super bombed by performed and I don't really have. I guess I don't really have an opinion formed other than you can do. It was supposed to do and that the government has shown that it's probably a pretty useful thing You know it's probably pretty good. That like the government told everyone to go home and has five pretty good that the government made a venture loans to people and monetary policy is important because when you see deflationary events occur. Then you know that you can go print money and like I didn't really have like a positive or negative Steve Nation ahead of this. Like I think he's done a pretty good job. And you had the benefit of you know seeing Paulsen fight really really hard to get all the stuff done before and I don't know I feel better about having government than not having won the second is you know. Were really focused. So I think a lot of you know. Investors are saying okay. What changed the world. That's going to stay the same after all this is over and I think one of the things we're trying to stay away from is avoiding any deal where because of the pandemic the revenues are up and they're like wow we're like SORTA countercyclical. You're not countercyclical like a pandemic cabinet. This is like weird that you're good at being remote you know but this is like a countercyclical investment that's like a pandemic cyclical countercyclical investment. I said those deals aren't really that attractive to us because at the end of this they're going to really big bump in Q. Jail and then they're gonNA go back to being normal mediocre companies always work I do think that there's certain things like. Yeah of course stimulants like I think Landis schools probably pretty happy about best I think income share agreements are gonNA get fucked and some are not in those zoom will probably matter and we have you know killing. I have really close friends in Atlanta that we almost never talked to or at least I almost never talk on the phone and I am and we're talking. We're hanging out with them every weekend now so I think that's really cool. You Know Brent. I bet you you feel like even better about not living in New York now. I think that you know it's really say commercial. Real estate probably won't come back in the same way. I don't know I bet you less undergrads are GonNa let graduate from college and say not really wanted to New York City in San Francisco so I you know I don't have any like really groundbreaking things other than if anyone sends me one more deal that tells me like gotTa have this portfolio companies doing amazing because pandemic. You should totally invest. I'm not interested in that I'm interested in companies are going to be good in good times bad. Yeah Yeah I would say the. The thing that I'm interested in is telemedicine in how that comes out of this so one of the A friend of mine Runs a a local group that he's been trying for years to work on state licensure type stuff? It's really difficult. I mean you have to get licensed every state practice medicine. They're the argument. Is that you know the Texas. There's something about you know practicing medicine in Texas. That's just fundamentally different than practising medicine in Wisconsin. Right and you've got to have local knowledge to know and you gotTa make sure that no the people they're practicing in Texas no no Texas people. As if they're different than than Wisconsin. I think a lot of that. Bs is going to go away. I mean one of the things I'm really hopeful for is even beyond telemedicine that a lot of this state licensed or stuff just tapped braided hair to do whatever a lot of this stuff gets opened up a scene for what it's always been which is to try to protect incumbents and hopefully we just clear cut a whole bunch of that garbage that that has been impeding up for the most part the poorest entrepreneurs amongst us from being able to businesses just a giant tax on small businesses. So I'm really hopeful that that's gonNA open up and specifically Intel medicine. I mean I think there's so much stuff that we do. We've done previously like urgent care. Type Type Work Buddy. Mine's a good friend of mine's a doctor. And he said he before this he had done. Maybe one or two telehealth visits if you WANNA call In his entire life and now he's doing ten of day you know and he said actually a lot more productive by clients. Don't have to drive to and from. We don't have infection issues within the office I think there's a lot of benefits to it and so I'm pretty bullish on that there'll be a whole crop of organizations of pop up that can provide a a sort of metal layer of truly fantastic health services. You know through your phone. In essence I think areas that I'm sort of I'm interested to see how they play out are really heavy asset industries. I mean this is sort of going into bad as far away from Tekken. Vc for the most part is you can. But I am curious. You know if you can take the aviation industry. I think it has incredible consequences up and down the chain. If you have a sort of fifteen percent let's call it. Material and sustain difference in air travel yesser taking air freight out of it It has implications up and down the supply chain. You know how often these parts are being produced by by companies. I think there'll be a lot of e shes that are created as a result of it but I think it's going to be pretty damaging to these large companies have his incredible infrastructure footprint. And and. So that's another area that we're watching pretty closely right. Now is pretty. Heavy asset a type industries and companies Heavy manufacturing things really interesting if you the margins have have never been great there but if you take out ten percent demand I mean. These companies flipped from being moderately profitable to being wildly unprofitable overnight. And I think that that's where some of these things are going to shake out. I think everyone's GonNa get haircut depending on what the industry is an WanNa come into the digital communities I feel like it's opportunities for really new social experiences like some people are saying imagine of Chat Roulette had come out in this era? I I worked on a video startup in a two thousand twelve. That would love to see Sarah game show type dynamic the you know this should be a golden moment for virtual reality. It's it's too early tech perspective but it was a few years later. I mean people are people are bored looking for new ways to connect and new ways to sort of Your share experiences. Now if you have kids at home you're not board but with that is actually interesting. I somebody the other day on twitter mentioned that they said there's like this big bifurcation right now if you have kids. You're like working. You feel like you know. Eighteen hour days right. You're going to start as you can all day long every day. And if you don't have kids just bored as hell so ironically online poker later tonight yet. Zaire Eric Online poker later tonight. One by Brent. He can't make ads like event. That's a perfect segue Ali to go back to see his kids and Lebron's vacant shore permanent equity and Alliott medical venture guys. Thank you so much for on the PODCASTS. You're an early stage entrepreneur. We'd love to hear from you. Check US out at village global dot BC.

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Jeremy Grantham  An Uncertain Crisis - [Invest Like the Best, EP.177]

Invest Like the Best

1:07:58 hr | 1 year ago

Jeremy Grantham An Uncertain Crisis - [Invest Like the Best, EP.177]

"Hello and welcome everyone, I'm Patrick, Shaughnessy and this is invest like the best. This show is an open ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date, but investor field guides dot com. Patrick o'shaughnessy, if the CEO of a Shaughnessy asset management, all opinions expressed by Patrick and podcast, guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management this podcast informational purposes only and should not be relied upon as a basis for investment decisions clients of Shaughnessy Asset Management May maintain positions and the securities discussed in this podcast. I, guess today's Jeremy Grantham Jeremy is the CO founder and chief investment strategist of Grantham Mayo Van Audible, Aka Gmo. GMO, which manages more than sixty billion dollars for clients was a firm that helped educate me early in my investment career. They've long publish thought provoking research most of which came from Grantham himself. He's regarded as a highly knowledgeable investor in various stock bond and commodity markets, but is particularly noted for his prediction various. In this conversation, we discussed the current crisis which he calls the fourth major event of his long and storied career as an investor as he says this one is the most uncertain. Disgust unique topics like commodity based companies, and how opportunity often lies between fields of expertise. Please enjoy our conversation. Jeremy Thank you so much for doing this with me. Today you've had such a long and interesting career in the field of investing that my opening question is a bit of a motivational one, which is what is the thing that for you as the compulsion or the deep curiosity that keeps you going in the field of investing specifically, despite long enlarge success. That's a difficult a difficult question. I like analytical problems data. My idea of heaven I know it's politically. Incorrect is a corona bars. It's flooding may with entrusting contradictory questionable data some as high grades some. It's low grade. Some peer reviewed some as room. It involves every aspect. Of Humanity in politics. And yet in a kind of grim sort of way, there is a scorecard on each country's response. That is the very essence of what it's telling me on. and. Life is analysis and statistics under uncertainty. Where humans intervene, and the quality of the data is mixed. You've seen such a large transformation of both investing and capital markets over the years. What in your opinion stands out the most from the perspective of someone trying to earn? We'll call it excess return versus a very bland broad market benchmark. What today is more important in that pursuit? Then was a few decades ago. I think the there's always been. Two major approaches to managing money. And one of them, which was effective in the nine hundred twenty s at is equally effective today. Is! The individual stop level in particular to focus on. unappreciated changes in the future what is going to happen and find out deduce what the market things and look for unappreciated changes, good and bad and bad against market. And that that urinalysis has picked things up that the marketplace. Has missed so fundamental. Fashioned analysis. Is effective anytime. We will lucky when we came in. And that. Some parameters that somewhat reflected. Value had worked. Pretty, well, as contrary indicators for eight years, or so when we started forty fifty years ago and those things I priced book p price cash price to sales. What I have long thought out the as dokie value, what they are really is just expressions of the markets discussed. And the cheapest price the book I really they assets which dollar for dollar the market thanks of the least useful. And the lowest PG the earnings market beliefs will be sustainable and the highest yield, the most likely to be cut on not sustained. There's no reason why those should work. And indeed for twenty years now they haven't been working, but in the old days they worked because the market loved comfort so much that it was constantly overpaying a little bit for the procter and Gamble's. And underpaying for those nasty cyclicals kept getting excess production getting crushed. And we came in my fest fun. I started in nineteen, sixty nine, and we applied those standard. Graham and DODD techniques. And they worked beautifully. Life was simple than whatever yeah and you occasionally had a string painful string of. Two three or even four years, whereas stocks for trash, you and your clients, but they came back made up for the lunch crowd, so if they gave up four points one year they would make it back and Alicia the usual full points a year the following. And so life was easy and I. Think the General Caliber Competition back in those days was very weak, and therefore if you did descend analysis looked for value, you could find it, so we were able to build simple mechanistic models at giving points for cheap, and so on and have a win on a very broad basis, so we could manage a lot of money. And we will winning two out of three years, and adding a few coins on average year that era perhaps started to end around two thousand. Too many machines where picking it up. Too many qualms too much money. And Pretty soon the aversion to The historical abrasion cheap stocks had disappeared. Because they acquired the reputation for having won, the klumps made it clear. They understood that for eight hundred years into the midst of time. These factors that worked. And indeed academics. wrote it up and got a lot of credit for such as simple minded idea. Anyway, that was passed, and those early pickings have gone leaving as I, said, old-fashioned labor intensive. Stop by stock analysis, not only intensive risk intensive because you have to bet. Things will change and you have to bet that the market is wrong. And that gives a lot of people. Not surprisingly a lot of trouble. One of the things that GMO is most well known for is its asset allocation or seven year forecasts of major investment, categories or groupings talk a little bit about how that idea has evolved, and what sort of the key components are analytic or quantitative that go into that very popular concept. Basic main religion is bedrock idea, so we studied the at which asset classes tended to mean, revert and around which levels. So asset allocation is profoundly based on history. Repeating itself off following some. Principals One principal is that if you have an abnormally high return in an industry or company or marketplace, it will attract. More competition and drive down to some historical, and it should work that way in a healthy capitalist system, if a subset of an industry starts to make forty percent year return. Everyone should drop what they're doing and spend some of energy and money a copying faithfully in this quickly as they can. And if they do you have a dynamic rapidly moving capitalist system, you also have one in which those returns will get bit down pretty. Fast Mola's towards speed more average pretends. That's a healthy. Now, we've diverged away in recent years from the last twenty years, and the degree of monopoly, particularly in the US has climbed the degree of corporate influence of government regulation. which facilitates monopoly the willingness of the Justice, Department. Break companies up has declined not surprisingly under those conditions. Consequently, the returns have been above average for much longer than would have been feasible in the old days. They would have been competed down and that process. has weakened. And in the short run at scrape for stock prices in the long run, it's bad for the capitalists process. It's definitely shows a weakening in the competitive spirit and speech conservatism in high return is put ahead now of growth, and being the first, and the biggest had something new, not that there aren't splendid firms who still do that, but just the meat and potatoes enterprises have become more conservative. If you. Take the old adage of. Don't fight the Fed and don't fight the tape. Perhaps we need to add. Don't fight Fang and using Fang here as just a convenient acronym for large growth kind of technology complex, do agree with that, and what's in investor to do in face of the reality on Plainfield here that these companies have just dominated not only market returns, but fundamental growth. Bell to take your point in pieces, don't fight. Fed has had a pretty good record, and has not applied to my life or oh, we have always plane value I! The Fed wanted to be on the other side of that game for a while. We would carry on godless and eventually the great bubbles. Broke, we didn't catch the top. We were painfully early. But. They broke and we won, and we made more money on the decline than we lost on the upside. Classic would be the two thousand tech. We didn't Really Find It until the pee on. The market became the highest in history. Highest Paean history had been nine, hundred, twenty, nine twenty one times trailing. And by early ninety, let's say January ninety eight. It was twenty one times earnings, and we were officially very barish. Why would you not be with his? History Anyway went from twenty one to thirty five, and it went from twenty one to thirty five on rising. And at the time the earnings were vastly overstated then they were later revised downwards, cruel and unusual, extra punishment. For everybody bulls amber so the the earnings. People thought they were looking at another two thousand were revised down probably more than ever before in history, but at the time they looked to a very prince they level, and so earnings had been mocked up enormously and two years, and the P. had shot through the roof, and it was a very grievous defense. Business Risk for us. And we lost. Half our asset allocation business, at least, and then of course sap collapsed, and the much cheaper alternatives did much. So the US Rit's. Going Shield at nine point one percent of the top of the market. We're up thirty by the market low. The SAT minus fifty US Rei chased plus thirty, and they were said to be entitled to behave like smoke. And I've called. small-cap has a High Beta. So. Small cat was meant be down. A sixty five s and P was down fifty, but the reit's a subset of small-cap or up. Because they were so cheap and a yield of nine percent, and the P. had the lowest yield in its history in. In March of two thousand that yielded I think one point sets. Everyone saying Oh, well, yeah, but the S. and P. has a high growth rate of the scuba dance, and we did the data, and we pull it out and show them and say yes. You're absolutely right. Yes, and peace dividend stream has grown one point one percent faster than the it. And that's why you get an extra seven and a half points of extra guild. Anyway the principal was we were perfectly happy to. What the Fed was doing going along with the Fed is a different game a short term take all these other factors together stood up and get lucky in and speculate. But I think if you're going to be an investigation value, you have to be prepared. To ignore little things like the Fed the Fed take today. The Fed is swamping. The system with paper is not producing jobs for people. Who are unemployed. Unemployment may go higher than twenty percent much much worse anything since the Great. Depression the Fed is not going to address that the Fed is not FDR having arrived for the second time with quake work programs to build bridges impacts. Refresh on railroads system upgrade grid oldest good things and winter is all the houses in the northeast or the north. That's real star. But paper is not to say. Ten percent of the people drop out of the workforce and neutral ten percent of the GDP and paper to a half trillion acid, and you think well, at least that will make competence better, it will help I get, but if you take that thought experiments and extended imagine a world in which everybody is on. And you throw twenty five trillion dolls of paper one hundred percent of GDP at it. What are you have? You have no goods, no services to buy and lots and lots of money to buy it with. Though of course, intrinsically inflationary process, we are cranking out paper as The output of goods and services drops way down, and that can easily go wrong in the short term, a lot closer to the market and pushes the market up. But my guess is based on history. When the earnings a finally presented as down thirty forty fifty percent, the pig is will drop, and the market will decline. That is at least a risk as the not you have today market that is at the same price. It was last June when everything great and everything is not great. Now we know, but you have the same stock price since valley, fantastical circumstance now given the power to you copy absolutely set that it won't go on, but you know it's not guaranteed. You know there is a balance of risk and return. And since the price is already high by historical standards in the top ten percent, before the season starts, and the debt levels of the highest, the been you know you're playing with fire. Is it not proved to be very cautious? That the world presents more opportunity for an active investor than in years past today and I asked the question, because what we see is a lot of those record price. Levels are driven by this. Don't fight the concept that the multiples on these companies are very high. Therefore, the markets is higher, but that within the market there are a patch of extraordinarily cheap stocks, so valuation spreads are quite wide at least in the US. Do you see something similar? And what is your take on where opportunity may live up to talk about resource stock investing here as well in today's market environment. I'd like to say to my colleagues and clients for that matter that this is the fourth grade. Stock Market Event of my career, and rightly or wrongly. We took a position in the previous three where we felt nearly. That we arrive and we presented it. That way I teach for fortune. Where my title was three uncertain times in the spring of await the near the housing market collapsed, risk premium would rise in profit. Margins would get wacked. I mean of course. They were Nisa and. And the one before that will stay tight bubble and the tech bubble really had a lot of craziness stood, sadly may be missing today, but the pet dot com, if you will that who had just hundreds of new enterprises on the aimed at the Internet, which didn't make any sense and very great majority of them. A went out of business completely, and the were the main tech companies who was selling it fifty six times just ludicrous. Nearly, not that whole thing would collapse and there were plenty of cheap to. In the bond market, the real estate market and smallcap market on the value market, they were all gloriously cheaper than the tech, and the Internet, and the one before that was Japan well in a way, the mother and father of old bubbles Japanese real estate market is probably the biggest bubble in the history of capitalism much bigger than the south sea bubble. The land under the Empress Palace really was and nineteen, eighty, nine, a selling per value greater than that of California. We spent a couple of days kind of tracking down. It really wants and the stock market which had never sold over twenty five times, earnings went to sixty five. Of course we were early painfully early, but we made a ton of money on the round trip and we were certain that we would win. We just didn't win the hell we'd win and the timing is always tough, but you know in the end these things will break. We thought and made a big fuss about it at the time, and in two thousand I painted. The boss of will Jeremy. Siegel I think it was nine times including some very big audiences where he was people. I was bad and counting regression collapse of the S. and P., and also in Zebra no eight. We were absolutely confident. The US housing market would break. We all data on the housing market and this was not just bubble. This was a three sigma of. Definition of a bubble is to sigma every forty. Three sake event is debris hundred years, and basically that had never been like that in the US real estate market. California bubble, but Illinois Florida would be busting at the same time. America became famous for that, but it took Banenky Greenspan. It took the devoted attention to have every real estate market in. By country like the US bubble at the same time, and it took them to miss the point of Banenky saying the US. Real Estate Market Milly reflected the strong U. S. economy. I mean it was complete nonsense where statisticians when you had a hundred year bubble anywhere. The housing bubble preceded beautifully to peak and slow down. And then under the surface, we were aware that some of the subprime was deficient. We had no idea how deficient by the way, but we knew it was going to cause a crisis and we didn't know how much with zone in Europe. But? We knew it was way enough to create a major league recession. The housing market coming back down, we calculated with a little bit of overrun below trend would remove ten trillion dollars with perceived wealth from US homeowners. Now that is guaranteed to be a economic problem, a really severe problems. And the market came down perfectly, so they were all Nisa Jeez. This one is without trying to ton this one this novel. This is different. It is completely original. We have never had anything like this. And I want to come back to your fangs, because they are novel in a completely different way, but everything about this cycle going back. Almost twenty years has been different. I Argued With grants of grinds newsletter at its annual conference. He called me an apple state in value. Because I had given up the pure religion that everything regresses to the me. All this time is never different, the five most dangerous words or whatever it is a main dish language, said John Templeton. An I responded by saying forget the fall woods to five most dangerous was an English language. Is this time is never different? Because occasionally, of course something really important happens, that is different, and the corona virus is one of but the entire base of American. Capitalism has shifted since two thousand with the emergence of. Of much higher levels of return, many more stock buybacks, a much more conservatism, the number of people employed in new enterprises in America that a one or two years old has ha- since the late nineteen seventies, risk simply not as aggressive capitalist system as we were so everything, everything has changed, and now into the teeth of that comes to bars, and it doesn't arrive at any time by the way it arrives at the end of a year longest economic upswing in history with the lowest unemployment. I e. But with the highest corporate debt levels ever, and some very smart people believe as badly understated in official data and the highest ever sovereign debt levels around the world with weakness in a you, and with odd leadership in the US, so a very vulnerable time the end of the ten year cycle exactly when you'd expect things to start going wrong. When you're exposed to high levels of debt, very vulnerable, not a toll, resilient and then bang. This thing has unique in many ways, not least way being that it's a supply. Hit Anna Demont. So you can be. Simaltaneously shorted customers one side, and you can't get roll material at the other. and Far and away the fosters rise unemployment in history much quick. At then in the nineteen thirties, and with colored cubes, stretching out tentacles. If you will out into the future will ally, travel be ever wanted was will not a lot of reconsider the need to make so many long tiring infectious type journeys. We already knew we were getting the flu and the the Coles every second trip. To Europe and now we throw in perhaps a recurrent corona virus. It's quite possible yet, so some industries will simply change. And it's also a period of introspection. What a good time to follow up on some of the reservations when we're developing about capitalism, inequality, climate change the things that governments were not doing well, and here we get to do and read and think, and maybe even growth at any tries to hell with the consequences which has been. The mantra of US capitalism, not always, but increasingly in the last ten years just as a side issue when I got here nineteen sixty four turns out to in about the sweet spot in American capitalism, everything was pretty done well with the notable exception of civil rights, but in terms of respect for workers, developing effective pension funds on their behalf, paying a decent wage, having respectable ratio between the CEO. Forty, times, his average worker, and as was Japan Japan. Today is forty times and we a three hundred. Forty Times to three hundred times your average, worker or fortune. So Accompany today does not necessarily have a nineteen sixty four level of respect for the city at works in the state works and the country. They have become kind of global prizes trading one country against another moving their factories on that work as where they can make money, basically following on Milton Friedman's definition of social responsibility, which was social responsibility. Cooperation is to maximize profits. And as I like to say, the corporations are treated like individuals. If an individual had a policy, which is to maximize myself interest, you'd say a sociopath. A workable definition of such path. So basically we have sociopathic. Companies Proud. Of that Metro. We were just beginning in the last two years to hear some pushback from that. Including a lot of more respectable corporation sang gone a little too fi guys. Let's reconsider. And now we have a wonderful opportunity. Don't wait to reconsider some of that and one of the side effects. Of the virus has been. Bad down even more on the chorus quarter of workers, and they not only get three quarters of the virus deaths, but they also a losing their jobs multiples of the top quarter. Who can safely a work from home as assigned doing? Here in the countryside, taking a couple of Beautiful walks everyday guilty, but it is part of the aggregate problem a word I'm signs because of all the things that have changed since two thousand in the this time. Everything is different world. Defines a one of my favorite examples. The fangs unlike. Any other the seventeen seventy S. There unlike anything that ever walked the face of the they generate market cap on. The years of assets it's totally unlike possible extended a bit of apple unlike it used to be, it's not about traditional capital, being appreciated and replays and cranking out widgets. It's all about intellectual capital and brand. And speak and using your brains and innovating even though I'm I'm really quite down on American capitalism as being a little fat and happy past, its prime I am very long on American venture capital. It's the really five part of the capitalist model bench. Capital was always the dominant one in the world, and it still is, and if you look at the fans to me, a I'm an old guy and I've been in this business fifty years but jam. Oh, we hired away. The potential employee number twenty two from Microsoft the oldest of the of the new modified group facts, so the simply not that they're not the procter and gamble's general of light trade, and an Exxon's and Merck's were around in the Great Depression these new boots, and some of them very new indeed, and generally the US Capitol Lynch, street remains vital an effective. And, if you have brilliant student today, he doesn't want to go and work for. Oregon. Like financial it onto be a management consultant like the nineteen seventy. He wants to set up shop and do something new and make a difference and make a fortune doing so venture capital is getting all the very brightest people to go into that area and why not? It is at least. Useful, it's dynamic. All the new great ideas so change is very densely constituted in venture, capital and fangs somewhat enough shooter that they are absolute winning winning windows of the last fifty years of venture capital are all based on you, technologies, new ideas and the different. So, my advise to everybody is be a little careful. You need a good value model that deals with intellectual capital that deals with growth. And with quality stability, you need to get far away from simpleminded PA and price to book when you're dealing with digital is maybe they're expensive is not what I do these, but they are not Cisco up two thousand. They're not sixty five times. That growing fast, and they're fairly have high priced, but you should be careful. dismissing these guys they are differ, but the downside Dad's may be. Society is getting a little fed up with them in the sentence that they. Don't pay much tax anywhere. They move around the globe. They exploit better than anybody the opportunities. Of trading off one country against another with taxes production, a complicated accounting, and they are playing fast and loose with political influence, some of them and irritating. Take your cans, but also some Americans, and maybe that will start to regress and caused him problems so I am not touting them by any means I'm merely pointing out that they wanted many important differences of this cycle of this last decade in particular and the old fashioned routines have to be moderated. You mentioned that this is the fourth extraordinary stock market event of your career. I'm curious how you speak to clients about your posture facing down in the midst of it. The first three GMO famously had a very very specific view. That view is very clearly expressed in portfolios, often very contrarian expression. What is the equivalent today? You mentioned that it's novel is GMO's response although novel relative to those three. Events. Yes our preface on the bottle of pills. You're taking every money. The warning is this is not the near certainty that we felt in the street prior. Events, this has more differences and death law. You can't be as. A POW, distinguished, Playa. As you could be. It's more complicated and it's less. Okay. That's the Cabbie, now have been given you. The long list longer term problems along the lines of climate results limitations. Along. And two longest economic cycle in history and the highest levels of debt. So. A now you imposed a stress on the system and the clearly that management around the world is very uneven. On how that dealing with this? This has created an almost uniquely risky environment, so the uncertainties remain completely for us, but they also dominator once portfolio a management attitude down. This is not as no future is even last knowable nome. And the Nisa have disappeared, but you know sure as I said that this market is in the top ten percent of all time PS and the economy. Trust me has not in the top ten percent. It's in the bottom ten percent of all time, economists. Is a splendid mismatch carried on the broad back of the Fed the Fed. We don't quite know how long and how impressed it comes stock prices, but if you're a fundamentalist and your patient, you don't like that combination of being in the highest ten percent of PA's and the lowest ten percent of economic certainties. Nobody knows what's happening in the economy. We all know we're GONNA have wipe out in our earnings, and we all know we're going to have a wipeout employment. And so and we all know it's going to go on longer than we thought Nelson interesting by the way when the market hit its lobes. How did you rally? But during huge rally? What has come out by the economy? Almost anyone at the brain is more nervous about the economy. In terms of the length of how the effect will be found in tons off. Peak levels of earnings setback in unemployment so pessimistic than we were at the very day, the mock at hidden slow. This is all once again carried on the broad back of paper. Being thrown at the system. I've liked to go to the almost exact opposite extreme from the intangible heavy Fang to a fascinating topic that you've explored for years now, which is natural resources in companies tied to those natural resources. What is the origin of your deep interest in this area? These very hard asset, very traditional I'll call them companies. And why do you think one? They're important and two? They may represent an interesting investment opportunity. while. The long term commitment is outrageous are simple and unarguable, and that is. You can't have compound growth on a finite planet. I always. Very quickly by a quick demonstration, just imagine the Egyptian Empire which lasted three thousand years by the way with the same religion, same Faraz and the same culture same language. For three thousand years, let's just imagine for a second that its. Population had grown at one percent a year. The wills population has grown faster than that my lifetime when it just tripled. And three thousand years later that multiplies by nine trillion times population. LBJ there would be no wet them. On this planet are several other planets, and if you do the same with physical output, allows one percent a year, one percent, a year increase in physical outputs, and you start with enough goods to fill one of the giant pyramids, and you come back three thousand years later. And if grown one miserable descent breaking all the economists, Ha and you have enough physical goods to fill up the solar system. It doesn't take as long as you think to come. Pound and craziness doesn't take as long as you think to. Stop cranking out so much carbon dioxide that the surface of the planet stops to heat up. For example just as quick inside the difference pre in the DACAS glacial face with two miles of ice on Manhattan. And interglacial such as last thousand years and allowed civilization to get going. With, the difference is a hundred pots, million of carbon dioxide from. One hundred eighty pods, two hundred nate and thank heavens, carbon dioxide is brilliant greenhouse gas. Because it went zero, we would be a frozen bull with not much life, other the microbial perhaps, but it would be minus fifteen to twenty five degrees centigrade, and so that first one hundred and eighty gets you to the ICE age. And the second hundred debt you to where we were in eighteen fifty and what we've done since industrial revolution is, we've gone from two hundred, eighty, two, four, hundred ten. We have added more. Million than that which separates two miles of ice? On Manhattan, from today's Manhattan I mean this is just a shocking in the mazing nights permit, and we're going to do the same again or to add guaranteed no way we can avoid it another one hundred twenty. That's enough and what that will do. Nobody knows for show. It is just the same kind of huge. UNKNOWABLE risk that you would do anything to avoid if you sensible. I think what we've learned since we knew. The risks of climate changes, the species is not that sense. And the it just plays short term acknowledged inconvenient long-term things and hopes everything will work out, and they'll be dead anyway and screw that grandchildren apparently. But, it's all available science and we choose at the government level to do quite a lot about it in a handful of enlighten governments and ignore it as a hoax and a handful of the ready West, at the other end. And everything in between with simply under responding as a global species, big time, and we will have the temperature go up on the floods. The most dependable. Is the flooding will go up a which we see everywhere even today as we speak, and we say the droughts ago up much less, but still and the main reason the droughts go off is not because there's less rain which there isn't. It's because the temperature has gone up and so by praise rates of the available rain, and produces a California's situation more often now as it turns out for technical regional reasons that Rizzi long-term profound drought in the southeast, which might have been anyway, but the high temperatures just. Just making it much worse so anyway, that's a digression. resist since with spend money attempting to propagandize and communicate the problems of climate change in reinvest op. Follow in green technology to try and do something about it, not as philanthropy by the way, but as purely sensible defensive behavior on the part of the family to look after its grandchildren and their grandchildren, but to go, you may have to repeat the original question which was on resource. It's okay, so you can't have compound growth on a finite will. Very quickly you start to run out at this that and the up. When I grew up, we had a cold front. And the coal since we were. Kind of middle class. The cold we did was answer. Side, which is denser than oil is relatively, claim hasn't got much dust black shiny stuff. They now use for jewelry sometime and it's gone. It was burned an north country England, five plays in nineteen, forty four, and is now just pit. Stop it happens and most of the high quality coal. In the UK, which drove the industrial, revolution has. Same, Germany? High Great Cole has simply. Disappeared, and you develop the cheapest shallow shallows thickest. Aw Minds I. And every succeeding mind has low quality. Aw, and the couple of the minds today have ten percent of the oil that you could find in one thousand, nine hundred, and it continues as far as the eye can see. Each generation of of mines is low equality in the case of oil, depot and off-shore and more technical. Aw, in the case of fracking. You've had to develop ways of using energy to squeeze a solid rock into giving up its soil. That's the way it always goes. To eventually energy cost. Of getting that. Low Grade, culpable from a deeper and deeper mine and shipping it around in these trucks, whether the wheels are bigger than a house is simply too energy intensive. And, what we noticed is that technology overcame this increasing embedded in efficiency. Of using the best I up until about two thousand, the priceless everything went down. The marginal increasing cost would push it up a couple of stand, but the technology would drive it down by four percent, and would net out a something close to a two percent decline for a hundred years ending in two thousand, and over the hundred years, the price of the average commodity dropped seven. Pretty, amazing help to get rich. And, then we began to head the transition phase where the ship limits. Began to hit up against the technology. So now you have the same percents technology, but now you have a full percent increasing cost, and that bouncing around at some going up some going down some going sideways, and that downward trend from nine hundred to two thousand is simply at broken and oil. Of course we can come to separate issue and very. Interesting special case, but the other day before the virus, the prize have spent a few years between eighteen and sixty and the average price back in the late nineteen ninety S. it got down to sixteen. In normal conditions to we had broken out in the price of oil oil is half the valuable commodities traded and that pasta inflection, point and long term decline driven by technology, had been replaced by a growing shortages and much higher percentage of oil, coming from deep offshore expensive wells, and no longer discovering the giant of the nineteen forties and fifties in and the Gulf why you put a hole in the ground at it bubbles up for eight years. and. It costs you in those days ten cents a barrel to pump it today. Maybe two Bucks Abou- but. Anyway outside that that you should take a list of. The, Rat Tara, metals. There's a lot of ion. There's a lot of aluminum. A set of the Earth's crust is aluminum and Foreign Office. Is I know? But then you get down, there's a huge drop often suddenly you get a less if you add nickel and copper and tin and lead and zinc, molybdenum and gold and silver and platinum palladium, and for out those together that they are much less than point one the they are some almost unbelievably time fraction of the amount by. So in general, you don't WanNa go short. You don't want to worry about I on our and aluminum. You want to really worry about all of those other methods that we need in a high tech. They are all beginning to run out there. All have supply pressure on them and you're going to go. What's going to happen as you get into a shortage, the price will triple quadruple love say cobalt people will redesign everything and substituted. and. A new clients you minds, and then the price will come down, but it will bounce off into other than the price of nickel will go through the roof, and so we will just have a patent from now on for a while where. The best description of commodities is that they will go up and down, and that the downward trend of one hundred will clearly of district. I think that is the case since two thousand in my opinion. And then starting anytime, so we enter the game when the average price of the average commodity including To go up as diminishing returns finally gets the better of technology. There are signs of that here there and everywhere. Again my pin and it's a long time I'd. And you never know of any given few years. What will happen to any given methyl orange given commodity oilers course super special case hugely important. And fracking completely changed the wolves Biden on balance for. Years the US out of nowhere started to add over a million barrels a day. The world's total is one hundred so on the margin, a million or two goes a long way to go from excess all deficit. And the US quickly added of the six years six million barrels a day, without which the price of oil would be way over one hundred Xing out of a virus, there would be a different world, however in the long run there isn't that much cracking oil, probably a outside two and a half years was a floral supply. But you can hit doesn't sound that impressed. But when you take it, and you wrap it up quickly, and you throw it into the market with no price control, no control adult note Texas. Railroad Commission telling you what to do like the thirties, forties, fifties sixties, exercising some sort of discipline. You just crank it out as fast as you can slotted into the market. But it's two and a half years. What so you run through your highest best? Tracking results is pretty quickly another couple of years when we would. PLATEAUING and build. But it was wonderfully helpful to the US you can back out tracking. Saying might have been a least Haas off the difference between us your. We have handsomely out to bond in economics in the last ten years. You're which has had a rather dismal ten years, but half of that has been the amazing fact up fracking in several states, but mainly of course Texas and. North Dakota That also Pennsylvania. Couple bothers you Mexico. There's a chart in the paper. You wrote on this topic, which is incredibly stark with shows, the relative discount of energy and metals companies, versus just the brought us five hundred historically, there's been an average discount of about twenty percent, so it's not unusual. These companies to trade at lower valuations higher yields etcetera, but today that same number is eighty percent, so we're talking about a historic discount all the way. Way Back to the early nineteen hundreds of these types of companies, it sounds like sort of the opposite story of what you described earlier where we've got top ten percent P. E. bottom ten percent economic conditions. I think what you're saying here from an investment standpoint is we've got sort of bottom one percent of relatives discount, but a good argument for strong fundamental improvement from here is that well summed up? Unfortunately have to divide commodities into three groups. Will I'll. Metals, and food for methyl signed his absolute might view. A longtime argument is very favorable to higher prices on these prices and the discounts. Are Typically extreme. In food there is a long-term squeeze on food supply demand relationships. And they productivity gains dwindling population, although at slowing is still growing rapidly. The growth rate is lying, but we're still growing of one percent year global population, and we're having a very hard time keeping productivity of grains at one percent a year. So, we're in a real horse race between population growth and our ability to squeeze out more an under the surface. We are eroding soils, and beginning to long term damage, the productivity of agriculture seventy, good chronic, yes, left at best and in places. We, already showing the downside of having one away through sloppy agricultural practices on overuse of Allah arable land all over the world. That has gone on. And the carbon content of soils and the US which come down from about six send in the mid West to about one and a half. So the. Activity level the ability to soak water is a small fraction of what it was a time when the floods coming as they are right now far too often much heavier. Downpours. We haven't seen before and add wants a 'cause roach. But they also the ones that need high quality soil to soak up water, and that is a direct function of the common content, the biological matter, and saw which we on a big AG modern techniques have been eating away an in many cases killing off with toxic pesticides, which is another topic we could get into those toxic pesticides a being doing a terrible job on killing all the insects on the planet. which down I do oblivion. No one can agree on the numbers. It's very hot, difficult topic to fix on, but here and that down seventy five percent and in other places. Places down only twenty five percent, but without insights you get into real trouble, the birds, and so on and everything else and the creatures of the ground don't have them to feed on, but much more immediate than that. The pesticides fact deaths, the chemical levels in our bodies has gone through the roof to such an effect that among other things off facility right is affected and I wrote a paper rather surprising special my job description that included a description of power sperm count in the developed world has dropped to a third of what was. It's about forty units down from one hundred. And it continues to drop it almost two percent a year. The leading. Epidemiologists say it shows no sign of. Yet so what that means is. And Twenty five years. The. Average couple is going to need help in the US. and. Trying to ago a handful of people, it wasn't a topic, but today you'll bump into it if you try. Because ten fifteen percent of young couples already have trouble, and these things are moving faster than climate change, and we will do nothing about it because we put value, the intellectual property values of the corporations so high. The way they act and banned chemicals in Europe. We do not. That is say if there's a reasonable doubt. They have to prove sex. If reasonable doubt, the benefit of the Dow goes to the corporation. which is an odd choice to put the intellectual capital of? Bio and Monsanto ahead of your spam. Count in the US when we do. It sounds though from an investment perspective. The medals cases, maybe the most clear-cut meaning the most clear-cut potential investment opportunity food is sort of rife with all these interesting issues and then oil. Talk about a bit, but I guess to some your point. You have to view these three categories separately. You're not making a case for all commodities, but rather urging investors to consider all three categories making a case, but the metals, but ignore I and aluminum all of the interesting Nichols tens of making a case for them, and making a case for good farming, the opportunity exists. Get into farming almost anywhere in the world. And do it in a more sustainable regenerative way where you improve soil and the carbon content. And the ability to absorb install water, and to have wonderful microbial life, the quality the nutrient value food goes up. The toxicity goes down because you need much less than the way. Pesticides, so that is a win win, and the famous can make more money, and it's beginning to get a lot of traction from our Lopez, but that would be great investment opportunity, and there's a love green technology round that Eric than we do considerable investing in our foundation, and yes, we do try and make money, but it all goes back to fighting the cost for agriculture and climate, change and good farming has lots of inter relationships with climate change done correctly it really helps, and then the third one is you say is aw. And Oil is very interesting. Special case because we are hitting the threshold now that people don't quite realize where the electric car is going to become in the next two three years cheaper to build as well as to run which it has, today is cheaper to run. Today is cheaper to maintain today. As fifteen movie pops, and as a proud owner of a tesla model three. It is beautiful drive. Trust me. And gives you an up to the. Quad House but it was expensive. And as the cost of battery, which dominates the equation comes down. That changes rapid. Twenty ten day, Tesla needed a thousand dollars a kilowatt. This. She probably a hundred and thirty, and if it's not committee one hundred twenty. But the next generation of batteries, which the introduce and talking about in there ought way is going to not back down to below one hundred below one hundred. You become as cheap as a regular car and their batteries in five years will be fifty Abacha less so they will be absolutely the default transportation and the car the Tesla in China's offering. If you pay up if you four hundred miles I paid up on version a year ago and I got three hundred miles. The starts bit heretic, but somewhere between three four hundred, and the new batteries will do five hundred into three and two or three. Yes, the last million miles away so that you'll be able to recycle car batteries to help out the electric grid. So transportation is dumb. Transportation is very big chunk of oil. So this is now a terrific hall hospice between the speed and the capital needed and the supply system to deliver the electricity to electric cost between that going on which choose a lot of money, and so on on the one hand and demand for oil on the other, it could well be that oil will peak as late as three or four years from now if the transition slow that it could have peaked. We might come out of this virus phase and never. Ohio oil demand level than we have seen so peak oil will turn out as many thought to be peak demand rather than peak supply, but either way. It's a special case and watch your check. In, terms of now having said that ten years ago, the SNP was made up of sixteen percent oil today. It's three, so you won't get rich shorting. Traditional oil stocks from hit. They have just been crushed and crushed and re crushed. And as has price of oil, it's the kind of. You could argue on the ethics of owning oil, but it's been a diabolically bat, probably as bad major group, one of the ten groups of the probably has battered drop and relative performance as has ever. In a decade and the S&P. Must characterize the things that I would call your sort of long portfolio as refreshingly diverse in unique, so we've talked about the opportunity in farming in a certain type of farming in a certain type of metals you talked about the benefits of what I would call technology entrepreneurship us, having a keen vantage in something like venture capital, which has led to these enormous corporate success stories, and then we've also talked A. A lot about all the things that are a little bit scary about the world I'm curious sort of where you think we go from here. What do you not understand well right now? You wish you did. Where are you going to be spending your time? As you think about the future, let me just add to that. Granted Foundation has sixty percent venture capital. If you can believe that are target the seventy. And we see the most amazing. An interesting dynamic auctions and green tech is one of the most exciting. But there are plenty of other areas adventure, which is also. An how it will be treated and handled in the virus. Economy Lord alone knows, but there should be lots of opportunities, but those of your listeners who can take advantage of venture capital opportunities that will be interesting cheaper opportunities to normal first of all. I think it's fascinating. The strength of that allocation the question is more around thinking through the future. What do you not understand well that you wish you did or ask differently where you try to run up a learning curve today? I am focusing on the intersection of the virus, the economy and the stock market. This is kind of what I do, and what you find is the seams between specialties aware the opportunities. And, where the ignorance it's, so you can have even in hard science you go to the boundary of one person's expertise and the next one, and there's a gap. So when we study, agriculture refined the soil, scientists know about erosion and the climate scientists know about other damage in heavy floods, but they don't know about the other person's work. So, we know more about. Erosion when we talked to climate scientists giving views on agriculture than they do. And thanked. How is this possible there scientists in this general feel, but it is possible and happens every. And what happened in the virus? Problem is you had? Biologists, Very confident they know more than everybody else. They know. They know more than everybody else, but they knew nothing about echo. And they were stomping all over the Congress and you have economists who know nothing about. They're all G on medical systems. and. You have people in the medical system who understands the spread of diseases, and all of these things and I know nothing about economics all sociology. And the economists know a little bit about sociology, but the medical wellness very little and then crowd psychology. And politics and you put them all together in a mess. And what we've ended up for a while was a world in which the medical people ruled the roost. This was not. A medical problem alone. This was an elaborate trade offs between medical consequences and the cost of addressing. You need it to put together a brain trust of handful of medical experts, a handful of economist suffused social experts and a few people with common sense on sit down, not let them out of the room kind of FDIC style until they have. Agonized through the sensible trade offs of cost and consequences and we didn't do that. We got into kind of. Happens price on life. On since we put a price on life all the time. By not having universal healthcare, you're putting a price on life. It's too expensive to do that. It's done all the time the idea that you could stop the entire economic system without consequences. To cycle is a single life is crazy. So everyone knows stops so now you stop drawing the boundary whereas the effective trade is in the. Swedish model, the German model. The New Zealand Model! There's a variable flooding along with that, too. Which is just competence? Competence covid how aggressively attacked problem how fast you attack it as well. Regrettably, some of the big countries have had very low levels of competence and some of the country's out east, including New Zealand. Along with Taiwan. Singapore Hong Kong China South Korea Vietnam have done brilliantly brilliantly. So we give a passing grade. Maybe to Germany, we hold it up as doing a good example. That's a quarter of the. Deaths of Brits. Much less than the US, but those that I just mentioned are Besse than ten times better than gem. How is it possible to have your standard of competence? Be Ten times what? in-depth, Taiwan didn't have unfair Stott gymnast quite the reverse. It was right next to China is. Part of China and outside who by province they did much better than ten times better than. Also in a country with one point, three billion people outside that province, and they had less than maybe a twentieth of the death rate of Jim. which had. Of the US and a third of the Brits, It's very painful to be a or a Massachusetts in. Massachusetts actually has more deaths per capita than Britain, which is a contender for worst. and. B. S this is a great. Every country comes with gray. They all started in fat Fai. They all had the same information about the same time. And some lockdown quickly effectively tested trays, or had cultural cleanliness and distance customs like Japan which again I forgot. Japan Japan is tense as bad as Jimmy and never had full lockton and is going to have less economic consequences than the heavy lockdown countries. Hardly any of the deaths. What an amazing opportunity to be efficient and yet Massachusetts New York. They talk a good game, but the numbers speak for themselves and the UK all terrible beyond belief incompetent is the only explanation moved too slowly and not effectively when they moved. So, Paige very high economic prize for dismal medical results. I'd be. What advice you would have for younger people interested in the field of investing given all that you've learned across the span of your career and knowing as much as you do about the current. Economic business investing landscape. What advice would you give a twenty something? That is interested in this field. I get asked that in real life and my honest answer is going to venture. Capital gives you the same opportunity to use your brains in your research your analysis, but it's more opportunity to use your imagination and to mix with people who are trying to change the world for the better, and it is useful private equity and regular investing shuffling hsieh's between one player and. Doesn't? Change anything. I sell a share you buy it who? Then Chapel is it taking new money away from something else, and you're putting it into a new idea you're building plant small may be. That would not have been built without your money. You're working on research. That would not have been done. You're producing products that would not have been produced. You are changing. And as it turns out, you're in the end going to be producing the next generation of fangs and the great companies. I love that answer yet. No, that's a nice simple answer I would really. Turns a bureaucratic job into a job that really. Makes the difference. Jeremy Mike closing question for everybody is to ask for the kindest thing that anyone's ever done for you. Wanted to people have said such kind things about me. You think we'll. That's on justifiable. Ridiculous I would think of the used to be an avid reader of one person who wrote for balance. Did date. The lead the intro for forty years at a very. flowery entertaining. Occasionally Jokey, occasionally very serious thought. Blocking his name, 'cause which is. A Muni amazed. I have had more blocks by now, but. Everyone used know him because they some of us a lot of just by Byron's really only that the sky was so good at the front. He died sadly five years ago, but in his classic style in his Intro, and of course getting into Tro-, embarrass was always a very big deal, and he kept his eye on my God lettuce, but just kind of apropos of nothing one week he says in the world of mountebanks and scoundrels Jeremy is model, the Birger. Now what do you say to that? It's a wonderful comment and it's something I think we can all aspire to write in in this business. First of all I would almost couple your last two answers in an interesting way, the idea in venture capital being fundamentally creative, I is positive sum instead of zero sum. Maybe that's a fair summary and our whole conversation really has that tint to it so I just WanNa. Say Thank you for joining me for all your time. For All the insight and a beer unique conversation. Thank you Germany. It's been a complete pleasure. By the way the guy's name was Alan. Abelson there you go. Fantastic well, we close on a good spot. Thank you. Everyone Patrick you again to find more episodes invest like the best go to investor field guide, DOT COM forward slash podcast. If you're a book lover, you can also sign up for my book CLUB AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum right away and then three or four suggestions of new books every month. You can also follow me on twitter at Patrick Underscore, Osieck O. S. H. G.. If you enjoy the show, please leave a quick review for us on I tunes, which will help more people discover? Invest like the best. Thanks so much for listening. Own.

US Fed Europe Jeremy Grantham Jeremy California Nisa Jeez apple principal Patrick o'shaughnessy CEO Japan procter Grantham Tesla
Assaf Wand - Innovation in Static Industries  [Founders Field Guide, EP. 36]

Invest Like the Best

57:50 min | Last month

Assaf Wand - Innovation in Static Industries [Founders Field Guide, EP. 36]

"This episode of founders field guide is sponsored by cleo one deliver marketing moments that lasts a lifetime. Cleveland's the ultimate marketing platform for ecommerce with targeted segmentation email automation sms. Marketing and more. Cleo helps you create your ideal customer experience. More than fifty thousand brands like living proof solo stove and nomad. Trust cleveland to grow their business. Keep your customers coming back. Get a free trial at cleo. Dot com slash founders. That's k. l. a. v. i. y. o. dot com slash founders. This episode founders field. Guide is brought to you by eight. Sleep eight sleeps new pod pro cover the easiest and fastest way to sleep at your perfect temperature. It pairs dynamic cooling and heating biometric tracking to offer the most advanced solution on the market simply. Add the pod pro cover to your current mattress and start sleeping as cool as fifty. Five degrees or as hot as one hundred and ten degrees. It also splits your bed in half so your partner can choose a totally different temperature. I was so impressed. After using eight. Sleep that i became an investor to embrace the future of sleep and get one hundred and fifty dollars off your new mattress go to aid sleep dot com slash patrick or use the code patrick alone. Welcome everyone. i'm patrick shaughnessy. And this is founders. Field founders field guide is a series of conversations with founders ceos and operators building great businesses. I believe we are all builders. Our own way in this series is dedicated to stories and lessons. From builders of all types founders. Field guide is part of the colossus family. Podcasts and you can access all of our podcasts including edited transcripts show notes and resources to keep learning at join colossus dot com. Patrick o'shaughnessy is the ceo of o'shaughnessy asset management. All opinions expressed by patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes. Only and should not be relied upon as a basis for investment decisions clients shaughnessy asset management may maintain positions in the securities discussed in this podcast. I guess today is asaf want. Ceo and co founder of hippo the homeowner insurance startup founded in two thousand fifteen in march. Two thousand twenty one hippo announced a merger valuing the business at over five billion dollars in our discussion we cover. How hippo approached innovation in highly regulated insurance industry unique strategies for building brand and trust and how direct relationships with homeowners has opened up the hippos business model to a wide range of opportunities. I was excited to speak to a soft given his experience as a serial entrepreneur and he did not disappoint. Please enjoy this great conversation with soft one. Maybe we could begin with what. I'll call your philosophy of business and ayla building things you built a lot of things. Just talk us through your high level view and entrepreneurship and business. Wow that's heavy stoute's not that have had my philosophy for business. But i'll give you what. I usually tell knows an excuse my french. I might chris a bit in this discussion. Join us. I think that enterpreneurship is hard. It's shit it's crap it's trenched wolf him but the good thing about them domino sheep basically three things. You choose what you're going to work on so it's your choice. You didn't join someone else to do whatever they wanted. You can wake up every morning and choose. What you're working on you can choose. We work with because you have a choice. If you'll hiring personnel not hiring a person it's up to you not always of the options but it's up to you and you can build a culture that you want. It's kind of like the epic thing of independence to carve for what you wanna do. You pursue what you want with the people that you want in That you want dots. The biggest benefit of indonesia in my mind because you need to find a good reason why you wake up in the morning every day as i told you it's trench warfare. Always tell the team. This week is going to be a week. That just going to put the helmet and put the storm and we're going to start being bombarded. What was your first taste of entrepreneurship. And how did that contrast with what you had done up until that point in your life. I was born to end panel and the reason i was born to being banou is because i'm the worst employee you can find. I'm the worst in politics of an organization. I don't understand him. I would always blake award. If something doesn't make sense. I believe in me talk with me in kindergarten in. Someone say something doesn't make any sense. I'm gonna fight it. It's an embedded thing. I cannot accept that someone above me doesn't do a good enough job but because his senior senior like that doesn't make any sense. I'm not set up floyd which the wheel this thing is. Because he's rayleigh was also in the military so you say fine okay fine. You didn't like this company and your shift to another company. Didn't like this fine but you'll in the middle. It's kind of an ira kind of organization so you can't really go to the generous. That's the dumbest thing. It just doesn't work like that but the good thing is that they easily military is a lot less article than a lot of other places. That's one and even within dat rigid organization little specific units that a lot. More meritocratic hands. Why is it's actually enforcing full enterpreneurship to say what you think about the mindset of lawyers versus entrepreneurs as a contrast. Yeah the span of your life. You kind of find. There is a linear line of different kind of mindset. I'm gonna give you another remark afterwards about another like mice found very interesting for me. I think indochino sheep isabelle you wake up every morning and you owe building something that you think are going to have an impact and changed the world and be a force of positiveness or it can be of economic whatever you want and then you have on the other side loyals in lawyers mindset is about only bringing up all of the negative in the world against the optimism of the contract worse but what if an outcomes a list of six hundred different things that they need to be saying. Now is the rule. I always tried to stick away from talking to lawyers which is very interesting because they only bring to the negative mindset and then constantly has ended up and will be positive so i'm trying to avoid that will in the process of going public which fires lots of lawyers host. I take over your life while you talk is accountants and lawyers and that kind of stuff. So i think it's very very different in the last two three years i found another really really interesting kind of mindset. That was very different to meet. So i work in insurance because he plays an insurance company. Any insurance there is a specific kind of pilsen which is actuaries. So enterpreneur restate you'll by sokcho and the most risk averse individuals on the face of the planet. Continue that once in one hundred fiftieth. There is a scenario. Isn't actually so. I think the company people that actuaries which is the most fallen mindset. I've ever met in my life. I'm like yeah we can do it because in one seventy seven years. I'm like what are you talking about the discussions. How many companies. Even last seventeen years that you'll even bringing this topic and what such an interesting mindset. What was the most interesting experience of risk taking the entrepreneurial sense sabi forest telecom. Those are two companies that you started prior to hippo. Talk us through the major lessons that you learned at those two companies that you brought forward with you or left behind. When starting about sabi was a company that was started with. The premise of the world is maturing and aging and people over the age of fifty half ninety one percent of the networth and sixty seventy percents of the consumptions priscilla of income usually. Oh parents more wealthy than you've been even if not making more salary. Finish painful for the home. So they have more of a net in the so. The thought was that people have more worth. The world is maturing in a fast paced in regular goals. So what i mean is. There was a certain point of time because of baby males which you can think about it is a python away too big and pig keeps on going through the belly of the bhutan and now they're all fifty five and above but he used to be twenty and thirty and forty so now they'll just maturing this massive population that basically created almost all of the worst in the world these other people that actually captured dot side of the worth but only five percent of the marketing budget is to them. So you have population ninety nine percent of the net worth but only five percent of the marketing budget. He's actually catering to them even in that five percent. I don't know my guess is north of eighty percent is always negative. All advertise to people above fifty four company. You don't have any friends you'll impotent. You will whatever it's always negative all the other side of it it's like. Have you saved enough money for your retirement. Do you have enough i. It's always on the negative side. And i thought that's ridiculous because people live the life very differently. My parents are like i know. Sixty six seventy old super healthy active travelling and stuff like that then. They shouldn't be catered like that. They should be a lot more positive. So i thought there is a place for a brand that celebrates that catered to them and not kato to the caregiver. All just the issues and the challenges. And that's what we started sobbing. Which is a japanese word which is part of this Wabi sabi kind of thing. So is a japanese quonsett about the beauty and aging that the patine passing of time over an object able to hardwood floors. That's what brings it cocktail. We started a company that the idea is. Let's create products the more geared toward these individuals. So it can be separate surfaces in the house and grab bars and things of that sold every once in a while. You go to the australian and you get up and it feels bad and feels bad because he was utilitarian which is horrible because nobody thought on the end customer now day feel just take mark that this is something regulatory that they need to do. And then you start to do some research and you see that. We worked with some of the best designers world. Redesigning and focusing on poor dots are a lot smarter and create new bosnia on this stipulate service new canes pill boxes which assoc shameful can they be which slightly more whimsical kind of stuffing a so. That's what we did. So if i'll come back to the point before what did they learn the maniacal customer focus in actually thinking of what the customer wants is a dissenting everything as opposed to. Let's start with will need these and stuff. No let's talk and talk and talk to customers and put any physical goods as much as i hate it then. It would never do physical goods in my life but there is so much joy in seeing someone actually using poured in you can actually follow up photo a person on his day to day with dean and see hundreds of different touch points that you never thought important that you can incorporate into the product to make a porta smarter better. You know something. The drains you joy is opposed to shame. You mentioned the. You'll never do hardware again or anything physical again. Talk about speed in business. The importance of speed. What you've learned about how you deploy it. So how do the has limitations on speed because if we want to come up with a quarter of that we want to launch it to more patrick and seven tomorrow so we need to design. Maybe that can be fast. We need to raise the engineer. It okay not so fast and then comes post this which is the most magical thing and hardwood Tooling so you need to basically find a block of metal the laser in scattered. It takes six to eight weeks in older to plug this block into a machine. The basically manufacturer on scape so no matter. What you in the middle of the sports. it's gonna take you to free. Months need to believe And then what about cheating. Y'all gonna if everything because he was going to kill all of your margins so now we need to ship shipping from china now within the world where they can't even find contain those. Let's say you find it contains that's gonna take six to eight weeks and cut stem and shipping and so on into more morning. It's like it's going to take forever and steichen. It takes a long time. The interesting thing is that fintech in insurance specifically also takes a long time. There is no. Mvp there is no. I'm going to start selling insurance to patrick. You need a department that you need to five eight and you need to approve it with department of insurance ended insurance takes time and by the way those fifty departments of insurance in the uso. The fact that i'm live in california doesn't mean i'm i can be live in oregon zone. Which are like around the same vicinity. Even that takes away any awfully the first four duct. If i ever leave insurance. I kind of need to have a quarter center because maybe you have a question and i need to awfully claims because maybe you bought the insurance the following day. You've been advocating. So i need to take care of you. So there is no mvp which changed how investments should look at anything on specifically the insurance in many fintech as well pens if it's loan payments and stuff like that it just takes a while and you'll managing in fintech. It's people's money it's not a whimsically tiktok it works. It doesn't work it's live. it's not like i'm not saying it's it has its own merit and it's unplaced but picked is not working to mole. They did a problem. Find those going to be. People are going to lose money because their livelihood is on that but it's not going to actively hurt a lot of people. But if i charge you and it's your money and you're going to something's gonna happen. God forbid you have a thought fire in your home and you to ensure properly so now. I can't really make you hold for that. That's a way more important problem soon. I fade out. You need to make sure that it's working hands white. It's not fast on the dockside. What's fast is that. Eat rations afterwards. On how you bring the market value focus on the customer value today do ab testing. I believe that sense of urgency is one of the core strength of a stout i of an ongoing fight to maintain it. It's a lot easier when you have thirty people now with the five hundred people. It's a struggle in a fight. We used to jump on everything that was going and fix whatever there is now southern does process and those this and we should really make sure that it's located as we have on the prioritization. This is part of the fight of a growth. Seal wants to push the company in maintain what i believe that the company to the fact that we have hundreds of thousands of customers and we need to maintain a system and we need to add horses and some standardization. So does this ongoing fight. That's going on. I believe that time to market speed iteration and things of that. So what would negate us from being incumbent and you bringing more people that are more seasoned bush to the other side in. That's the inherent fighter. I have frank now in the company. How do you personally act to increase maintain inject urgency into the business even at the stage. Where you as the leader doing actively to try to keep that up you lead by example. Oh you do things is our everybody's gonna do things as close to that. When i got married a friend of mine came and said listen. I'm going to give you two teams for the wedding tip number one is you'll know the host so don't worry you paid a lot of people to be the whole so you don't need to make sure the patrick is eating and stuff is fine. Chill on the second thing and this is the point. I wanted to make on that. One is will ever you going to be. That's where the guests are going to be. So if you want everybody to dance so you need to be on the dance floor. You won't ever between just going needs you. Want everybody to mingle and being the bar being developed. You can't expect everybody to be in place. You're not done deals you like the you'll the point yielded the weights and you will will basically the the force of gravity. So if i'm as a seal. I want to have a sense of urgency on sales now. I need to focus on sales in the gravity is going to lean towards dot side and i think my job is to constantly see will stuff is needed and changed mutation in being dot area. And that's what's basically gonna push to focus on that side. And i need to constantly think of well. Is the problem right. Now move the gravity. Unlock all of all kinds of riddles differ favorite example within hippos history of you doing this where you recognize something that needed movement or momentum and you led the charge as the first person in. It's almost a daily thing so when we when we're willing to world of of insurance which basically means that of view is that a reason to being company is to take care of your. When shit happens. I don't know how to explain it in every once in a while she'd happened. There was a catastrophic losses in texas will. There was a massive free recently. So i need to work. Twenty seven and take care of customers and employees is an old. I'll claim and court center is in austin where which the model ship epicenter. Yeah yeah and we had so. I had to take a little thirty two people to find them homes my employers. I because we have people with kids that didn't have you know with a two year old. The didn't have heat. So i was on the phone with temporary housing talking to a friend who have no tail if he minds pudding the otell online and bring it in so i can put my employees after that. Let's stop taking care of our customers. I old what was it. Like a thousand lasagna's but it was my credit card because there was an issue at the beginning to basic go and handle ville to customers. That didn't have heat and this is just one example. It happens on an ongoing basis. We have a problem with basically selves levels deteriorating. All of a sudden why we shift of leadership we have a new crm system until they learn until not and this is unacceptable to me like we're supposed to be the best thing customers period and if something doesn't happen so let's let's acknowledge it that's one instead of giving excuses and stuff like that. Let's acknowledge it. Let's do something which is even would force. Let's let's take the party. Let's put all of our people over time and just take care of it any the back. Make sure that all of the systems are going live so every week. There's a new thing that happen. Every insurance review requires my time. Now it's about going public. So i'm somewhat of the face of the company so i need to be shown more with specific investors. Sometimes it's the. It's always like the i used to tell. My chief product officer was one of the first employees. That is not the first that i worked with in the company. It was a point. Well it took me to discussion and said listen. I don't get the love anymore because we used to talk all the time and all of a sudden hardy seal and i told him that's the best thing that can happen to you if you're gonna often then it's probably something is wrong and it's not a good thing so as long as you don't see me it's really really good. Sign for you. I love to rewind the clock. Twenty fifteen and the bounding moments or insights of the business. What did the industry the insurance industry look like and feel like to you right at the start of hippo and then i wanna use that ground setting as a great excuse to talk about how the business has evolved feel like at the start until the magic of insurance at twenty fifteen eight looked exactly like it looked to me at two thousand and five and friday exactly like it looks ninety ninety five so it's that's the magic of insurance. That's why i think it's an amazing place to south eventual. So of the idea was when i was working with mckinsey new york in the financial institution And amount of the customer disturbed of insurance companies. And you serve them and they can't you realize that they can hardly implement anything. There's politics does regulation. There is lack of systems. There's just a lot of issues like there's no lack of speed you know. We talked before about speed. This is still kind of industry. I've ever seen in my life. People are very content and happy to go with four percentage in you can actually do it by increasing some of basically the premiums which is fine. Because they're going up. I'll than inflation anyway so everybody's contempt and happy so i looked at starting to business in two thousand and five and it was the same kind of business that basically set up at twenty fifteen difference is actually not the industry change. Is that the world change around the locker more so in two thousand and five the reason i felt like it's not a good time to start. The company was the three things one is. You couldn't build a back end so if we're talking about starting an insurance company i would've done the research and then i would have said okay. Fine it's gonna cost me three to four hundred million dollars and it's gonna take three to four years and i would need to bring a company like duck creek or guide while to build it back. In and these services company knocked rate the company. Especially at that point of time. I would need to bring to by oracle database nine. I would need to bring essential to build everything they would ask me a question of how many customers you think you're going to have at seven and i'm going to say i think two hundred and fifty thousand customers and because they find you're gonna pay us pill customer in seven and that's how it was wired. I'm like okay. I guess that's not the number one venture to stop. His second thing is was the lack of data. So whenever you wanted to sell something you would have asked. How can you compete with state. They have ten million households the showing they've been in business for one hundred and fifteen years. How can you compete with him and the answer would have been. I probably can't and then the third one was the was in a different place of trusts over new brand insurance game of trust dinner. They you want to know that. If god forbid something happens to you the council side is going to be able to take care of you and pay you and all of that kind of stuff. That's basic insurance. You'll buying a promise does know poor that is the wheel the sport in the world. It's a product that you as a customer one of us in the people that sell you the product don't want you to ever use. It's kind of what you'll buy is rights to file a claim. If god forbid something happened in you will in fraudulent. that's what you'll bind. The rightfully claim in thought people would not trust the new grant. That was kind of the three things so lack of ability to build a back end lack of data. And i'm not sure people trust in your brain fast forward to twenty fifteen. You realize that you can everything escape using aws filled out in tokyo for that full that and Intercom for the chad. The so much stuff that you can actually build on scale and you don't need to commit for many customers because many customers are going to have the customer they're going to have and you don't have one of the legacy because i don't need to commit up for something that's going to be legacy by the time it's actually going live and i can build a stack myself. And it's a lot more cost effective so dot hurdle basically dropped second thing is a point that you realize it's the complete opposite side of data within the world with an abundance of data. You have unlimited data so you in a world where it's a benefit to be a newcomer because the snow legacy you can build them. Scale and data is an advantage as opposed to disadvantage and the third one which was brandon to trust. And all of that. There was a point where i realized that you know assad is doing everything online. I'm getting my student loans from sulfide managing my money with what foreign trading in whatever it was. You know each right now. We'll be nude etcetera fine influence one more thing so it came to that and then on top of all of it. I'm going out one more. Random thought that i realized is that the world is moving to specialization as opposed to bucking things together. Because i got this questioned by law how can you compete with thumbnails and travels because daylight saving bundling in what we realized. Is that two things one. The world is moving to specialization in have specific for the way better for what you want to do. So it's actually going in that direction and insurance it's still somewhat set up his bundle but it keeps on being this mitigated and we have a saying the company that if you tie to walks together don't float but you rang a crappy insurance crop insurance and connect. It doesn't make it a better border. It's still too crappy poor that's connected to get so you should buy the right auto insurance and the right home insurance and it's way better for you as the customer and it's moving in that direction so i'm just adding into the three points that i said about insurance is that i also had this conviction that being a malign company that is a militant it's interesting how in the internet era it does seem to be easier to build a brand quickly bootstrap that trust if you're incredibly focused on one narrow thing because then people just assume all your effort is going into that thing and they're used to using a lot of products what were the most important things you did to bootstrap trust. It still is an insurance business. It's not a dvd brand or something where you can spin up a brand story. You still need people even if they think you're so focuses home insurance and that's good. You're still brand new. So what worked when it came to bootstrapping trust quickly. We will lending someone else's brand. That's the best example that i find so there was a point. Will you realize following thing which is most actually. Don't buy insurance what you buy you buy a home if you buy home you need a mortgage and if you need a mortgage insurance so you are a sideboard act of home-buying and because of that we realized that it started with distribution but it's actually has to do with brands in although that i wanna work with everybody has to do with on purchasing so we work with companies like bell mortgage and blend on the mortgage side. We work with domo on the title side. We work with banks. We work with mortgage services companies like own point. We work with comparison. Relay g on the real estate side with lena. In toll brothers on homebuilders' sides we work with everybody that has to do with it. So it's really good distribution but to your point from before out you build trust and what you do with that. You're basically lending the brand of chase if you're getting mortgage from chase and chase his saint. Patrick do you wanna have insurance. Okay you just doing it. I'm basically rioting chases brand because if chased it and they like means. Then i'm probably good enough. I have the halo effect of the chase france. And that was part of the thought of audi. We increase customer satisfaction. Until we're going to have scaling-up in word of mouth renting and marketing and enough people that have claims which was a positive experience and people are a net promoter score which is whatever seventy five in claims one these things thanks to a wine so we will using other channels brand to basically gain a quoted. Trust by folksy obviously begs the question. I think i've seen utah elsewhere about one of your top strengths being distribution and maybe even partnerships more specifically. How did you convince them so same problem. One degree removed. So what was the key. They're relentless when i was a young business development prison so my vp was talking to me about how you build business development and there is a. It's a bottom up kind of thing. Which is we're gonna get three full small customers in once we're going to get three full small customers then we're going to try and get one medium one and then we're going to take us two years and we're going to bring through to a three one and then you're gonna try and hit your way i. It's kind of like you go into that. I'm not patient enough for that. It never works well for me. I'm starting from the top. So we bought comcast cast and we both line out and we bought an you know the interesting thing is is probably not a high each racial but once you find that. The ceo of the now gets what you'll try to do. The entire organization is busy on online. And then all of a sudden you actually start with the way in this case the close of us and one aboard et cetera in you get recognition in the other. People in industry are looking at you instead of like heights. A nice step. What did these guys got the order. The like we have to do as well see actually top down which is a lot more effective but it requires my job to be. I don't know fifty percent time chasing these these people. I think that you bill relationship by being very honest transparent and not overselling because it's never gonna fly and basically started with a partnership becomes a friendship or something that all of our partners our friends in in some ways in those many times what we need to make choices that are not for the benefits of hippo but for the benefit of the partners. Because he'll taking a long-term view over the wind you bill. What the nation. This is what you do and you'll start winning. It begs yet another question in the chain. Which is you mentioned earlier. There's no mvp here like there's a lot you actually have to build and do regulation fifty states all this stuff. I guess i'd be cures. Hear more about what the original building blocks of a business like this were but when you show up for these partnerships what stage are you at. What have you already built. It seems like you always need to be a little bit ahead of where you actually are right. Talk through that. Like what had you built when you were talking to. These people always a lot less than what i thought they built up. And then detecting. No no crazy cannot do that. You just told me it's okay. There's a significant slack in business development. These i have failed to see a business development deal that is you know less than six months. It's like work. Speed needs to be an organization of being to say. Listen we can put it needs to be careful and never going to work in full because they have another. The good thing is that you're actually buying time in business development. You'll selling a facade. Will behind it. It's it's it's does nothing in it. It's like a movie set in. You know that you'll also even if you're going live it's not gonna be unscathed. It's fine to have people moving papers around in the back and you'll buying you'll sell more capabilities over time what you also realize in silicon valley is filipino. Don't catch me on the number. I would say eighty percent of business development. You don't work but raise money on business development so you come to the pitch with a v. c. n. we just got but is don and this is gonna like and they have fifty million pixels into the twenty one out of every day that's awesome. He'd never worked nafta. But you raise money on dot which enables you to build some other stuff to scale into the next thing never works not because of strategy because of implementation because the person that deal just move to another company and nobody cares about you and you become an old fashioned kind of porject on. There's another biology and difficult. Wasn't doing well so that about increasing margins and play. There's always reasons it's not bad though. It will be legitimate reasons. Just a business. Development is usually doesn't work so one of the things that we did is we doubled down on the business development so the people that led our be round concussed and the people that are around will now so daiwa on our board. They have the silt level of incentives. We'd like some warrants. Which will only if doing your hundreds of thousands of customers and stuff like that up to a point where it's like. I'm happy to give you. If patrick gives me a million customers i'll give you five percent of the company because when you're doing ten thousand custom of other happy give you that because their appreciation in the value of the company is a lot more than five percent. I'm going to give patrick. So you'll doing kind of incentives you're bringing them to the bold you'll investing in this relationship which improved the chance of business development into work basically one hundred or whatever it is. The tough stuff is willing. Silicon valley and silicon valley worshiped name-brand. Vc's because that's what they built. This is the neighborhood as with the brand so every time you will announcing around early so he took comcast. What the hell is that. And then i need to start explaining. I don't know if you know. But congress have twenty eight million households that basically serving the when a move to smartone and they wanna do some stuff so i can target twenty million customers which is quite a lot for a company that had one hundred customers can have a deeper discussion. And then it makes sense but it's not trivial and you find yourself explaining why you did that. Instead of raising money flowing sequoias and excel and stuff like that so we took a route of strategic but only if they bring us distribution at any given point and. I think it's actually one of the things that will the most successful for the company took a bit about the lessons. You've learned on. Innovators dilemma by building in the insurance space. Because you've already mentioned how in most ways the product was the same in ninety five and five fifteen like the doesn't seem to be a lot of product innovation. What are your thoughts. Innovators dilemma on. How has that influenced what you've built. Try to address it in civil ways. One nobody's insurance is not an internet ordered. Its regulatory four. Duct penn state. Everything needs to be approved in admitted. It's not something that these allow so by stuctural. You have a lot less than ovation. Now on the flip side we think of still a vast amount of innovation that can happen. It just not disrupting it's about evolution and so usually what happened is when i'm sitting in a room with investors then. I'm asking them guys okay. I'm gonna ask you a question. Well do you guys insured and he takes them a couple of minutes. And usually i get an answer like oh no. Let me all stake. No stay song. Salmon's that's so. They know the name of the company or does not show it still company in the second question. And he's like okay. What's the difference between allstate and farmers and then travels. I don't know. I have no idea. And what we try to do. Because we're competing in a feel. The competitors competitor spending north of a billion dollars. Ill on creating brand names. You know them because you like you can't open a tv and not see commercials eh. Five second after you the commission. I'm gonna ask you. What was the commission for. And you have no idea but it was one of them found this list it one of them and one of the team one and these guys have caught on quarterback to which one is which you know the brand. You don't know what they are in does no differentiation on the border. So he ple will differentiate on the duct and the main differentiation is to focus back when patrick Because this is an industry that the main point that you realize that they've forgotten the customer. The customer for this industry for one hundred was the agent. So there's gotta be just a million ways to create a business model around the home when you have a trusted relationship with the homeowner. So what is your vision for the firm. Are you an insurance company or are you something different if we come back in five years and you've been successful in your vision. What does that meet. I think the on the head vision of the company is we call it. Protecting the joy of ownership it's about homeowners about focusing on them and what you see is that there is this massive gap between dilomatic view of patrick buying a home. And you're going with your partner and you're like oh let's look at his home in you all you have is this really is. This is going to be magic. It kids roam around the yard and going to ride the bike. And i'm gonna watch the plants in the back and i'm going to drink coffee and read my new york times over the weekend. You have this. Like whoa manic view of what homeownership is and then you moved the house in three months late you have a what the s kind of moment is like ho god. The plumbing doesn't work with and we have a problem on that side in. I need to fix this thing. The window is ricky into the back. Door doesn't lock and you'll find those damn. I thought i have a fulltime job. All sudden they have another full time job which is taking care of the home and you know what it's not fun so we'll shine to help people basically be the best owners they can and help them take everything. I view it as we're going to be the one eight hundred number of every that happens in you all brawn. It can be locked out of your home and you need a locksmith. Call us. don't go to yelp and find random quotas. Were going to send a locksmith. You install a shelf. We're going to help you with that gut. Fulbe does a water leak. We're gonna take that you'll fridge is going to be not working anymore. We can help with that. Maybe have i don't relationship with the soothing expert You know kind of thing that can give you the backyard gloss and whatever it is. It's i want to be the place that takes care of your home and focus back on the customer. We also have a belief that bitter maintained home going to have less losses unless losses is going to be beneficial for me on the loss ratio is well as happy. Customers going to recommend differentiate him as we talked about before because what's the difference between farmers at travelers. i don't know. But what's the difference in equal because they constantly helped me take off my home. I'm actually trying to have multi touch point with my customers in an industry. They're trying to release that. I think you build the brand by the value to the customer and focusing back on them. I've obsessed with this idea of static business models changing what i call streaming business models and this is a great example of that where rather than just one and done policy never. It's this ongoing relationship they're able to build because of data because of the orientation of the business model etc in every example that you've given us that's kind of fun and interesting about what you're building. There's this commonality which is sort of like a first principles approach. You're just looking at the situation and wondering all right. What's best for the customer like. Let's just do that rather than do things how it's been done in the past. So i'd love to do to sequential series of questions on different parts of company building and product building. And just hear you're sort of unique first principles take on them. Maybe starting with culture so you've built several businesses now. How do you think about culture how important it is how you can be intentional about building it. And the reason that it's worth investing effort into it. I think it's key super important. I'm going to add a couple of things first. Culture is about what you do what you say. The number one principal of of the company. Is you say what you do what you see. Dot component itself is people all the time. If you're telling me you're doing something something. But i need to basically make sure that i'm doing it. You build culture by constant feat delivering what you do. And the biggest enforcer over the country is actually the dna. It's about hiring people that have the same kind of level of kutcher talking about it all the time and then they're going to be the ambassador to keep on trickling down and feed it into the organization because there's a certain point you can't do it and why okay i can go and talk once a week to all of the people that that's not what bring customers how you behave when something happens. These eldest stories that basic trickle down. This is what people see. This is what people watch you need to be very consistent with without. I want to say one more thing is so he plays the collection to all of my previous fuck ups. I had civil companies. I have different beliefs. I believe that you need to work harder than anybody else. You need to work twenty four seven and you know how can you compete with the big guys you. I'm going to compete with it. I'm gonna actually work and then you realize that you actually make me stay aches. And he's not the right thing and it's on and not a sprint and you're going to bring everybody down and it's okay that i'm going to work in a southern way. Much not expecting people to work in a way. I think the so he but since dot com i also have two kids and i think it's really important and you know for me personally to be present dad into trying to have dinner with him and said i'm not talking the entire equilibrium changing the world. The tollikson like my my kids sick of seeing me. I mean like before that on a regular basis. But i want to have that company. That's people are happy to go to work. Work the ninety six or whatever. They need to work but he's also immature organization. So what i mean is. There's no facetime i don't wanna see you have your job so just do it and if you need to go to recital go to the recital of your kid. It's completely fine but you manage your on time afterwards to do the work. I don't care whether you're with. I kill that you'll doing the job that you need to do. And you raise a flag if you don't do it in the ability to constantly deliver on the act and act in a way that's what builds the country. It's becoming harder. Bill in covert and when the company becomes dick. One of the things i don't like about covid is that it makes all of these things to be allow people to be more medicines than missionaries. You try to our mission to the company and to build mission hill is kind of thing you need to have ongoing touch when we'd be in when half of the company the company's going like crazy half of the people are less than year in the company yet. Now add to never step the day in the office never saw another employee never a lot how into instill culture into them when he's older mode is very very difficult and something that i don't think anybody cracked deal now but it becomes a lot one of the challenges of of covid hence while you constantly need to deliver on what you're saying. Hopefully it would trickle into everybody. What have you learned about the importance. Internally and externally building stories and narrative in bolton storytelling is basically communicate. You don't communicate with like bullets and points and stuff like that. People remember a story people. It's vivid when something happened i. I'm okay that i'm not that good. If i'm telling a story. I need to deliver on it. I'm not telling a story because it's really nice. I'm telling a story that i mean it. You can test me on that you can check out and if we failed. Please call me on that. Which is the other ways we can improve. What have you learned about managing a product roadmap so a lot of the story of hippo. Is that. you're really building what it needs to be an insurance product. There's a lot of elements to that that you've walked us through above all that is managing it. So what have you learned about that part of the business. Probably one of my biggest goal failures now that the company is a lot more bigger in stable. There is a road roadmap. we have monthly. We have a quarterly eerily would showing not to change too much became realistic. That we actually give twenty five percent of the capacity for one of the craziness that we're going to change anyway. So the political. Mike is only for sixty seventy five percent just acknowledge that we can do one hundred because we know that we're going to change it so let's just college it and keep a twenty five percent location in the they'll ideals that we're going to come up with an extra capacity bills so much as asian in the company. I'll give an example. Usually running sprints in the two weeks kind of increments and we started adding one out of like false francis. Stuff like not is equality sprint. We never had quantities. We will you'll just sprinting but then realizing that you'll starting to carry bogs and all kinds of stuff like not so you had to stop and say guys know. This frame is equality spring. All we do is fix up all of the bug because he started realized that the of bugs that you knew about for the last three and a half years and then he's like the hell avenue we fixed it. We haven't fixed this because it's not that the and we kept on developing other stuff and we're like no no. We need to bring it to brian kind of level so we started embedding that into the process of poor told mom is somewhat more rigid. I think it's very rigid compelled to buy. The team thinks it's not rigid enough. Which is fine. It's a balancing act sam. What do you think about the customer we started with the lesson you learn from early on was just respect the customer. What is it about the customer that you have to respect is at the better cheaper faster preference that they have. What does that mean to you to actually respect a customer. The main point in insurance is that you pay fairly and if you are honest and wearing fortunate. I'm gonna make you all if god forbid something happened and this is the promise. It's a very simple premise. You pay for something. God forbid something happened. We're going to make sure that we take your view in. That's the number one. Promise that we have with the festivals. And that's what i'm constantly basically pounding the team. That's what we need to. However this thing can tweak. I'll give you an example. If i'll pay everybody really really fast for whatever they say then all of a sudden they're going to be very very happy if you told me. Listen the damage fifty five thousand dollars. Say patrick you'll six. Of course you're going to be happy. But i'm going to do a disservice to myself as an insurance company because i can never make money out of that. So what basically saying is treat the customer like you wanna be treated yourself be very honest with him ton tell them bullshit. Tell them exactly. This is what cover. Let me explain to you. Treat them as adults be very honest with him be. Slt of but be attentive in being pathetic because people when they use the pool shit happened. You didn't buy a show and it's like oh that's going to be nice to be. There is a thoughtless file got four. You're not going to have a home for six months. Whatever it is. I need to. This is not the time to have in a serial kind of thing which is structured out. This is said. Can you be empathetic and explain and take the time. Accord center is not measured on time on court with the customer. I always tell the people on the phone that if patrick polls in they're going to ask him patrick all your wings with now he's going to say and they're going to ask you the questions you know you wanna walk me through leo crank potty seat it's a few. I'm completely fine that they're going to say at the end of the day patrick actually formulas covering very well. I think it's really and i'm telling you in the long-term game you'll not going to shut them. I don't care about your conversion. there's a good chance that panic is gonna fill five of his friends. Because they was so honest they checked it and they said it's fine and maybe in two will follow a gonna miss some think. There's a good chance you're going to move to us and you'll building something over long-term that's what it means for me. To focus on the customer will do the right thing on the long term and not just shoulder and most customers of appreciating dot overtime Honest if you will loyal if you took care of them if you treat them honestly you can be pissed at you. Were expecting something but at the end of the day at the bottom of your art. You do know that someone treated you fairly. You went from very fast. Startup attacking an industry which really hasn't changed much over a very long time and going public. So hopefully soon. you'll be the incumbent. Do you think about defensibility of the business. So insurance has got this regulatory aspect which we've talked about a little bit. It's got these huge brands that everyone could name but couldn't really tell you what that means. These are things which take time and are hard to attack and protect us businesses. How do you think about protecting your business as it matures if we keep on focusing on the customers and we're going to do well by them and going to take all of them and we're going to hit on our vision which is protecting the joy of all mental shape. I'm actually still very. It's fine so that's on the michael. We just need to keep on delivering on a promise to customers on the micro. It's really really interesting so home insurance. It's one hundred five billion dollar market in the us in premiums. It's actually going up at five to six billion dollars. You keep on going like that for a long time. They'll simple reason one. There's gonna be more homes in the us next year than this deal. It just is to labor and material have a tendency to always go up way faster than inflation. Just look at what happened with temple and stuff like that and in the last year it popped by like eighty percent so he has a tendency to go inflation which means that if you increased it by three to four percent out of one hundred and five. That's a billion dollar increase in the market in. The last component is a tendency to basically get more complicated and sophisticated over time. So when i go up. I used to brush my teeth into morning. Instant in line with my brothers for the one baffled that we had four of us and now everybody has an on suite and everybody has an open kitchen. A homes became more complicated in dot entails more risk to the home though so premiums and the point of making is the fine if you have more bathrooms and of course there's going to be more losses because we're gonna be more water damage but it also means that there's going to be more complexity in it now if you have a market that is dot big. And there's only one player that is north of ten percent in that state fall and then the second one is less than ten percent of the market. So it's very very fragmented. You can build a munster company by being the number sixteen enjoy. Which of course is not our goal. But the point of the making is that it's not a winner-take-all who so wild form. Vc's that the governor saying that by twenty twenty seven. This market is going to be two point. Seven billion dollars in fifteen companies chasing so he can be a really really big company can be less than one percent of the market in like three years and have one and a half billion dollars in premiums. That's not a bad outcome. And i actually think this is just the beginning so you have such a vast option to go up. It just uncapped. My portfolio rica castle was president. Always say that. We're not even into staged with collecting. the lowering. enforced was collecting. What's on the floor and my cmo with say and we're still hitting the watermelons in when we're walking. It's such a vast market. We are so early that it's not about competition does more than one way to skin a cat. I don't need to cater to every customer that just need to cater to the customers that we want and they think that this is what they want and mortaring take on insurance. That's going to help them. Take your the home in general. Think vast Unity in that. Let's go back to where we started which is trench warfare. That is entrepreneurship. There's a lot of people that listen that are just starting companies that are thinking about starting a company seems like hopefully. We'll be entering new golden era for entrepreneurship after. Maybe a long period. Where there weren't enough entrepreneurs the tooling you talked about as a big part of that etcetera. I'd love to close our conversation by spending ten minutes on this topic. Just what you've learned about this trench warfare which is hard. It's really difficult but ultimately really rewarding. Maybe we'll start there with the rewarding part. What is so rewarding about it. Why should people contemplating this life do it. I think those too much when dubbing bengals in those because it's easy and you can get money. A lot of people are in it for the wrong reasons and people do not understand how tough it is does. A mental dole is the psychological toll it. It's not an easy thing it's like as said it's trench warfare and he's like fine to for a day or two but to do it for a long period of time it's it has a total people always think once you reach a certain scale it becomes easy. It's really really hard at the beginning but once it's like a big company to no it's not it's actually do. I need to deliver on numbers. I need to constantly i have. I have five hundred people. I need to kill. It's not getting easier. But i do think that within a world will doesn't abundance of tools abundance of capital now. This is pro two golden era to do something i'm talking more about technology ventures and things of that so i think technology save the world in the last year think about. What's the narrative for this craziness. I'm not talking. Just about the vaccination. You couldn't have got food on you couldn't have done course. You couldn't have done that if this event would have happened ten years ago to put them in a very different kind of scenario so within a world will technology actually came and save the world. You can actually see them. The public markets as well in the appreciation of what we basically people put on technology stocks. So i think we all getting into an era which is kind of like a golden age. But it's not for the faint of heart. It's not easy. People should know that if you're doing until doing this for the long term and you'll doing it because it's the right thing for you and it doesn't fit everybody. A lot of people are wired to someone. Tapped him in. The back of patrick was pretty good. Job does no. Nobody's going to give you a good job about it's all about. I think people needs to be very honest. One of the things that's It's a very weird euler. Bipolar kind of you'll talk into the outside. Like everything is amazing. And inside your it's gut wrenching that nothing works in very brutally honest and what doesn't work otherwise you can have a fix it and you have like these two on the outside. It's amazing the this guy's shit doesn't work ethic any needs to be done all the time. A lot of people that are not handling it very well and it's something that is important but it's always the saying that you've never goes up into the right. It always up and down and up and down. Eventually severely fragile Stopped obesity flavor. It'd be still so many things that can kill you over the time you know you become more resilient as less of these crushing moments but at the beginning the difference between a success not. It's it's super random. It's it has many times stuff that has nothing to you. People should just be aware of what they're getting into and have honest discussions with each other on. What does it entail imagined trying to dissuade people from doing it. It's magic for the people that wants to do it. As i said it's about choosing the team choosing what you work and choosing the show which if you care about these things than nothing is better than with a a world will wolf. Accumulation is becoming cindy fast it took centuries fulda oke officials or whatever and now in a span of four or five years. You have kids the twenty seven years old. It was becoming billionaires. It's the monetary price is also very very high for people that are highly successful on benicia. Wasn't the case before it seems like there's a perverse set expectations around the feeling of these rewards. Money is one reward. people that succeeded. This game tend to get very very wealthy. Talk about what. It's felt like to get very wealthy like has that ultimately been something that feels good. Is that what people should be aiming for. Or is this more about service and people and experience getting these not a bad outcome. Let's be honest. It's not a bad outcome. But i think there's a silken liberal which is almost immaterial and it's not about so for me. My biggest driving life is learning and it's about constant learning. I think the pace of learning that you do is a seal. Running a stealth up in these glowing is insane. Oh we can have a discussion on public markets ideals fac and stuff like that six months. Before i didn't have fricken clue what it means. People biking oh. I you know devices and systems and saints in you constantly have to reinvent yourself and learn which that's the biggest drive in my life but good any help for i think up to a certain scale does stilton point that i get a lot more. Every person in equal has equity into company. I mean every person quarter center for it. And every service person how equity and not negligible equity by the way so for me. There's more of a joy on the hundreds of people that we have on our core centers that some of them are going to be millionaires and ford other than they're going to make hundreds of thousands of dollars which is life changing money more than any giannini will made x. a wide and he's going to have sixteen other options later ability to influence an impact. People that will out of this world is something that i get a lot of joyful and metal semi and the fact that we're doing it as a team and not as a solo kind of justice off. He's doing it is something that really really is important to me. It's a wonderful place to end and turn to my traditional closing question. That i ask everybody. What is the kindest thing anyone's ever done for you or god. Well i have like five hundred. Different things thoughts that are popping in my mind. What's the meaning of kind. Is it like doing something. That was unexpected. That the difference between what you expected in what you got was so high. Was it something that a person that was above and beyond. It's very easy for a person that has a lot of stuff to do to be basically kind but people who couldn't engage so i don't have a good answer. I'm just telling you of the craziness of those in my mind now. The one thing that i have is that people choose to keep on working in april and work with me every morning. So i think that smart capable people always have an option and i want people that come to work at apple to make the positive choice that this is what they wanted to because they don't have any other option and they need to bring to the stuff because i think what are the people that we have any super talented and can work so for me does an act of kindness but people that every morning shoes that working in hebron working with me on this venture what choosing to actually do and i view into one of the things that drives me and motivates me south. I think if you looked up entrepreneur the dictionary or the encyclopedia. You might find your picture there. I think you're just of classic quintessential builder. This has been so much fun together. Been really looking forward to it. Did not disappoint. Thank you so much for your time. Now that was awesome. It is a big fan. So thank you so much for doing this with me. Pledgers online if you enjoyed this episode check out join colossus dot com there. You'll find every episode of this podcast completely transcripts show notes and resources to keep learning. You can also sign up for our newsletter colossus weekly where we condense episodes to the big ideas quotations and more as well share the best content. We find on the internet every week.

patrick shaughnessy asset management patrick shaughnessy Patrick o'shaughnessy o'shaughnessy asset management sabi forest telecom steichen department of insurance asaf hippo
Turner Novak  The Past, Present, and Future of Consumer Social Companies - [Invest Like the Best, EP.182]

Invest Like the Best

1:00:41 hr | 1 year ago

Turner Novak The Past, Present, and Future of Consumer Social Companies - [Invest Like the Best, EP.182]

"This week's episode is brought to you by bottomless. Bottomless is a smart coffee subscription, which automatically reorders coffee for you based on your consumption habits, you may remember bottomless from episode one twenty four, when we had co founder and CEO Michael Mayer on the show, I'm also bottomless customer, service and idea so much became an investor. Here's a bottomless works. They send you a complimentary Wi fi scale with your first coffee order just set up the scale with your Wifi store your coffee on top and then from that. That point forward bottomless sends you coffee at the perfect time with no additional effort, the coffee itself is always roasted to order and ship straight to you from a network of roasters across the country. My favorite part about bottomless is how the technology could be used for almost anything I buy regularly. It feels like magic, and how everything will work in the future, bottomless is offering one month and your second bag of coffee free at bottomless dot com forward slash Patrick. That's bottomless dot com forward slash Patrick. Hello and welcome everyone on Patrick Shaughnessy, and this is invest like the best. This show is an open ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up to date at investor, field guide DOT COM. Patrick o'shaughnessy, if the CEO of Shaughnessy Asset Management All opinions expressed by Patrick and podcast. Guests are still lead their own opinions and do not reflect the opinion of o'shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of a Shaughnessy. Asset management maintain positions in the securities discussed in this podcast. I guess this week. Is Turner Novak? A partner had guilt. Many of the largest companies in the world today are consumer social companies, so Turner I discussed the past present and future of those businesses when executed right there often the fastest growing companies in history and the rise of Tiktok and some other companies we discuss, makes it clear that there may always be room at the top. The network effects that support these companies make them unique. These to analyze and Turner's writing has been my favorite content on the topic. Please enjoy our detailed conversation on this important area of public and private markets. Turner? Thanks so much for taking the time to do this today. The device that we're GONNA use for our conversation is the sort of past present and future of consumer social businesses, which obviously represents some of the biggest and most profitable businesses in the world. Some of the fastest growing will go in other directions as well, but that will be sort of our true north through this conversation to begin it. I think it would be neat for you to share with the audience. What you think is sort of the first relevant idea or data point in the past piece of this, what antecedents are important for us to consider before we get into today's landscape of consumer social companies? Thank special crab me. The first big thing that I really think through is there was a point in time where facebook was the fifth fastest growing social network. There's a lot of things you can on there, but I think one of the big things is that growth is really important, but the quality and the type of growth that you have is a social company is also very important. And they kind of ties into the competitive advantage that you're building over the long term, and with they'll still pretty good one and we've seen that reflected in how the companies and the business performed over the last two decades. Say More about that quality growth. So why is that interesting to you? How does the fact that they were once? Not The number one rocket ship in terms of growth matter in terms of how you think about investing in how you think about how these companies can build a durable advantage. I think one of the prime tenants of sort of social networks is UGC user generated content. And that essentially gives you higher margins over time, because you don't have to pay to acquire the content, your users who have for free, and then you can show ads in between the content in historical cases that's been the case, and that's super high margin when you hit scale. So I think that the quality and the competitive advantage of the facebook bill, it was all built on real identities in high quality, real identities that kind of use that as a position of strength to expand into what they built today. Maybe at the time. If you're looking at spreadsheets looking comparing user growth looking at charts, that might have been hard to see compared to some of the competitors. So I think it's really important to look at the product that's being built and social specifically. I think friends are A. Key component to building a strong social network and real identity to more about that. Why friends wise identity so important? Maybe why have some failed to invert the question a little bit when they have included those things? Ill I think a way to think about friends and identity read. It is a super popular social network. If you want to call it a social network specifically in the US, which is where people have the highest disposable income to spend on things that are shown in ads, but they really don't make that much money right now. Part of that's related to the AD product with part of it is also related to. They don't actually know who their users are, so they can't target them ads versus the way facebook built a business it was let's figure out exactly who these people are, and even before they rolled out a lot of the machine learning. Pushed advertising when it was update your profile, and you tell us your ten favorite movie, your ten favorite musicians, your favorite activities. That's basically what the AD system does now is it just figures those things out so face looks product was basically having people create their advertising profiles for them, so I think looking back. If you were to be looking at some of these companies decade earlier or two decades earlier, when facebook was kind of getting out, and you could say wow, they're. Users are not only creating user content. They're also creating user generated. Add profiles which I. Don't think anyone's matter anymore because facebook does it all medically. Based on how you interact with the product, but I think it's a core piece to how I think about social is. It doesn't have to be had, but it's more of what's the business model is GonNa. Look like. How do you go public with this? and Are you building towards that today or are you gonNa have to change, and then just how? How do you think about creating the business model as you grow? How often are you seeing new proposed social networks, and when you're evaluating them in addition to identity real identity again I would call it. What other major markers are you looking for in the idea behind new social network? So you've got deceive got real identity. What else matters again and again? And one of the big things helping. Consumer or helping the average person, express himself and connect with someone. I think that's the really social networks digital social networks they're replacing are offline. Conversations inhabit so. If you can figure out a way to make it easier for someone to have a digital conversation or digital interaction that they would have had in person, I? Think there's an opportunity to build a business there and there's a lot of people trying a lot of different things to your point of how often do I see them I think the flavor of the day lately has been Tiktok the next tiktok. TIKTOK were ticked off for X., but one of the interesting things about that proposal is those usually. Don't work trying to copy what other people have done. You typically have to find some sort of behavior that already really exists or is just starting to emerge, and no one else has seen yet and then create a new network of friends or people who interact with each other around that new behavior. and. Specifically I think to be really successful is a behavior that some of the other existing social networks will have a really hard time trying to copy or layer into their network, just because of the DNA of the product makes it of the existing incumbent product. Just makes it too hard to copy what you've done. What do you think is? Let's go to tick tock now because I think it's the big obvious topic by dances I. Don't know when they'll go public, but it's an enormous company that will go public. Public with a huge market CAP. It's a fascinating product. It's controversial. You've written an extensive history of Tiktok specifically I think we'll do a few times where we touch on existing companies as ways of exploring, you're sort of frameworks, so let's talk through Tiktok. What are you find so interesting about it? Describe what you think. They do best why it has been such a meteoric rise. I think the best way to explain what happened with Tiktok is to I look at some of the existing products, so facebook was founded. And grew up on desktop, and originally it was profiles that you could post to eventually tied together with the news. which was probably one of the greatest products of all time I think facebook did seventy something billion in revenue on a trailing twelve month period at extremely high margins, so one of the best products of all time the whole product is built around desktop and even instagram, which was kind of its mobile play, which was a great acquisition. The product was designed for really the feed was designed around desktop. It's the same sort of idea and for facebook like it was a great acquisition who had I read somewhere that took them six weeks to basically copy paste and tweak the code from the facebook newsfeed into the Instagram newsfeed and instagram twenty billion in revenue in two thousand, nineteen, the anybody for billion eight years ago. So Pretty and so I think when you've kind of seen snapchat emerge, it was really mobile. I probably one of the first mobile or social networks to hit scale. Just the behavior on it was different on the kind of unlocked. Really, the ability to quickly communicate people with your phone. You could send a tax to someone. You could say hey patrick. I'm hanging at the beach I'm with my friends. My dog here here were having sandwiches and just crack. Open a beer. We're on the beach. or You could just take a picture and send the same thing in two seconds, so reduce the friction to communicate with your friends and snapchat did a lot around that general idea to build like a really big business, but as kind the court case, it was way different than what you do on facebook. And then obviously stories was a function of your sending messages to your friends. You'RE GONNA. Send it to ten people. Why not just throw it on your story? So you just click one more button and it just sends it to the feed of. Full screen video play back and forth. It's like A. Progression of all the different messages eventually not actually think that we're post story purpose, and that was obviously full screen mobile video. Probably one of the better advertising products you can have on mobile slowly got away from the feed which when you kind of think about how the feed works. You're scrolling your feed. You see an ad on facebook. There's a lot of white space is the ability to comment and light which blocks part of the video. There's persons name so when you really think about how advertising products work on. The facebook feed the instagram feed Hex, probably only taking up about thirty or forty percent of your screen versus in stories. It's a full screen ad so theoretically it's going to be more effective I think the pricing on those ads is still kind of figuring out what the equilibrium will be. They'll probably increase a little bit over time, but really those are probably the best ads for Mobile, and so instagram obviously saw the rise of snapchat how good it was doing and they said. Oh. Let's add this product to. Let's stick it at the top of our feet. What's have a feed? Though the APP open so the feed and we'll stick these little circles up at the top of the feed that you can tap into and get into this full screen product I mean in theory, and evidently what's happened? It's been very also very successful for them. But when you really think about it. Why do they still have a feed? Why do you have to tap to get into the stories experience? I think what Tiktok ultimately did. There were a lot of competitors over the last ten years that we're doing similar products, similar sort of full screen videos I think talk really did was. They designed the whole product for Mobile, and that's really what makes tiktok different from instagram and say twitter. Twitter's another classic example of it was gopher desktops text updates. For sort of the people that are growing up on mobile, it's probably not the most exciting product and go of you can be you obviously, because it's more tailored to let, and we used to stop a lot more tailored to kind of how we use social media, but really these mobile first experiences are more targeted towards the average person, and there's seven eight billion people on a world right now you have a much higher total addressable market of humans. You can reach with your product. So it took, it was entirely designed from the ground up for Mobile. It was full screen video. It was basically you open the APP, and it's instagram stories or snapchat stories without all the other thing. And tying to the monetization, potential stories or full screen video, the actions are right there. You have an opportunity to get every single user into one of those more active ads. I think that's kind of the core. What makes tick tock different from sort of the existing broadcast network? I think snapchat is a little bit different, because it's more focused on France versus something like twitter and Instagram is, and Tiktok is much more focused on following creators or influencers. There's a little bit more that you could probably unpacking what makes? I reminding that's really the big one is entirely built for mobile is really the first scale broadcast network that was designed for the smart money. Can you say a bit about how to talk deals with user friction and bring this topic up because your answer is going to be related to a social product, but I think one of the best things to think about when building any product is how to reduce the time or effort or cost between the user, being aware of something and getting what they want, and it seems like Tick Tock is the ultimate example at eliminating or reducing frictions. Can you talk about how they do that? And whether or not? You think that's important from a business standpoint. Yes Oh. What I think Tiktok did was dea. Of Follower, graph or social graph is completely nonexistent on Tiktok. The core product is an algorithm that shows you what you want. Without you actually knowing what you want. So they basically figure out similar to what Youtube or facebook or instagram will do where they basically figure out. Okay, person's this age in this country here. Their interest based on how you use the APP Tiktok does the same thing, but when you're on instagram me. You usually have to be shown contact of someone that you follow her. An account that you follow war on twitter, you'll see content from people you fall interacted with Instagram has the explore tab which is content you might like, but that's not the core product both the feed and story that are really the two top core use cases of instagram maybe third. Maybe even the fourth. You kind of think about viewing profiles and. So it's really not a core part of the product whereas Tiktok, it's we will literally show you what you think. You will like the most as it used. And as a creator or as an answer, You might go on Instagram and you want to start a cooking account where you post pictures or videos and talk about your cooking. Maybe want to sell a book or you want to launch a TV. Show eventually you want to get a show on the food network about cooking. You have to work extremely hard to grow that account and go from zero followers to whatever follower threshold you WANNA. Get versus TIKTOK. What they do is. They'll show the video to ten people. She performs and then from there they'll run other tasks the open up to a thousand see. How performs they kind of gauge how people interact with video day like it? Share it they. They re, watch it then they go to profile and they follow the person. What time of the day was it? There's thousands of different things they'll to figure out if you actually liked it as more and more people like it, they'll just keep showing it to more people. That essentially a fit, so you kind of think about it on twitter. Let's say you're trying to get started on twitter. You have something really smart to say, and it ends up being right in ten years, and you're the smartest investor ever, but nobody knows you exist vs on Tiktok, you put it out there and basically there's this concept of finding your hundred to fans or your. True Fans, technique will just find them for you, so it really takes away a lot of the rich in of creating follower, baser fan base, and it's just totally different from how the other products work, and I think we'll have to see instagram completely rip the concept and the notion of a follower graph if it ever wants to truly compute Tiktok and I don't think they will. It's kind of a core DNA of how those products work, so that's another thing. Thing that took just don fundamentally different from everyone else and makes it just a completely new product that hasn't existed for is usually answer, really centered on the supply side that the creatives submitting videos it's also demand user side that of US Tiktok before to check it out and then had to delete it because it's so damn addicting that algorithm so good, but I don't think I ever followed anyone or created the user profile, but they just match the IP address. Address to my algorithm basically and so there's literally no friction like you downloaded in two seconds later. You're watching videos. You never have to do anything if you don't want to. I'm really curious. You said two things earlier now we've introduced why tiktok interesting to bring back to ideas. You said I was the tick tock for x just like we used to always here pitched uber for accent. The startup world why that is going to be a bad idea seems like. Like some of these ideas could be good ideas to apply to other places and second, you said on social friends and identity matter a lot and I get that identity here is sort of being served up without friction again because you're building a profile, what the person's interested in through the algorithm, but doesn't seem like you need to have friends identity on so I'm just curious how you think about that. Concept applied here and why Tiktok for axes about idea. I don't know of Tiktok is actually a social media company. It's a media company. It's not really a social product. It's really the first what many people would classify as social product. That doesn't have a social graph so they again. It's just totally different from what traditional social media has looked like an in terms of tiktok. For what you see a lot is we're GONNA. Make Tiktok for sports or talk kids, but Tiktok an already. Do those things based on? How described the product if If you want to watch sports in a TIKTOK Lake setting just go on tiktok. It will know that you WanNa Watch sports, or it will know that you're a kid, so I think you're always taught in typically, if you want to create some sort of Matt work related around that concept of product, you're competing against Tiktok for that sort of supply, if you think of social networks as a marketplace between supply and demand, the existing networks typically have some sort of monopoly on supply. People kind of social is to build a new social network. You need to create a new tool or the creators for the supply side. And what Tiktok did was they made something that was very easy to use on mobile, and this kind of gets in where tiktok is fundamentally different from Youtube. Kind of think of how do you make a youtube video while you set up camera? You sit down. You probably spend a Lotta time planning and thinking about what you're going to record you, might you? Might Story Board it? Some of these youtube videos are twenty minutes long, and also some of these youtube videos. Eighteen of those twenty minutes are not very insightful, and it's. It's like a blogger or influencer, just chilling you in on backstory of their. Their life or something it might not be relevant what you really WanNa. See and then also a lot of these youtube accounts once they get big. You don't have the time to invest in planning editing making connections growing the branding all that kind of stuff selling gift sponsorships. You can't really do that all by yourself. You start to hire a team and you. You go to a point where maybe you're the person in the video in your the person that's up space of the Youtube Account, but you haven't editor you have to cameraman you have to who during the brand deals, you have people who are commenting and interacting with your fans at the bottom of your video. You really disconnected from a product versus the way. Way Talk Works. It extremely easy to create videos and use on Moult, so you sort had entirely different, creative or class, where their DNA is built for mobile lot of younger users who are typically more cricket and more willing to take risks and try new things. They're also putting more effort into these things, and it's usually them. They're the ones that are. Using the product in knowing what is the best table content to create, and they're doing it on their phone and a lot of these videos are twenty seconds, so they can make them in an hour, or in some cases less than that and some people added on the computer, but for the most part really a kind of comes back to that end of it's really the first product from mobile mentioned that there may be a media company, not a social company as they don't really have the traditional social graph. There's this trope going around that. Every company needs to have sort of a media company attached to it today. Sometimes this is. Is Big brands pay absurd amounts to have a social media strategy or media strategy. I do think there's a lot of truth. Everything is going more direct to consumer and therefore products and services and brands and companies need to do the same and think about this for the Media Lens. How would you advise somebody? Go about building a media company in terms of? Let's assume that we've got some sort of content distribution wise. Is it a scattershot? When should they go to Youtube? When should they go to twitter? When should they go to tick tock? I'm just curious. Your thoughts on building a media strategy given the prevailing platforms of the day. I think it has to do with. The audience that you're going after wants to see where they are. And I think even before that. It's the question of what are you good at? I wanted to media company today have no money to hide her anyone by married with a kid. I don't have hundred twenty hours a week to work on creating content I need to figure out what I already know a lot. About what am I good at and just start doing it and just see what sticks and see who follows me who my fans are, and just put it out there and just see what works and go with it, and if my audience is predominantly on Tiktok, maybe it's. It's people who like watching lip synching, dancing, videos, or Tiktok, actually done a very good job of watering and other forms of content, which is a successful or maybe I'm on instagram and very attractive. I boast about how great my life is a lifestyle going out to eat all the time, and that's what I do naturally, or that's what I want purvey. That's where I need to go, so I think it's about understanding what social network reflects the ethos of that a network reflects what you're trying to accomplish as a media company. I think it's important to not rely on anyone. Platform or distribution channel. I think figure out one that works. It misses a common way to grow, actually create a social, your own social network I. Mean you look at Instagram really grew on the back of sharing the twitter. Facebook and after the acquisition. I think I. Look it just way user growth kind of shot up after the exhibition at look about seventy five percent of instagram's new installs or actually coming from facebook, just from the feed, so it can be super helpful to find another distribution channel to grow off, and there's a certain point where you WanNa make the trade off of when do I own my own distribution, and when do I diversified other channels but I think it can be super helpful to piggyback on another channel like look at snapchat grew entirely on Iowa. They weren't even on Android, and their android was not very good up until a year ago. So I, think it can be growing on other people's platforms. Use Them for free discussion. Produce your hostile. All your customers users, so yeah, in terms of starting a media company. I think that there's a lot of different ways to do it, and you just have to be creative and know your audience and know where they are and how to speak to them, and just iterating on what they want and make them your fans, and then do things it helped them. What do they want to learn about? WHAT DO THEY WANNA watch? What are they enjoy doing? And if you build for that, you'll be able to building during the. We talked a lot about building really rich identity profiles to make advertising more programmatic easier, and we've seen facebook and Google absolutely dominate the AD market. Maybe TIKTOK now will be on the rise snap and twitter, maybe smaller players. What are your thoughts on other business models that social or social media or media companies could employ outside of advertising that could create really big businesses that investors might be interested in. One of the ones I've been thinking a lot lately is coming, I think subscription. Is you kind of set a ceiling for what your revenue looks like when you have subscriptions? Versus when you really think about commerce. So if you kind of think about facebook, most of the ads that you're seeing on facebook or snapper Instagram, there siltation cops I think facebook did a hundred and eighty six dollars in revenue per us user over the last twelve months at the lot, hundred and eighty six dollars of our poo if you assume that. The average marketer is spending. Spending already to about a three x return on their investment, you take one eighty six times three. It's five hundred sixty. In Commerce. That's, being, Transacted because of a book which sounds like a lot. But when you compare it to the average, US household income which I can try to figure this out. There's very wide estimates, but if you assume it's anywhere from fifty to seventy thousand. Probably about one to two percent of annual household spending, which some says, you think. Wow, that's pretty low like it's only one or two percent, but it's also wow. FACEBOOK, probably driving about one to two percent of all spending household do in the US. That's pretty incredible, so facebook is potentially leading some of that money on the table. They're facilitating the axe. They're saying okay. We're giving all these other companies that are using our product. We're giving them three more revenue that we capturing ourselves now. Obviously, there's different margins on that revenue, but I think there's an opportunity to get into something where you go more full stack in these different categories. That instead of generating money from advertising, what if you're? A Mobile Game Company, so let's say there's a good example in China with bike dance which owns Tiktok so by chance saw that a lot of gaming education companies were spending tons of money on their platform. So. My guess is they were thinking. You know what? Why don't we just yourself value? Why are we giving your door advertisers? There's a ton of opportunity for us to and I. Think it was two thousand nine hundred. Am I two thousand eighteen. But sixty sixty eight of the top one hundred mobile game spenders in China, so basically the companies that spend the most on advertising sixty eight of the top one hundred spent over half their marketing budgets on Tokyo, which is by answers, other product before Tiktok. So TIKTOK is starting to get into mobile gaming now at similar what ten date! If people are familiar with science? Basically we chat, which is kind of the facebook slash. What's APP of China? And then they started getting really heavy into gaming, and a lot of the revenue comes from gaming, so I think Tiktok is doing the same thing where there's been some pretty good early success where they've had a top APP or a couple weeks just a mobile gaming, APP in China but also Japan. So. TIKTOK is saying okay. Set up showing ads, someone. Let's show a quote unquote. Add for our own product and shift them into this game that we that also have forty percent fifty percent operating margins on, and let's start monetize that way. So I think there's opportunities beyond just advertising I think advertising is probably one of the best places to start, and you think of facebook and they've got their marketplace initiative. Kind of craigslist facebook. There's obvious benefits to having your facebook profile and being able to verify who you're buying from right there, and yeah, there's a lot of opportunities to push people in people sharing the sell things on facebook marketplace. What happens when you can suddenly place ads in the marketplace? What happens when you take that I don't know if this will work, but you start putting. Putting actual real firsthand products direct from brands and manufacturers in the marketplace, instead of just a second hand, people trading things so I, think we'll start to see a lot of the advertising companies in the US really start to get further and deeper into nine advertising based businesses, but I think it's a good place to start at the same time. You have to be careful because we've. We've kind of seen. FACEBOOK'S AD product is probably one of the best of all time you have I think it's eight million businesses advertising on Facebook, and a lot of them are on auto by the other credit card hooked up and they say to facebook if you can guarantee us, three x return on every dollar, we spend show that we don't have to do anything the facebook. FACEBOOK can make someone make one more scroll or a couple more scrolls, and show another or to. It's nearly zero marginal costs on that new revenue, so I think facebook runs into the challenge of okay. We're trying to shift people in the stories. We're trying to show people into the marketplace. We're trying to get people to use messenger this. We chat like system within our messaging product. Feed. Make so much money. It's on autopilot right now. So how do we make that transition? I think it's really hard, so then you have to be careful, and just you have to be very intentive about how you build your company, and how you add different product lines over time and make sure the incentives align. Not only for you as a business, but also for your users I think we've kind of seen sort of facebook. If you look at their user growth in the US, which is where most of their revenue and cash flow comes from, it's been flat for almost a decade. They're growing like one or two percent quarter. Since the IPO in the US, that's all the money comes from so that's a little bit concerning. Obviously, they've reach a lot of people in the US, but a lot of people are turning out. Out because the product they're just like I don't want to use this. As just. A bunch of ads and none of my friends are on here anymore. It's just not a product I enjoy using so. I think there's a lot of trade offs with different business models, and you have to think about the way that people use my product and the way I'm making money. Do they go hand in hand? I actually generate cash flow in revenue from creating a product. People actually enjoy using people are using a lot. He took a bit on the social commerce side about Pinto duo, and what that company does why it's interesting, maybe why a similar opportunity could work in the US and I thought maybe before you answer the question everything you just said reminded me of a tweet that bill really sent out on the topic of how advanced the Chinese infrastructure is kind of in social and on mobile that I thought I would read. It may be part of your reaction. I would just love. Love to hear your reaction on this, so bill says the Chinese ecosystem has two things that the US doesn't a competitive programmable payments system and competitive programmable logistics. Startups in China can build upon the core infrastructure pieces with an API call, cheap easy payments and same day next day delivery, so obviously those are really important payments and delivery of really important for commerce, maybe with those two points in mind, talk about why China has been so competitive, and what can do does doing. This is gonNA. Be a long answer so I'll try to kind of tie everything together I think Hindu do it's the same thing with Tiktok Bite Dance? It's the first commerce company. The tit scale reaches hundreds of millions of people that was built for Mobile. So when you think of Amazon or in China, think of Alibaba and JD hosmer Kinda take to a lot of these products on Amazon. You search you type in what you want. Whereas on kindle do. There's no real concept of search and it's really more of like a game, so the way pin duo duo initially started. It's not quite like this anymore when it initially started. Could. Do kind of group buying to get discounts on products, and they started with fruit so jumping back a little bit. The core proponent of duo duo is there's no search, so of course it's Tiktok you can place ads really when people just open you happen you just you're showing what you think with the things you need to see in. The user sees what they think. They WANNA see, so it's like what. What the facebook newsfeed as you scroll, it's not chronological. It shows you quote unquote thinks will be battery Ho by the way thirty percent of it is at so can do. Oh, did was they partnered with basically fruit farmers in fruit vendors, and basically said Hey, we will help you sell your products to people that you want to sell to. So if you think about as a farmer twenty fifteen when? When Pandu I was founded as a farmer. You have to plant all your your craft harvested. You have to bring the town. You have to sell it. That's kind of not quite that most people sell products in two thousand fifteen, so they said we're going to help connect you with product, so they basically said we'll give the example like apples is one of the first couple of things that they did. Did Apple farmer wants to sell their products. It's tough to sell one apple or like a bag of apples. You can probably make the equivalent of one dollar, but if you could all of a sudden ensure that you can have one hundred apples, being sold thousand or ten thousand kind of starts to be worth it start using this weird mobile app that you probably just got a smartphone recently but this. Is your apples. On the consumer side what they did was, they said, targeting people in sort of third tier, and below cities in China, which is is just federal way describing more rural areas, people who maybe didn't have quite as much income as the big cities and they said Hey. We will help you. Buy Your fruit and buy your groceries, and by the way. If you invite a friend to join and by with you, we'll give you a discount. So what happened was a lot of people started inviting their friends, and instead of one person buying one apple. You'd have ten people buying an apple, each or maybe a couple of apples each. And then you'd also with that same farmer Hindu would connect hundreds of other groups, also doing the same thing so as a farmer. You're like. Wow! I, just ten million apple's ten thousand apples over an APP. This is an easy for consumer. You're like wow. I just got fifty percent of these apples on my groceries from minding my friends and his can do do oh, you're like holy cow just got a ton of users for free because our user all by each other, that sort of the holy grail is consumer products, friends, inviting other friends to use the product and keeping them in Ekofisk. Fast forward to today. Really their core value proper. A lot of these manufacturers and brands is hey. We will help connect you with consumers instead of let's say you're I. Don't know if this is the best example, but it's when I think. Let's say you're vacuum manufacturer you create vacuums for ten dollars each, and then you saw them into an American company for thirty dollars each then the American company goes and sells them for two hundred dollars each overseas. Why don't we? Instead of selling to a rand in US why don't we be that brand and actually one of the more interesting things that they did is first they took inventory in. They took stock of all the things they buy from the manufacturers and then sell to consumers now just literally marketplace. So you kind of think about it. A good example would be the US. You're on facebook you see a watch you buy for forty dollars is probably manufactured in China for like five bucks. A unit brand bought it for. Twenty bucks a unit and I made a markup selling it here in the US, and what into a did, was they? Those manufacturers in China sell directly to Chinese in China of course, the price point was a little bit lower than the Ford year the two hundred dollars the US, did probably got about the same amount that they would have gone if they just sold. To the US manufacturer the US brand of selling it overseas, and then by the way they also say while this is all going on. There are still producing for these overseas manufacturers. They probably have excess capacity so pinned to do outside. Hey, you can produce a million more nets. We'll help you sell. We'll do this whole process just topping out your existing capacity in your factories, so they made it super intriguing for all sorts of pieces of ecosystem to build this product together, which now they, the second largest e-commerce. E-COMMERCE company in China and they were five years ago. It's probably one of the fastest growing companies ever I mean the revenue year five of a business I think they did four point. One billion in revenue might be a little bit, but it's just insane. How fast group so I I think that's an example of how you can. Really the products related commerce, but most of their revenue comes from ads actually so similar to Tiktok where you open the APP, and it shows you what it thinks you wanna see. With Pinot duo you the APP, and it says hey. Checkout toilet paper, some paper towel, cheap lamp, a blanket wrapping paper because it's Christmas. They just short. You random well of discount things you might get at the dollar store, and some of those things are actually advertisements and it's. Taking a cut of I think they said in one of their disclosures point six percent is the average that number could also be off, but it just a really small cut so I think there's a really interesting opportunity to potentially try that in other markets, which maybe that might tie into. Another question that you might have next. Debt. I'm going which is in an APP that I. Think was at the top of the APP store which may be also relevant for this conversation, probably coming from a company that very few of us have maybe go in that direction. That was actually a different question than I thought. You'd ask, but I wanNA answer this one to let's keep our ordering right. What question do you think I was going to ask? And the answer that one and then we'll come back to say. Okay. I thought it was going to tie into snapchat and what they're doing, so maybe the backup, just a little bit and kind of jump into what I think about what snap is doing so. When you really look at the numbers snapchat. Eighty six, eighty, four million daily active users in North America which was about half as much as facebook pretty close to Instagram and analysts peg instagram as being worth. Anywhere from two hundred four hundred billion dollars I mean the numbers pretty insane. How valued they think that businesses men's Nafta has a really similar reach in Saint. Countries that instagram and facebook make money. When you look at sort of the Delta between the pricing of the ads on how many users and how many total impressions they could potentially show. How much time is spent in the APPS? There's a pretty big disconnect I. Think we'll slowly close over time. But snap. That's also product that a lot of people in the ballots countries use. A. Lot of these people are early adopters and people who try new products. Young Teenagers People in their twenties people. Thirties so in snap his sort of always had this sort of ambition to become a little bit like we chat. Which is we talked? What earlier is one of the big social products in China? And that's actually how do grew. So Hindu duo in the early days, it was basically when you do. One of those group is when you get your friends. It would say hey. Shared on chats. He'd go, and you post to your feed, or you'd send a message and reach at someone and get them to join purchase. Over time. We chat slowly added these in APP mini programs. It's like an APP with inside we chat. Call them mini programs and they made it so that other developers could build little pared-down APPs super lightweight. Maybe a couple megabytes, maybe even last that you could actually run your APP Within reach at so a couple of the really big mini programs that really took off were can do which as of two thousand nineteen had hundred million users in there. We Chapman Program. May Thuan, which is, it's kind of like ubereats or Grub of China mixed with a little bit expedia mix with a little bit of for some of these other on demand last novel, every providers. Jd was also big. One had about fifty million users lie different commerce companies. There's a lot of these somebody that grew really quickly on these we chat programs and Pinto duo was the standout two times bigger than the other ones group away faster I think market cap is over one hundred billion as of today when we're having this conversation. Conversation this founded in two thousand, fifteen, pretty incredible, so snapchat recently rolled out a new initiative that it's calling snap minis, which is the same thing there these little bite size third party apps that live inside of snapchat and I think understand the context of snapchat is actually used a similar amount by people in the US, and in Europe s some of these other big companies who think of these dom and social platforms like facebook instagram. You're like There is actually a pretty big opportunity for building third party products inside snapchat. And then you kind of think as well, you say okay snap. Has This third party Avatar thing called the Bit Mogi sort of a digital avatar that you can change, and it actually plugs into other APPS and there's a keyboard that goes into all these other APPS. So you kind think Sanchez has his bit Mogi Keyboard. That is basically a back door into facebook into messenger and instagram into twitter. That sort of like, if you were pushed gifts out that you post online, just the same thing with Mogi, I wonder if there's an opportunity to actually put these mini programs in that keyboard, and you also look at one of the announcements that they just made snap recently announced the keyboard was going to be integrated into every single. Samsung, which the pig smartphone manufacturers to say so the opportunity for snap minis, actually potentially extend beyond snapchat and the actual user base of snapchat with pretty. Pretty big, so my thinking is I wonder if someone will be able to build a really quick company really fast on the back of the snapchat, many programs and I've thought a little bit about what it look like. I think the stage that was sat in China with your original question about being able to really quickly do payments for a small fraction of the two or three percent of its charge today, because that eats your margin, and then also these programmable last mile delivery providers I. Don't know if that's quite yet, but I think there are some companies that are doing things like post made stored ashington hoover. Sort of last mile AP is I. Don't know if it quite ready yet, or if they're cheap enough yet for companies to really sort of scale business on, but it might be there eventually, so that's one of the big feces. I've been kind of playing around with over the last. I mean really for the last year when I heard and when I realized what they were doing with their snap, get product which is. Is Basically an extension of that, which is sort of like their developer toolkit. Where if you're developing your making a product, you can use some of snapshots tools to build your product on, so it Mogi a few launch an APP. You have an instant always on avatar every single user if they use their Emoji, there's no default cities ugly avatars. It looked like no one's using the APP. Every single user has an identity. and they're integrating things like Sanchez advertising program will probably eventually incorporated many programs as well so I think it's really interesting ecosystem to build on, and it probably means great things for snaps business performance. There's probably a lot of opportunities for them to make them on to. So I've been trying to pay attention trying to think about. How could you really do us I don't know it'll look like kindle do, but I think there'll be something on so I kind of thinking about and been on the lookout for the last couple of months. It makes me think that this is a much bigger conversation than consumer, social or social media, really down to brass tacks about the businesses themselves were talking about commerce. This is relevant for Amazon I. Remember Scott Galloway suggesting one time Amazon, just start sending you the equivalent of physical feed the box of what guesses you might want, and you keep what you want and what you don't, and it builds an algorithm over time and I thought. Thought that was so clever at the time until you realize that these social companies are doing that at far faster feedback loops like they're learning way faster than sort of physical feed ever could, and I have to admit like I order everything on Amazon. If I was in S- constant, some social product that knew me intimately and just made my life easier, I probably switch my commerce there. It seems like it's literally a competitor to Amazon. Yeah I. DO think that and I think the interesting thing with retail is that a lot of these retailers are built on figuring out new forms of distribution and logistics, so sears was basically built on the catalog, and the for like the Postal Service back in the day, and it really hit a lot of people who are marginalized people who couldn't afford to or were shunned from going into these big department stores with. With wealthy folks they'd say you're not allowed in you, so you can get a catalog to your house, and you can buy a lot of same things. That was a big mistake by some of the sears, competitors by basically cutting off half the population, just because of the color of their skin, or how much money or income they made, or they weren't able to commute into the city, and then you think of Walmart. SORTA did a similar thing where they hit this sort of different demographic. That wasn't quite being hit properly by. SORTA by sears, but also optimize a lot of things on the infrastructure side. And then even with Amazon Amazon, really is a logistics company, I mean. The core products for consumers isn't really that great. I don't know of anybody who opens up Amazon says. Wow, I love ordering the experience of using Amazon is so much fun. I think the experience people like the quick shipping when they built out that logistics infrastructure, so I wonder if. You can kind of sort of the bill. Gurley tweet the. You're talking about programmable last mile eight minutes. I wonder if you can build something on basically this outsourced Amazon's fulfillment network and that's maybe something. That shop is kind of doing. But Amazon's also doing it as well with some of the stuff that they're doing the third party. Phil by Amazon, so I know it's tricky thing with commerce. There's a lot of related to getting a distribution and reaching consumers, but also related to you ship things to people, and also how do you pay and make make profits doing that? which lets the key generating cash flow? Flow, let's come back now to Zinn, which was probably an APP that almost no one's heard of I hadn't heard about it before reading your post on the topic, I think the top downloaded APP in the US at some point recently describe what that is, and why that's related everything we've been talking about yes. Oh, Zinn was an APP will is was I'll get to that where it was basically, Tiktok was exactly the same thing, not quite the same sort of polished features. The big difference was you've got money for watching videos. You got about a dollar or a dollar fifty cents per hour watching videos which? took. Waste my time doing that, but for some people you watch Tiktok a couple of hours a day you can make. Videos online people do that kind of stuff all the time. And then they did a thing. Where Hey, if you invite a friend, we'll give you twenty dollars so as someone in this launched in the beginning of May middle of May. So if you kinda think about the state of the US, we had something like forty million people that were on unemployment, so people didn't have a job. So if you could suddenly open up an APP and make a hundred a day, inviting people to it and watching videos, which you've probably doing anyways when you don't have a job, were you do have a job actually? It made a really interesting sort of environment for an athlete this to grow when you really think about a lot of these people who are maybe you're working at a hotel. You're working in a restaurant. You're not really making that much money the amount of money you're making from an apple. This always similar, so it's basically this complete entire copy of tiktok. They went to profiles on. On tiktok and actually rich videos, so they went to certain creators, and they just download their entire profile in re uploaded in Zip. They would also go to popular sounds. Music audio is a really big thing that talks done. You can search for a certain sound. You'll see all video that have that same sound. We didn't really touch on this when we talked earlier about talk, but. That was one of the big things that Tiktok did. They basically created audio means. Familiar with memes are typically more used by Gen Z., Eleni elder, a way of expressing something funny, and typically at you take the form of media that was posted, and you do your own take on it and related current events or something culturally so tiktok basically did this with sounds where there's a funny video with a certain sound, you could then use that same sound in reenacted, and it was really a to its DNA initially being a lip synching APP when it was called musically before by cancer acquired them in two thousand seventeen would sit in. Some of these popular sounds and just ripped all the top in heels, and put them in their own APP, so the whole thing was. It wasn't very good. I mean it was executed. They steal really quickly derogating getting hundreds of thousands of dollars today they were the number one APP for a couple of weeks. It wasn't just number one in a certain category like I think they were an entertainment. They were the number one overall APP suddenly they were just removed from the APP store. The reasoning for removing them was that they copy contact, which is really interesting, because both paying users to do things and coughing content from other companies is par for the course in China. I mean it happens all the time. That was one of tectonics big growth. Growth strategies just copied videos and use their ability to feed the best people wanted to see. Teach them and make the product really enjoyable, so they copy of video that did well somewhere else, and then it would do ten times better on Tiktok so that's what ended in the reason. This was interesting so when I i. sort of saw the top of the actor I'm like silly like just a giant pyramid scheme, but when I looked into it I found out that they were actually backed by show, which is light dances big competitor in China. If you WANNA, compare the twitter or snapchat in relation to face. Sort of like a little brother. People maybe didn't quite give them quite as much respect because they had slightly more rural user base, the revenue and cash flow wasn't as high, but they're still valued at like thirty billion dollars and right for in December of two thousand eighteen. They raised three billion dollars from. I think Sequoia tencent. Pretty big. Chinese venture in growth state busters so I mind. I was like wow. You guys have a lot of money to acquire giveaway to people to download and use the APP in one of the big things. That Zanan quite shouted in China was. There a little bit different from dance dance generates most of its revenue through ads. Quite show generates a little over half of their revenue from live streaming. which is, it's basically TV qvc where you watch, and then you can buy products from them directly from the content that you're watching it. Kinda made me wonder in it. Kind of gets more conversation earlier about friends. A lot of these new media companies that don't rely on a friend graphic constantly brings the user back into the experience and re engage them. You really have to do it. Through content of some kind or push notifications gets onto open the APP net costs money. If you on creating for free, so one of the thoughts had was are our of these sort of next generation TV networks where quiring content, and the probably not gonNA. Be Five hundred billion dollar businesses like facebook or instagram. But you could probably make ten twenty fifty billion dollar company like CBS Viacom or like a Disney where you've just got a lot of media in your acquiring Ed, or even like a Netflix so it kind of tweaks the way, maybe think about social and the different opportunities and I think if you really want to build a business has a defensible competitive advantage that has textbook definition is higher than industry average, operating margins for an extended period of time I think you really have to have a component that helps you do that. which is probably friends that are creating content. What a fascinating competitive story! If nothing else right I mean, you really do get the sense that these are were like battles between these huge massive global platforms just yesterday as we're talking here today on the thirtieth of June, the majority are a bunch of the. Chinese APPS were banned in India whether or not that lasts I. Don't know, but it does seem like this is a geopolitical conversation to Amazon cares nations. Dates care I mean this is literally talking about what hogs. The attention of all humans are pretty big market. And you kind of think of what's probably the most powerful person in the world I mean the president of the United States is typically one of the most powerful in the world. What does he do all day? What product does us all day. Thinking of how much strategic. Business power societal power that product has over the rest of the world and we're talking about twitter. You really need to think about these is. They're not just social networks there I mean they are should works, but they compass so much more than that, and there's a lot of different ways to think about them in ways to think about the value, the creatine world and also sort of the business power when you think about a competitive edge. How that all relates with each other, so it's fascinating I'm sure we could probably talk with this remarkable hours if we had the. What have we not mentioned about? Social Technology Media is whole general area that you're really interested in that. We haven't covered yet I. Mean I think one of the interesting things I've been playing around with is kind of relates to Hindu duo in commerce. They basically created a social commerce. What other things can you at a social graph to to create a product? Then Mos a really interesting example added a social component to payments and sort of a peer to peer network, which it worked really well for them. I think cash Abbas I. Guess outperformed out executed in, and they don't really have a social graph, so I don't know if a social graph necessarily works exceeds business models in other industries, but I think there's interesting ways to incorporate social components to sort of AD network effects to products that might not have network. So my closing question before my traditional final question, talk to us a bit about this idea of a fantasy draft portfolio sounds like a fun game to play, but I suspect there's more going on there in terms of what it forces you to think about and learn, so let me share why you do that and what lessons you've taken from the exercise. So for me in order to get into venture capital. There are typically certain. Requirements that Avi see who's going to hire you or L. LP? That's GonNa Invest in your fund is looking for and pretty much had none of that. So. I didn't go to a school. Anyone's heard of I. Never worked at company I also didn't have any money to invest. So what I did was I basically just I shake angel masted I mean I didn't do this. Is Fantasy fantasy football. It was for investing pure public market investor. It's kind of like a paper trading account. Where and that's maybe a better analogy of that your listeners as a paper training compromiser, I basically picked the first one, that I did I picked seven startups that. Had maybe rates couple million dollars. The valuations were ten to twenty million dollar valuations, basically not on anyone's radar. There is no massive sequoia capital coming in and putting in hundred million dollars, and everybody knew about the product. It was mostly stuff that other people were really adding on and I was kinda trying to prove the insights that I had of. This random guy listen at West but I follow this pretty closely and I really think about venture is is investing a lot of people see it as company building and catching momentum waves, and looking at charts, ramping up I think about it a lot, and all that stuff's important to you by also joined busting so I think about every investment like what's the competitive advantage here? How does it go from being a ten million dollar business to going public one day, so that was sort of the land I took I didn't have any data for any of these companies I reached out some founders and There's mixed reaction. It's not everybody really got back to me. Some offered to beat up or send me their doc or I never actually ended up getting any data for anyone I basically just looked at the website scanned, looked online as much like finding articles finding podcasting your views, youtube interviews looking at their social media profiles. Try to get an idea who they were, and just figuring out what I bet on his founder of House VC. and. It's easier to do that when you don't actually have real money and it's just kind of game. It's fake, but that's what I used to build a track record. Nine of the second one is well. I picked up eighteen companies when I broaden my scope a little bit on it was. Kinda supposed to be usually when you do venture, you raise a small fund. Then you raise a bigger fund and you slowly raise larger funds as you go until you hit. Hit the sort of your sweet spot of what your strategy is going to be long term, but typically you can't go, say hey, I've never done this before, but I want to have a two hundred million on. You have to start at three or five, and then go tan and I go to fifty, and then go to maybe a hundred. You slowly build up over time, so I started to kind of do that some companies that I would do very well and. And I kind of use that a fake track record, and just say hey. Six of the seven companies in this portfolio have race all on financing three have raised multiple rounds of financing, which some cases in venture that much, but it means that somebody else thinks that the valuation aside because of how the company's performed an wanted companies got acquired so I kind of use as a track record of going interviews and say maybe I could good at this I think a. A lot of ullmark investors do similar things when they're trying to get their first job, and it's similar to venture where you may be Angel Invest. You have fifty thousand dollars to put a couple of thousand dollars in this in France. Companies just like in the public market a fake account we have a million dollars, and you just do a strategy, or maybe you have your own account, maybe a million dollars, and he just make an for yourself and bill tracker so. That's what I did and I recommend it to a lot of people. It's actually a lot of fun. I learned tonight, basically learn how to be had to force myself to make good investments. which I thought would be able to do. It's harder than you think. It is especially if you come from. More of an investing background you're thinking about what's the opportunity here? You're probably looking at financials and audited data, whereas if you're a startup investor, basically somebody telling you an idea that they have and here's a product or a product. We have that we have four customers. Are we have three employees and we WANNA go out and build a public company so the way you think about it as a little bit differently, but I still think there's a lot of lessons to be learned by from his going on. On, and just doing it, and just trying to go through the motions, and whatever way that you can so I recommend it to everyone trying to venture, just do a fantasy portfolio especially, if you don't have a lot of money, and you don't have the capital, the right off a couple of hundred thousand dollars, just putting into startups and seeing what happens, I think it's definitely the way to go the closing question that I ask of everybody is for the kindest thing that anyone's ever done for you. I knew you were. GonNa ask this I was thinking about this. It's a hard question to answer. I think I had a friend in sub-grade I kind of grew up with a single mom. We have have a lot of money. There's one week we didn't have enough money for groceries and the actually bought with his own money. We were in seventh grade. We bought groceries and I've always thought about that. That's sort of didn't have to do that. He was totally looking out for me. Obviously it was one of the nice things anyone's ever done for me. I just kind of try to have that same. Give it back. Sort of mentality and everything that I do. I love it simple, powerful story, and get a reminder to us all so turner. Thanks again for all your time today, and for everything that you've taught us awesome. Thanks for having me looking forward to the next. If you enjoyed this episode. You can sign up for a new email. Newsletter sent out each week called inside the episode each week. I convinced that weeks episode to my favorite big ideas, quotations and more I've been recommending books to members of this email is for years, and we'll keep doing so in this weekly email. You can sign up at investor field. GUIDE DOT COM forward slash. Book Club. Our.

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CoVenture Credit - Esoteric Credit with Ail Hamed, Brian Harwitt, and Marc Porzecanski - [Invest Like the Best, EP.108]

Invest Like the Best

1:07:49 hr | 3 years ago

CoVenture Credit - Esoteric Credit with Ail Hamed, Brian Harwitt, and Marc Porzecanski - [Invest Like the Best, EP.108]

"Ooh. Hello and welcome everyone on Patrick Shaughnessy and this is invest like the best this show is an open, ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money. You can learn more and stay up-to-date and investor field guide dot com. Patrick O'Shaughnessy is the c. e. o. of Shaughnessy asset management. All opinions expressed by Patrick and podcast. Guests are solely their own opinions and do not reflect the opinion of O'Shaughnessy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Shaughnessy asset management may maintain positions in the securities discussed in this podcast. I guess this week, our Ali Hamad Brian Horwitz, and Mark pours can't ski who worked together at co-venture credit. When I first had Leon. As a podcast guest, we discussed the many aspect of what his firm does ranging from venture to crypto to credit. We glossed over the lending side of the business, but having since learned a lot from them on the topic, I was excited to get a chance to talk with members of their credit team for today's longer exploration of esoteric, high yield lending. I'm always proselytizing the value of investor education. So this week we have a podcast I, the co-venture team has prepared a long series of posts that correspond to our conversation and go even deeper into the topic of credit investing. You can find them in the show notes at investor field guide dot com. Forward slash credit. This isn't tireless different from any conversation I've shared before. So I hope you learn as much as I did. Please enjoy my discussion with team co-venture credit. Thanks guys for doing this with me today. It's going to be a a much deeper conversation maybe than the Nali and I had the first time he was on the podcasts about a very specific part of co-venture and that's unique or teric credit. This is almost the exact inverse of venture in many interesting ways, but is enhanced by the fact that you guys also play in the venture world. So maybe Ali, you could just begin by framing this whole call it like a sub asset class. Why? It's so interesting and why the sort of intersection of early stage or venture and lending might represent an opportunity that most people aren't even aware of shirt. And so thank you so much for having us back on the podcast. And one of the things that we've been talking about before this is it's really easy to grease over a certain type of investment thesis, but it's a lot more fun to like really dig in deep and so hopefully that's what we're able to do today as a reminder. The way we ended up setting up our business and built co venture in the beginning was we thought we were gonna be a venture capital firm, and we were. Making equity investments in early stage startups. But some of the startups that we were most interested in were in the alternative lending space. And the reason we were interested in that space is because we sort of saw this wave of lending one point out which was lending club, ondeck prosper. So fi businesses that became really large, but primarily we're taking loans that banks used to make offline and putting them online, and there was this huge promise of these lending. One point companies, they were going to lower the cost of origination so they could decrease the loan size Len were banks no longer could, and they were going to use data that other people weren't using to decrease default rates and price loans better. Not only that they were then going to sell those loans to retail investors who for the first time we're going to have access to yield. They never had access to before the problem is almost none of that actually happened. The cost of origination didn't go down because as everyone else realized it was a good idea. I became a flooded market and there's so much competition that the cost of acquiring a borrower went up the. Thing is people would come to us and say, hey, I gather one hundred fifty data points about our borrowers, and we're using these hundred fifty data points to price are loaned and Lord fault rates, and we'd say, wow, that's really exciting of one hundred fifty data points. How many of them provide signal and they were like three. Okay. So in one of them was FICO. Okay. And the last part is the lenders on the platforms were mostly not individuals. So you ended up just going right back to institutions all over again. And this whole idea of democratising yield just didn't exist in the way that everyone thought it would to look. I would have loved to been an angel investor, a seed investor in some of these companies. Some of our partners actually personally have been because they're worth hundreds of millions of dollars to a couple of billion dollars now, but we thought the bigger opportunity in the longer-lasting opportunity was going to be new lending companies that were creating new credit products. These are credit products that had never existed before, and the way they were being invented was because you you're finding technology companies that were one using their technology to observe a data point. No one had ever observed before that could meaningfully. Drop the default rate by an order of magnitude, not just one hundred basis points and to they would have a bird entry. The thing that gets us most excited in the world is when we find technology company that's using its tech to invent any type of credit and where if everyone else in the world realize that that lender was doing what they were doing, they wouldn't be able to compete. And so you know, there's a few examples of how you can create that buried entry. One of those examples is switching costs. So imagine you are lending through appeal a system, and a lot of people have tried PS financing, but it's sort of an interesting concept in that. Let's imagine I go to a jewelry store and I say, hey, you know, Mr. jewelry, MRs, jeweler, I'm going to start lending to all your customers who can't afford this necklace at once and I'm going to lend to them at twenty percent APR if a competitor came to them and said all into your customers at eighteen percent APR we wouldn't get whipped out because we're already in the system. They said, fifteen percent APR. It would probably be the same if we went to a small business and we said, we're. Integrate with your system and we're going to lend to you at a floating rate based on how many customers came in this day because we have a lot of customers. You're a healthier business, and somebody else came and tried to rip us out of the system. They just wouldn't switch us out. So that was a big bear to enter that. We got fascinated by the second is what's data point that you can observe that no one else in the world can observe. We talked a little bit last time about produce pay, but I think it's a good example where what they've essentially done is built inventory technology that tracks shipments in real time and understands or produces any given moment to they can finance it once it's on consignment for them to get ripped out, you have to go to a distributor or a farmer and tell them replace your inventory software and he'll start financing, you no one's ever going to do it because you know if they're charging x. amount per shipment, twenty basis points isn't going to change a life as much as switch in their inventory software. So that's a chance where we can observe data that no one else can observe. And the third is if it's a platform that can affect the outcome of the borrower. So let's imagine. And this is example we haven't found yet. I kinda love it to illustrate the point if Amazon said, hey, we're gonna start lending to the vendors on Amazon dot com. And if any of our vendors ever become late, we're going to tweak our recommendation algorithm to drive more traffic to that vendor. So then suddenly make more revenue can become current on the loan. So those are are versions of the unicorn when we find a company that's using this technology to invent a new type alone and has a barrier to entry where can protect the yield. So that would happen to lending club and ondeck and all these other businesses doesn't happen to us. We're all of a sudden are yields get compressed. So that was sort of the impetus of our credit business. Maybe talk just for a couple of minutes about the importance of seeing both the equity sometimes and then also being the credit in some of these deals. So I think what's what's interesting and we'll be the focus of our conversation today is underwriting credit, not underwriting the potential for a unicorn seed stage equity investment or something like this. And as you often pointed out to me, there really are inverse of one another. There's sort of uncapped upside and one downside on the equity side on the credit side. Like, you know exactly. Your max return for the most part. So it's really all about downside risk mitigation, but it seems as though a big part of your edge advantage, if you will, to the extent there is one is seeing both sides of this. So talk about kind of the early stage component of this on top of those three things you just listed. Sure. So I'll start with a couple of things. The first is in venture capital. Your job is to make money and in credit your jobs to not lose it. One of the first things I was ever told about venture capital was from this sort of, you know, offer a successful VC and he goes to me, he goes, look, if you invest in a company, the most you can ever lose is one x. If you don't invest in a company, the most you can lose is INFINITI ex. If you missed Uber, you missed INFINITI ex that is very different than what every credit underwriter in the world would ever think about and venture capital is sort of this art, whereas credits really a science going back and forth with somebody yesterday. And they said in venture capital, rarely is a portfolio made by your structure of a deal in credit. Your portfolio is almost always made by the structure of a deal. So there's so many differences between. Those two. And the third part is the equity of the debt of a company are often inversely. Interesting. For example, if the equity of a company is to be ever interesting, it means it a built, a really, really big loan book. And traditional lenders will be able to come into the space and lend at a really, really low yield. Or if the debt stays small book stay small and your yield stays high. You never wanted to be in the equity. It's a really difficult problem for us when we're under the company to figure out, do we actually want warrants in this business or should we just ask for a higher yield? Often, it just makes sense for us to make a small equity investment the business or for no warns at all. Because what we're really trying to get is just sort of a higher bogey because we believe a lot in the asset as opposed to try to be on both sides of the trade in terms of the advantages of being both one of the things that you find for a firm like us is we face a lot more origination risk, and this is something that probably Mark talk about him Brian. We'll talk about it in a moment, but we face more origination wrist than other lenders in that. When we find a company we have to decide, are they actually going to be able to to attract borrowers. If I'm lending at twenty five percents APR to super prime borrowers. It's pretty good credit product. I just don't know if I'll ever put any money out the door. I probably won't. And so what we have to say is their product market fit here, and can we sort of think its venture capitalist in terms of Candace grow quickly? And I think that's just a different skill set than than most people are traditional lending fund would have. The final thing is our deal flows just different than everyone else. Our deal flow comes from the people. We've co invested with venture capitalists or in spaces that we've developed adventure thesis. So the people who are referring deals to us, our founders of tech companies other venture capitalists, other people were saying, all do the season series of the equity. If you do the debt, it's something that differentiates us from another credit business that might be cold inbounding to a bunch of borrowers who might be an thesis that they like before we move on and certainly try to get marketing Brian into the conversation to talk about return. Lee would be really interesting as an example, just because I think you mentioned already this potential accumulative data advantage that some of these companies can occur. Grew over time that makes it very hard for competitors to keep up. That'd be a great example just to frame this whole thing before we get into some of the deeper details on origination and sourcing and all these, these fascinating parts of this process. So maybe someone could kind of sum up what return Lee does and why. That's interesting. Sure. So return Lee is a business that is a software business focused on providing returns management software to e commerce platforms, mostly focused on middle market, ecommerce businesses in originally, would they would do just process your return help the returner print out a FedEx label and handle the logistics surrounding that return would they realize was if you offered an instant return to a shopper, you're actually able to increase the likelihood that they were going to purchase another item on that website by four times. And so what they began to do is offer instant refund at checkout, which began resembling factoring of that commerce return receivable in which as long as the bar returned the original. Item that they had purchased. Then return -ly had fronted the capital for the refund the next purchase after the refund and then gets paid back once that original item is received. And so an example here would be if I bought a hundred dollar pair of shoes, I realized they were a size too big. So I said, all right, I want to return it, but you can get instant credit instead of having to wait for your refund to be processed. I then click it. I buy the shoes. This smaller, I print out the labels and the other shoes back. And when they arrived back at the warehouse return, Lee then receives the money back that they had fronted to the the commerce platform. So in this case where they have what return Lee has an advantage of that? No, their company would is they can see the returns behavior of different individuals. So this person has shopped at ecommerce her ex, but they've also shopped at Wisey and all the other stores within the ecosystem is they could say, are they a good returner? Are they bad returner? Should we extend them the instant refund credit? Or should we not? And so that's unique advantage they have. Additionally, on the merchant side, they. Have the ability to access not only the sales information associated with the individual merchant. They have the returns data so they can say our people returning items in mass back to the store and do we really wanna be providing instant refunds to their customers when we know that it's sixty percent of the items are going to be returned. If we provide an instant refund, is that item going to be returned again? And then you know, this is just a bad store to be in business with. And so it hits on the court. These that we mentioned, which is no one has ever in the world provided ecommerce returns financing. The second thing is return Lee is the returns management systems. So it software as a service which means has switching costs, which is one of the great advantages of SAS companies to begin with. So it's never like we're gonna get ripped out. And the third is because the companies working with hundreds and hundreds of ecommerce companies, they know which customers in the world return stuff and which ones don't. I might not return something not become a bad person, but because I've just I've been to the post office. I never want to do it again in building on that. Not only as an individual basis, they can start categorizing by zip code by. Different geographies on who are good returners in who are not good returners. So they're building out data algorithms based off of the hundreds of thousands of transactions. The companies already processed of these instant refunds. These microloans essence, they've processed over two hundred thousand and so the gathered tremendous amounts of data around that in addition to all the other transactions in returns that don't flow through the instant refund, just general returns that are processed by the company. So it's a new type alone. They have data, no one else in the world has under tight switching cost so that if anyone else tried to do it, it wouldn't be compete. Let's use those features as potential bugs. So how high of a turnover do you expect? Let's say looking forward five years, you'll have to have in terms of partners like a return -ly where the yields can remain this high because classic market stuff, you see yields certainly anything that's backed by anything that has yields in the high teens or twenty, or you know, some of the numbers that we've talked about in the past and my first reaction is well, like that's going to have to come way down as it gets more stable. Do you think that that's true or do you think that some. Of these advantages. These all them lending boats or something are sufficiently strong that those kinds of returns on the credit side can can remain possible for, let's say, years to come. Yes. I think part of this is that we are getting paid for being transformational capital for these businesses. We're getting outside risk adjusted returns for being very early in a company's life cycle. So we are provider of capital where others are not. I came from more traditional larger asset managers where deals were being competed by dozens of parties, and as a result yields were compressing massively here, we're one of very few people who are competing for these deals. In many times, we're finding opportunities on our own and being kind of the single party that they're talking to. And as a result were able to command yields that we think are good on a risk adjusted basis, but that are borrowers are very excited to take because no one is providing capital to them. Does that imply then that maybe I have it wrong in terms of how long the last and it's. About how much you can actually push through. So the capacity of this style thing, because earlier stages just much smaller than a, you know, a fortress or a Blackstone or someone who's going to get involved in. So if you think about us entering on kind of day one with some of these companies, a fortress for Blackstone, probably doesn't want to be doing business with a company like this until they're at year three, four, five. So I think there is sufficient time where we can command higher yield for that. And one of the things that was interesting to us when co-venture started financing. These businesses more from the credit side than the equity side is we thought this is gonna be sort of a hobby business or side business that we would offer to our LP's. And we never seen this sort of explosion of new types of credit are bottleneck is not necessarily deal flow just we can only close so many deals at a time and do a good job of it. So I think that from deal flow perspective, we think that this could be a pretty much bigger opportunity than we ever had mentioned it, which is why we started bringing in a professional team in train this into one of the core things that we really do. And then Secondly, when we work with a company, we don't just say, hey, we're going to. To lend to you for as long as you're willing to let us line. We kind of say to Mark's point, we're transformational capital. We want to be the story of how you get built and we want to be a part of every part of your capital stack along your maturity. So in the beginning, we're probably you're only lender over time. You're going to want to erase your capital base by having multiple lenders, and so it will let what will end up doing saying, look, we're going to provide you capital. Now in the exchange, we want to go to lend to you for the next three to five years at a similar rate. And then eventually you're going to have to lenders. Regan originate assets. You're gonna put them into two TV's. We'll end to one of them. The other lender will end to the other. You're going to have a third party that sort of decide which assets go into which STV that were. There's no negative selection by each time. And then one day you're gonna raise Bank dancing, but the Bank finance is gonna have a really, really, really tight credit box, and we're going to be the one to always help you build that next product out. And if you think about a lot of the great lending companies today, they don't just do one product. They might have a different region different country, different demographic, different FICO score, and we expect Arlene companies to do the same where in ear. Four, they're going to be experimenting with a credit product that we love, but still only has one year of data and so, well, they might have Bank financing for one of their products. We now have relationship with the company. We're the preferred lender because they already know what it's like to work with us. We happen to think that we're not the worst people on earth, and so we think that we can definitely exist with these companies in the next midterm work with them extensively, even after the mature on their newer products. And from top of the funnel perspective, it's been really amazing to see it's it's just a renaissance of credit school just because this is something that's fairly unique. I wanna get as many examples as possible to illustrate some of these points who talked a little bit about produce, pay about return -ly. I remember if we could pause before getting into sort of the diligence process that you go through when you meet one of these new opportunities with maybe one more example that you think well represents some the that we've talked about? Yes. So another sector that we really like is something called payroll deduction lending. And so this is not to be confused with payday lending what it is. It's lending to employee. Jeez of large employers where the loan repayment is actually withheld from their paycheck in the same way that your health insurance premium or your taxes are. So you're top of the waterfall, so to speak on someone's paycheck before it even hits their Bank account. And what that means is that your underwriting not the credit of the person themselves, but actually the likelihood that they're going to remain employed employed, correct. So the the risk of default is that they're the leave or terminated. Its still remains alone of theirs, but you're not getting the same mechanism. And so one reason we really like this is because we see this as the leveling of the credit playing field. This is saying it doesn't matter whether you're subprime borrower as long as you're employed your loan. Repayment is coming through like clockwork. And so it allows a subprime credit to perform like a prime credit. So that's something that we really like. And we're pursuing a lot of things in that space and therefore reduces the cost of borrowing from payday loan level. One hundred percent APR. To significantly lower than that. So how might that work? Like what's the actual workflow then of the platform? So they're selling, I guess they're selling employers, the employers like it because it's like a perk that they can offer to their employees, like what's the incentive chain? Yeah, that's exactly right. So they sell it to the employer as an HR benefit, say, your employees can now have easy access to credit. They don't have to jump through many hoops. In fact, some of these guys don't even poke FICO scores or anything like that. It's just the Lendu based on the fact that you're employed there. The example makes me think that maybe one key advantage here is finding like unique types of default risk and being able to underwrite them better. And it comes from a couple of ways. In this case, it's under a new data point that other people haven't underwritten in what you're doing is you're underwriting the employer's ability or inability to lay people offer fire people as opposed to underwriting the borrower's credit score. So you're literally under any different data. L. keepdriving at home. You have the switching costs by integrating with the payroll system, said, no one's gonna ever up you out. You have the identifying different data point than anyone else was ever identifying before, which is underwriting the churn of the employer, not the credit risk of the employees, and you have a repayment mechanism that's really, really important that allows you to pull a percentage of their paycheck every couple of weeks. So it's essentially an annuity. And so you're able to lend to borrowing base that would traditionally have to take to Brian's point payday loans because it's just really hard to lend to them at that size and be at their traditional default rate and make them microloans because you have a really cheap distribution channel and a really, really low default rate relative to that bike, oh band, which is not a two hundred basis points improvement. It's an order of magnitude improvement, which is really, really powerful thing. And so we love it because it's really good for the borrower. It's good for us. We think we're getting paid for doing something interesting and it hits all of our check boxes that we always look for. So let's dive now into an again as many of these similar stories as we can conjure throughout the conversation as samples. I think makes it easier to to follow along with into the diligence and sourcing and diligence process. So maybe since we've talked in the past about the venture capital, say founder archetypes, things that you might look for in early stage like equity seed investment, use that as points of contrast to what you might instead be looking for that unique or different when evaluating a platform. So you mentioned already kind of how you see these things, which is from the venture part of the business from your LP's. I'm, you've got a lot of unique places that you might get the original look at the deal. But once you've got something on your on the table, that seems somewhat interesting. Walk me through the diligence process. What is sort of the checklist that you need to see in order for you to do deeper work on a company or a platform? So definitely around the founding team measuring team to your point. What I think we really like and has has been true for a lot of our founders is that they had previously worked in the industry that has lack of access to credit. So in the produce pay example, Pablo had came from farming family and saw how difficult it was to. Finance his farm, and he saw that as a huge problem for companies that we looking at now, they're looking at financing, healthcare insurance deductibles in they, they come from hospital administration as it were having a difficult time collecting on individual patient receivables. So people that have that sort of background, they understand the problem. They understand how to actually sell to those customers is really important in how to deliver that product and then pairing that with someone who has the expertise of credit underwriting in maybe the more traditional credit background. Yeah, I think although we're dealing with new companies or emerging companies will we're not gonna sacrifice on his credit quality in helping that company defined the credit box so we can set parameters around what they're doing and the types of loans originating. And so even though it may seem new, we're still putting kind of traditional bells and whistles around what they're doing. I think one of the toughest things to underwrite his actually their ability to scale. So one of the things where we're traditional lenders on the one hand, but we have to wear kind of. VC hat on the other hand is, can this company actually get to scale? Is it worth because to us doing a million dollar deals, the same as doing a fifty million dollar deal in the sense of time and effort and energy expended. So we need to really make sure that the what were investing in something that can grow to scale. And that's something that's really hard to underwrite. And so some of the features we work, indoor deals, for instance, like we can put a minimum utilization threshold in the deal, which means they have to be at least x percent drawn on the deal in six months or year, whatever or interest is owed is if it were and that's a way to promote growth. Another thing we might do is actually lower the interest rate with the amount of dollars that have been deployed. So another incentive to try to get someone to scale and then going back to the underwriting point. A lot of it is things at all. He has detailed before. What are the barriers gentry here? How can you maintain your yield? What is the underwriting that you're performing and how is it unique and different compared to to someone else? How are you? Are you taking advantage of borrowers? We don't wanna. Be in a situation in which we're providing financing to someone who's taking advantage bars, which is why we liked this payroll deduction model because we feel like it's providing a significant benefit over working with payday lenders or other lenders of that type. I mean, you know, I often joke and we're talking to our investors, you would you all these really complicated things to come to a pretty simple end, which is Emma going to get a mid to high teens yield and like a one percent default rate in a market that really, really need this and would be willing to borrow from the other day. That's really what we're doing. And there's a couple of ways to do it. The first is we can underwrite better with a new data point. We can originate better through a new distribution channel and never been distributed through before we can lower our costs. So we can write a really short duration receivable that a traditional under candidate, and it's got to be something with barest entry. If it hits those points, we can use all these really fancy mechanisms in the structure of the deal to Mark's point, make sure that they have to draw the capital and we get paid one way or another, or we can work with them to define their credit box. Usually when a traditional enter will come in, they'll come in three or four. Into the deal. When the credit box is already defined, we're sitting there with them defining eligible own criteria. That's a differentiator in what we do. So we're also looking for management teams that know their bar well enough to know what they'd be willing to take, but also management teams that have a season track record where we believe the eligible loan box we can come together is really collaborative and sophisticated. One of the other things that Mark sort of instilled in us from the years he's been doing this is when we underwrite a deal. We also have to say, if original goes bankrupt tomorrow the day after we've closed our, we fine. You know, the two biggest risks of new companies. One, they don't originate, which we've already addressed. The second is the originator goes bankrupt. We might be secured by all the assets they originated, that might be an SUV or in our facility or otherwise. But are we actually able to go service those ourselves if we need to or employees own, who can go service does. So there's this checklist we go to through of are we going to get a reasonable yield in a really, really low default rate, and even if our models are wrong, there's a ton of wiggle room and. And can actually originate these loans. And in a worst case scenario, gonna sweat and hopefully answers. Now, as you guys have described it kind of like when you talk to early stage venture investors, there's this rise of interest in founders who have deep familiarity with their industry like founder market fit is the term you is here now, and I think what that gets at is a deep awareness and understanding of the problem at hand. A second key component what you've kind of talked around is, I guess, answering the question like, why hasn't someone else dealt with this already? Like is they're just an insurmountable problem that it may be a problem, but we can't fix it or can't fix it right now, thinking maybe one from each of you, what is the most interesting problem specific problem that you've come across that somebody's either trying to fix or that you're just personally aware of that you have yet to do a deal in. So like sort of a wishlist, if you will of the types of problems that this setup might sol-. Yeah. So I listened to a little bit earlier, but the interest healthcare insurance deductible. Financing. So what's happened now is one hundred forty million Americans that have high deductible, health care healthcare policies, which means that they have a thousand to three thousand dollars deductible before they start receiving any benefit from their insurance with this creates is essentially a huge gap in fraud. People that are utilizing these high deductible plans is they can't afford that deductible. Now, near fifty percent of Americans can't afford a four hundred dollar emergency payment. And I think a lot of the people that are taking these high deductible healthcare plans fall in that. And so what you're seeing is there's a lot more receivables that are being service individual patients being serviced by hospital systems and healthcare providers that are use only working with insurance companies. You know, ninety percent of their receivables used to just be with insurance companies. And now with the rise of these high deductible healthcare plans, which has just been a function of being more expensive for employers to provide health insurance to their employees. You're seeing a massive defaults across these individual patient medical receivables, and then these. Patients are forced to default on their receivables today I want to do which impacts their credit. And so what we're looking at and what we're interested in is finding a solution that outside of payday lending for these individuals, which is often where they have to go to cover some of these payments. So we've seen a couple different interesting ways of approaching this problem. One is through working with hospitals as a century billing and outsourced servicing and collections department paying on day one at a certain set discount that's negotiated between this company and the hospital system or the healthcare provider, and then providing a line of credit or a very affordable financing option to the bar or the patient. And so instead of paying, you know, in seeing APR you say, I'll give, you know, no interest in what you're able to get. The economics is from negotiating a discount from the hospital and thereby lowering the potential default rates still creating an interesting attractive yield for potential investor capital provider. The other way of doing it would be more like an insurance model where in employer and employee pays a certain amount per month to have access to a credit line. That's equal to the amount of deductible and they have to, you know, if they have some sort of Bill that they have to pay, they're able to access that line of credit either no or little cost and then pay it down over, let's say six, six, twelve months eighteen months, which we see as a tremendous alternative to on people who are taking out payday loans to fill that gap. And so we've seen a number of different companies in are are looking to partner on in the space that I think is approaching it pretty creatively. Fascinating. How about you Mark? I think the access to credit for subprime borrower is still really lacking. You hear a lot about credit being freely available to folks, but it's really only prime credit. So when you think even about lending cluber prosper, which seems to be delivering loans to the masses. I mean, they still have minimum FICO score cutoffs of six sixty or six eighty. So there's large swaths the population that are being under banked and you know, you walk into a store like best buy or something, and they, you can get zero percents financing, but that's underwritten by an HSBC or synchrony or someone who's providing again, prime credit. So I think the what's still left at two to happen is kind of the disintermediation of the payday or other industries you think about payday? Right? It's about a fifty billion dollar a year industry. I think this is there's more payday loan shops, and there are McDonalds and Starbucks combined, which is just mind blowing. And so what I think there needs to be your new products. The payroll deduction is one, but for instance, point of sale financing I think is another one that's going to be very large. So this is the best buy financing for for folks who don't have access to the HSBC credit card. It's allowing them an option to purchase a refrigerator or something that they need, but at a subprime demographic until I think there's ways to address that. And I think that's going to be a huge industry because a lot of people who are taking payday loans are actually doing it to fill some sort of need. Their car broke down. The refrigerator did break. They need some sort of emergency medical expense, and I think we really need to address that. How might that happen? So it makes me think of this. Awesome line that Warren Buffett said to us, which is that prices his diligence. So if you think about payday lending as like having ridiculous yields or ridiculous, maybe they need to think less about the default risk just by pricing it appropriately with like a margin of safety, if you will, on the yield, what is going to change to allow more thoughtful underwriting of the subprime borrower like what? What might be the unique data sets data points that we've talked about as a key in all of this that that make this change from the system we have today. So I think you need an improvement in the structure of the loan to bring the default rates into something that is more normalized. So in payday, for example, default rates are really high thirty forty, fifty percent even and so will people don't like to talk about is the demographic who has taken out payday loan. Actually, you do need to charge them a high rate of interest and the average person on the street thinks that fifteen percent is a high rate of interest, and that could be appropriate to subprime borrower, you know, unfortunate. Yeah, I don't think that's the case. I think they do need to pay a higher rate of interest, but I think the way to get them off a payday level, which by the way, payday could be five hundred percent interest or more. So I think the way to get them is through a structural fix and to payroll deduction is one. That's great because it levels the playing field and introduces a mechanism that turns a subprime bar into a prime borrower. If you think about point of sale, financing or rent own structures, that's also something that get someone from regular subprime loan into a more fluid repayment mechanism that gets them normalized. So you need to actually see a structural change in the way that the the product is being done as opposed to just lower rates. You need to actually improve the the behavioral mechanism. And I think increasing financial literacy of our people in our country is also an important step here because most people walk by a store that says, get cash now, no background check required. It's great. I need. I need cash and they don't realize when they're signing a contract. Act that they're essentially signing up to be in a debt cycle for, you know, in the indefinite future. And so I think part of part of tomorrow's point is, is is training people to avoid these debt cycles which are often completely avoidable. But people don't have the resources or the knowledge to avoid them and cheat. Not us wanted to go through a few quickly and touch hunt on March five, the two weekday cycles insane. The fact that we get paid every two weeks and that eighty gets annoyed at us that we wouldn't want to take our paycheck every day. That will not be a thing at some point. And so we're really fascinated about how do we factor receivables in that period, etc. To that second point, doing short duration. Receivables is really, really interesting thing to do online because traditionally a Bank or a brick and mortar can't originate a three day loan because it'd be too expensive. That's why that's part of why payday loans are so expensive. It's not just the fault rates is that if I'm going to originate a two week loan, that's five hundred dollars. I'm paying a brick and mortar, so I have to pay somebody minimum wage, which in New York is fifteen dollars an hour, and it takes them twenty minutes to reshape the loan. It costs them five dollars just pain that person to explain something to the borrower, not including the marketing, the brick and mortar the real state, everything else. And so if I were to charge state Usery of about twenty five percent, I would make like four dollars and thirteen cents of revenue on alone that cost a minimum five dollars for originate. And so the internet's amazing at originating short duration loans where you can handle the fact that as long as to fall rates are low, the total revenue on loan a small. The other thing is we've value different things today than we used to. It used to be this common cliche in credit that you should lend again, somebody's car because the car is the first payment they'll make and still one of the first payments they make. I care a lot more about my smartphone though they do about my car. If you take my car, I'm going to be really annoyed at you. If you take my smartphone from me, I will do horrible, horrible things. And so there's a company called page ROY that we're not lenders to, but we applaud from far they're helping people finance smartphone purchases and they're secured by the smartphone. There's a genius thing to do. And then maybe the last part is tomorrow. Small businesses are different than today. Small businesses, the great small business of tomorrow. Not the drugstore on the corner. It's the Airbnb account. It's the ecommerce company. It's the Instagram handle the things that we might have talked about last time. And so we're looking at not yesterday's small businesses we're looking at tomorrow's. And so those are some of the broad themes that we like to kind of dig into. So let's let's assume now that we've got, you've identified something you're sort of comfortable with the major checkpoints. Let's call them that this might be somewhere with the capacity to put fifty million dollars of your clients money to work in, and we're further down the spectrum here. We've referenced a few times how important structure then becomes we'll come back to some of the mitigation of downside risk, but certainly structure is one way to mitigate downside risk when it comes to credit. Maybe you could touch on like the major struck structures. I'm thinking here about four flow agreements, AB l. structures, things like that. Describe what those terms even mean, which I think a lot of people won't have heard those terms before and how comes down to brass tacks, how these things are actually structured. Sure. So there's two basic types of ways you can get involved in an asset taking asset level. Risk. One is a traditional AB l. which is basically an AB l. stands for asset back lending. And all that means is that you are lending to assets as opposed to accompany. So traditional credit, you're making corporate loan to accompany in asset back lending. You are lending to the acids, the way you lend to an asset is you put it into a special purpose vehicle you make that s p bankruptcy remote and in doing so you are not taking the risk that the originating companies going to go bankrupt. You're just taking asset level risk. Another way you can get exposure to an asset is called a forward flow agreement whereby you are agreeing to purchase assets from an originator. So XYZ company makes loans. They then sell them to you on a forward flow basis. And therefore you are buying these assets and you're gonna wear the risk of the asset and the way that it's different is that in the first case in the AL your secured lender and. And you typically have what's called over collateralisation, meaning your lending ninety cents on the dollar. And so you have ten percent of cushion. Whereas in a forward flow, you're actually buying the raw asset and so there's less cushion or no cushion in some cases. And so typically the the pros and cons are you're getting paid more in a forward flow. You're just yielding more. But you have fewer kind of protections from structural perspective. What roles that we play almost as an educator of these lending platforms. Because for a lot of them, we might be the first lender they've ever had, and so we help them figure out what do they really want. And so many people, the first thing they ask is what is the rate of return then we have to give up for the money that might be like the third most important term of the deal. So in a Ford flow agreement, you're selling the assets that you originate to a lender at a high price, but at least you don't have to understand how many loans you're gonna originate. That month startups are like just notoriously bad at projections. And if you're a startup that doesn't know if it's gonna regain one hundred dollars or two hundred dollars or three hundred dollars next month. It's really good, have afford flow agreements that you can sell, take that burden of cash drag and put it on your lender. Some funds can do it. Some funds can't if you're doing it in an AB l. facility. But you do is you originate alone. You put it into Bs TV and you're usually guaranteeing some rate of return. God forbid, you don't originate as many loans as you thought you were going to you money on assets that aren't even yielding you any revenue. And so there's pluses and minuses on our side. There's also pluses on minuses on the originator side. And one of the things that we try to do is introduced the originators. We work with two other people who've built big lending companies so that we're not the only people giving them vice that way. They can kind of triangulate what other firms have done in the past and sort of the advantages. Also the the deal structure is driven also by what the originator wants to look like. So if they want to be an on balance sheet, finance company, they'll choose Nabeel structure. If they wanna be asset light fintech company, they'll choose to engage in forward flow purchase agreements because that way they don't have the assets on their balance sheet and they. Can try to look more like a technology company that the goal is to trade at a higher multiple essentially by being asset light, which is what a square is doing with their merchant cash advances. They're sighing them in Ford flow manner. One of the common teams lately and just in people I've been talking to is like home services, things having to do with the home that are critical. You mentioned refrigerator earlier, which makes me think of like h vac and like lending against in h vac installations where the acid is an ego, rip the thing out of the house of got friends who have have certainly been involved in this sort of this sort of lending before. And that seems like something that is very critical to a person's life, but also seems maybe a little bit more traditional, you know, that's that's something that maybe he's been around. I don't know. I'm curious your take on this idea of the home as an interesting playground for credit opportunities. I think that what's interesting is I don't think anyone's gonna own anything anymore. So we have to founders one thirty one forty two forty year old was talking about a car youns and at thirty year old looks at him. He goes, that's so gen-x. Have you Tony. Car. I thought that was a Kalari comment, but it's true. So I think I'm gonna like lease everything that I ever have. I don't even know if I'm ever going to own a home. Like there's all these nomadic living places where you can pay one month's rent, but have access to a place in Berlin, Miami New York and like Ali, you clearly don't have any kids. Sure. But I do think that that's sort of an interesting concept of coupon. We're gonna live in places for less time than they used to live. So I own the asset and there might be an ability to lend against them one of the problems that we've seen. So we've seen a lot of these furniture companies are saying, you should rent your furniture, not own your furniture. These companies are just basically lending companies where I give you a couch, I assume that you're going to pay me once a month for that couch, but God forbid, you don't pay the loan. I'm not going to come to your home and try and take the couch that sounds really expensive. Some lending against an eight hundred dollar asset is really hard for me to make the economics business work because what you're doing your core competency that company is actually to be a collections business under eight necessarily better. You're not able to secure against an asset in a way that structurally different. You just have to find a really, really cheap way to collect in the event of the person doesn't pay you because that's ultimately where a lot of those things will break down. We've seen a lot of these h. back borrowing business it or lending businesses in our world of what we think is niece that's like super mainstream, and I'm sure you know for many people that is nation in his free esoteric. We've just seen yields because too many people are in that space that are in the high single digits in ten eleven, which just isn't interesting enough to us if we can do fifteen sixteen seventeen percent of all rights. I think you do wanna lend to assets that have high use cases. So h is a good example refrigerators a good example things where you don't wanna lend against our things like vacations or something where once it has occurred, there's really little incentive to repay, but a refrigerator, right that you continue to use or your h. back you continue to use. I've even seen a company once that was leasing pets. So the idea being that you have such a high emotional affinity, your pet, sure that the likelihood of you defaulting is so low, right? So in love to see you run a collection. Nice guy to do that deal Mark. It's an interesting opportunity. Given your background, maybe you could you touch on what you're doing prior to co venture just to ask your opinion more generally speaking on, I guess like the macro economic situation that we're in today, maybe draw some points of contrast between working at a massive business versus a very small one and the sort of credit opportunities being pursued by huge scale organizations and kind of what that landscape looks like today. Sure. So I started at Credit Suisse and then was it Angelo Gordon, Aries and I think the well we were looking at those organizations were asset that could scale into hundreds of millions or really were starting at that at that point. And so what that lends itself to our opportunities where you're dealing with assets that have been in existence for decades and you're dealing with originating companies that have years and years of experience. And you have tons and tons of data, and you know with certainty how these assets are going to perform, what that means is you d risked a lot. As a result, your yields are going to be low because there's so many people who can then underwrite that risk. What that means is that a lot of opportunities are overlooked where it's at fledgling company, but we know what they're doing. We can still get under the hood and underwrite the credit box. And so that's what we're really looking at. A co venture are all the things that are falling through the cracks because they don't meet the criteria of you can immediately deploy fifty million bucks. You can immediately put money into an originator that has ten years of experience or that has originated tens of millions of assets. So we're looking at those opportunities where we feel like we're getting outside risk adjusted returns because we're new to to that company. How do you think about adjusting your behavior relative to like your view on the credit cyclic where we are in a credit cycle? Does that matter more. At the higher scale than it does down in what I'll call more idiosyncratic type stuff that you're dealing with. Now talk a little bit about your your view there. Yeah. So when you're lending against assets, what you really want to do is lend against the acid, you don't wanna have to take macroeconomic view. So there's two ways to do this. One is to lend against really short duration assets. So produce pay, for example, is a thirty to forty day asset return. Lee we were talking about earlier is a fourteen day asset other things that we look at our maybe a year or two tops, and so does short duration assets because there's so short duration. You don't have to take a five year view in the economy. So that's one way to deal with it. Another way is to find uncollated assets. The most uncoordinated asset I've ever seen is actually a pharmaceutical royalty. So this is a situation where you're buying a piece of a deal that's, for example, a multiple sclerosis drug or leukemia treatment drug. These drugs are medically necessary. You have to take them in order to continue your way of living. And as a result, if you look at the data through the crisis of how these drugs cell and perform, it's completely like clockwork. I mean, and so you try to find these assets that are completely market neutral. So that's the other way of taking longer duration risk. But in a way that's completely mitigated another. One of the things that we think about in terms of trying to mitigate lending against an asset and why we feel like it'd be less correlated is one if it's short duration asset, and we're pricing that asset. Let's say, thirty days before we expect to get repaid and we're lending at fifty percent LTV we're able to take the tolerance of do we believe that asset is going to crash fifty percent within thirty days and so it's someone might be thinking is okay. So I thought the mortgage crisis was lobbying against assets wise. Not not the same. You know, those were ninety five ninety seven percents on TV loans that were taking years and years and years to pay off. If we are able to finance a fifteen thirty Forty-five sixty day asset at sixty percents LTV you know it's not. Perfect orders of magnitude better than just unsecured consumer lending or auto lending, which is, you know, lend at ninety percent on TV against the car. And then as soon as you drive it off the rely because depreciation Don linear, you're suddenly underwater. So it's a lot of those also nuances that make sure you know not all asset back lending is created equal, short, duration, low LTV, all those different things are super important in terms of making sure you're actually adhering to that less correlated the economy, so I can always rely on you guys to doing interesting things. So I have to ask a little bit about the background on lending against bitcoin. Maybe you can describe what's going on there and why. That's interesting. I'm going to let Mark describe this one because you know, Mark comes from this sort of structured credit background were on his first day co-venture. He was wearing a suit. We've knocked out and we put him next in Kiel who's head of crypto, and Mark comes us and he's like, what stellar. I thought there was only bitcoin into theory of said, the idea that we've actually convinced Mark that Lenny against bitcoin is a good idea. It's really, I mean, it's huge, inflection point co ventures history. So I'll let Mark kind of pitch this because you're the biggest berry going into it is. All that is true, and I will say I would've never thought I'd find myself in a situation where we're actually going to be lending against bitcoin. So it's quite a change. But what what's interesting is it bears all the hallmarks of a good asset to lend against because you have Mark to market pricing on a twenty four hour basis, and you have the ability to custody the bitcoin in your own wallet, and then you have the ability to sell it instantaneously if there's a margin call. And so what this is essentially is margin lending against bitcoin, and so someone makes a fifty LTV loan. So if you've one hundred dollars a bitcoin, lend you fifty dollars, and then if things get so out of whack that it's now reaches a certain level, they basically will margin call you. And if you're unable to satisfy the margin, call the liquidate your position and they have the ability to do that twenty four hours a day and in that way and since they're holding physical custody of the bitcoin, you have a pretty. Impenetrable way to secure the collateral and sell it. And so like I said, I would have never thought we'd be looking at this, but it bears the hallmark of of a liquid asset. And you know, that's one of the things we've analyzed as what is the liquidity of the market? What is your -bility to get out of the asset? How much evolved Tila ty- spike? Could you sustain before suffering a loss in situation like this? And so it's a really interesting opportunity in something that we're, we're looking at closely and a lot easier to collect on the couch. Indivisible all sorts of things that make it more attractive to lend against. Yeah, it's actually really funny. So a lot of the stuff we do people look at like while there's super funky and weird, it's actually less weird unless hard. If you're trying to take a lever position to try to eke out a certain yield, that's a lot harder to do and underwrite then just lending against an asset that most LP's would look at like sort of funny, a traditional lender. They're issue is no matter how rational it is lend against bitcoin. God forbid, you ever lost money on it. They'd be like, well, of course it was bitcoin and they look at you funny even before you started doing the deal, our LP's when they talk to us like they just assume that we were going to do it from the beginning. Then the ven diagram people who have a crypto business and a asset back lending business like super narrow. And so that's part of what earns us. The yield to get is not being like waste smarter than ever now to Mark's point, it's an obvious asset of finance. It's just that we have a different l. p. at expect certain things of us. So two more questions in light of our conversation so far. The first is on the origination side. So talking a little bit about that, like who is trying to borrow again, like, where's the. Manned for this and how is that part being handled? Like what's the capacity of this idea? So the demand is coming from a mix of parties, could be an individual who has seen a rise in their bitcoin asset, and therefore they're looking to take off some liquidity, some chips off the table. But in a way that is a non taxable event, or you could see a company could be a mining company or could be a hedge fund that is basically looking to lever or again create liquidity. So those are the main main opportunities that we're seeing. What's fundamentally the belief is that the rate of return on the underlying bitcoin will be greater than the interest rate that they're paying. So they're willing to do it in Patrick. I hear you hated Jeff and bitcoin. You want to borrow from l. listen. So so talk to me about how to determine the rate of interest on something like this. So I'm just thinking about on the one. It was a week or two weeks ago when there was this like almost bug that got into the code that got could've done, you know, God knows what and they're sort of like this, this sword hanging over this whole thing that it seems to have been remarkably secure a, which is why it's so interesting, but you just don't know right it software. So how do you, how do you think about setting interest rates and price relative to sort of a weird risk profile? Let me just start all at market. The more detailed answer. We are the view, the bitcoin could be around and one of the best ways to test that is the fact that it's had a really big bounty on its head for a long time. And if it was going to break, it probably would have broken by now. There's a lot of really motivated individuals. Now. Sure there's going to be bugs, but there's enough of a developer community around it where I don't know if it's going to be twenty thousand dollars, five thousand dollars, ten thousand dollars. One hundred thousand dollars. I hope that one hundred thousand dollars because I'll have a much nicer apartment. If it does. We were of the view that it is going to be a thing. And there is enough of. I think structuring it in a way where this way for that variance with the right LTV and the right liquidation terms sorta helps with the price in. But yeah, so so I think right now it's the pricing is less sophisticated than should be because it's more a function of supply and demand is who's actually going to be on the the lending side of this transaction in what's the re rate of return that the requiring versus how many people are actually asking for this right now we're seeing is I think there's a higher amount of demand for these loans than there is supply of institutional capital actually to provide these loans in. So that's what's driven the rate of return so high at this point in time, you know, you're seeing, can you share what roughly ballpark will? Yes. So you're seeing anywhere between twelve and twenty five percent for APR's for this for this asset to me, if you off the cuff fast when you've been interest rate, pronounce it like this where there's fairly few people willing to lend against it that should be like a high teens, Reiter return. I mean, because I've heard some people say, oh yeah, bitcoin such a liquid asset. It should be like eight to ten percent. Just intuitively feels too low for something like this. Fascinating. What have we missed in terms of the key determinants of success in this style of investing? I feel you've done a pretty good job covering on the things that you look for that make what kind of we referred to as lending two point. Oh, trying to deliver on the promise of this original online platforms that that didn't really come to fruition. So we've talked a lot about, like the specific characteristics that you look for. Have we missed anything major that you think is important to cover? So one of the things that people always do when they talk about investing is every moment up until you've actually closed the transaction, but probably sixty percent of great invested. Everything that happens after you close a transaction, it's the monitoring, it's the portfolio support. It's the making sure they actually do it. They said they were going to do. We will get by somebody at some point and knowing how we're gonna get and defending against it before they try it beating control the cash. So I think Brian May make sense for you to kind of talk about when we're modeling something, how much variance we give to what we think's going to happen. What could happen before out of the money, and then also just sort of. In the portfolio the on sites that we do, the spot checks that we do, why UCSE ones are Dickey stupid things to rely on everything else? Yes. So when going back touching on our underwriting conversation, when we're looking in building out a credit model, we're really trying to understand what's the default rates within the asset base that we can incur before loss of principle loss of income. And that's that's critically important. So we do that by building out cash flows those underlying assets projecting integrative default rates building a sensitivity and then comparing that to some sort of base case assumption for default. So if there is historical data from the company will look at that if not, or if this not robust enough, we'll look at proxy data. So you other data for small business lending consumer lending within that space. And then we're able to come up with a multiple in Las coverage. We say, you know, base offer our base case of five percent default rate, and it looks like here we can sustain ten percent before loss of income. We have to ex- coverage multiple now for our deals. We typically say, you know, to to seven x, just depending on how much struggle. Data, how much volatility in the asset class we believe. And then throughout the investment period has all he's alluding to monitoring's critically important. So every month we're receiving portfolio tape from our different platforms. It says here all the different receivables we have right now, here's the performance, and then we can look at that and say, how is that compared to where we projected, we change our base case default assumptions, and we need to rethink anything about this investment. And that goes beyond just the portfolio as well. Probably point, you know, there's there's a million different ways to lose money in this business. It's about making sure that they're complying with every covenant in all e likes to say that's getting. But I think we say covenant compliances is the more appropriate word of calling it in. So making sure that everything is going well and doing consistent checkups with the businesses that we're working with doing on sites to catch anything that might slip through the cracks. Otherwise, just looking at, you know, excel file part of it's also getting smart in the very beginning of the deal via either having termination triggers based on performance. So you say, hey, look, are. Case years, five percent. We can incur a fourteen fifteen percent default rate before lose any income and thirty percent before losing any principal. I'm quoting numbers from action actual deal done on the head good enough data. We felt like that was a reasonable loss coverage ratio. As soon as they get to eight percent. Default rates, we stop funding at twelve percent. Default rates. We defaults on the loan and just start collecting receivables. So a lot of it is making sure that in the beginning of the deal we get in front of those scenarios where things are going to little bit sideways. We don't have to keep lending. And the second is also just making sure the borrowing base make sense. So there's another facility where you'll see a lot of cities where we say, look, we're gonna lend you ninety dollars, but we need a hundred dollars a good assets in the event that you know five of those dollars of assets go bad. You either need to contribute new good assets in there or put your own cash from your balance sheet. Otherwise we won't keep London. So a lot of it is having the tools in the terms. So if all you're monitoring something, things go awry, you can immediately act on it. And then a lot of it's also expectation setting venture capital is probably my favorite asset class too. Via part of, but it's also when I like to talk trash about the most VC's just don't really do a lot of monitoring support of companies and don't do just really nice guys. Everyone's were founder friendly, everyone's this fat in credit. You don't have that same luxury because you don't have the opportunity to earn at the times multiple. And so we have to tell them a head of time. This term is in the document. If you breach it, we're actually going to enforce. So just be ready ahead of time because what we don't want is supplies. One of the things that was one of my biggest learnings and investing, and I think we've all kind of learned. I used to think it was a really good thing when I knew more than the borrower about the deal. You know, in my head, I think what we've done a ton of these things and I'm able to negotiate the document better than they're able to negotiate it. And so inevitably all come out as a winner. If we negotiate a deal that the other party doesn't understand and they breach something they didn't realize breach. And then all of a sudden we screw them for it. Something's going to go wrong. And so a lot of education about it said, hey, look, these are all the covenants. This is what the gender is going to be on the onsite. You know, of course you have to surprise. On certain things because there's audits and everything else, but a lot of issues sort of having this good firm but reasonable bedside manner with the company where they understand the deal they've gotten into and understand how we're going to act when things go wrong yet. So to touch point, again, documentation, which is part of the structuring is incredibly important for all these point there in also constructing the borrowing base that all he was talking about. So making sure if you think you're collateralized by hundred dollars assets that it's actually a hundred dollars of asset. So for example, if you I'm going to lend eighty dollars against a portfolio of loans as one hundred dollars of cars in it. When you actually have to collect on those vehicles, is it really worth one hundred dollars? Or is it actually after you know, the auction value in his hiring a skip tracer to go find the cars to fifty dollars. So making sure that you're actually properly collateralized into all these point again about educating the borrowers who are early stage companies don't always have the sophistication from structured credit perspective is walking through the key terms, not trying to hide anything, making sure saying, hey, this is the this borrowing base concept. This is what I'm gonna expect from you every month. This is what. You need to report to me is this realistic in walking through like that. And we like to consider ourselves sort of training wheels before they eventually go onto a bigger and better facility where the, you know the chances of their face getting ripped off for a little bit higher. And so I think that's that's one way to look at it. And then I would just add that you need to make sure you've thought through every possible risk. So there's a lot of hidden risks in these deals. So just two examples that come to mind. One is we've seen a lot of deals where there's some really cool piece of technology requirement that's going to be and the deal sounds great, right? Is going to be leased on long term leases to investment grade companies and the technologies. Awesome. It saves them all this money and you know what could go wrong, right? Well, we'll could go wrong is that the technology actually doesn't work or conches out in your three and all of a sudden, and the leases cancelable and the whole thing just falls apart. But that's not something that maybe was obvious and day one or another example of something is of looked couple times lending against art, which sounds really cool. Like, oh, you have a fifty million dollar Picasso. Why wouldn't you lend twenty five million against it and deal. Sounds great. Will will give it to you. So you're physically holding it in a secure vault. What could go wrong? We'll we'll could actually go and it's insured. So sounds great. We'll turns out that you can't get insurance against fraud. So if it turns out that the CASA is a fake, the whole thing just blows up your classrooms worthless and there's actually no good way to verify that the art is legitimate. You can only rely on a letter from the estate of Picasso to tell you that it was authentic, but that's not really good from a chain of custody perspective or title perspective. So there's a lot of risks that seem obvious when you think about it, but when the deal is presented or just not there, it sounds like it pays to be a pessimist in many ways in this world versus the more optimistic venture capital. I am very worried mother, and so that's sort of been great positive my career you. The other thing is also like, what are the things that are either false positives, things that are assumed to be true? You know, one of the things that actually a borrower came to us a long time ago about, and we've always repeated is the is like one of the great falsities of lending. A lot of people say, oh, my security interest is perfecting WCC. That's basically self reported data from small businesses. Like how good is that? Probably going to be probably not that great. The other is Brian was bringing up earlier when we were on our way over here. Insurance policies and feels AO the assets insured. What percent of lenders are actually Rian that insurance policy all the way through hopefully most, but there's gonna be some someone out there who isn't, and then you say, oh, it's an insured product grade or wanted to get renewed, stupid, stuff like that. So there's a lot of things that people sort of take for granted and those are the things that are the easiest to overlook or you say, oh, don't worry about it if this, oh, we have a backup. Servicer is on the great one. Hey, we're letting against these assets who care if the who cares of the original goes bust. Because we have I associated with our backup servicer. Everyone has I associated with their backup servicer. And so in the next credit crisis, they're probably going to be really busy in less. Our loan book is big enough to get their attention like we're not Morgan Stanley, and so I saw two, it's probably gonna go service their biggest customers at a time of crisis. And so just stuff like that where you kinda here in every deal, don't worry. We're using this firm or this is the vendor for this kind to be critical about all the things everyone assumes are. Okay, are easy. Well, this has been awesome. You know, really great overview of something that's different from what I usually cover them such an equity person that heart that talking about credits been been really interesting. I've already done this with Alli and maybe you guys know this is coming, but I like to ask everybody at the end of these conversations for the kindest thing that anyone's ever done. We can start with whoever's ready. We, we've discussed this in the office at Lang, and we both were struggling to go outside of our parents, which is, I know cliche answer, but is that is that an acceptable? Who's the bar overpass back facet. You can do anything you like. I know this sounds incredibly cliche, but it really has to be my parents who, as I've reached my adult years, I realize how much they sacrifice and how much they they really have put me ahead of themselves. And so many scenarios in afforded me so many incredible opportunities to to put me in the place where I am today. So. I'm forever grateful for them. And then for their parents who put them in similar situations to succeed, I would say, you know, obviously my parents have helped me a lot. I was very fortunate when I started my career in investment banking to have three bosses Russ Chuck and Steve who really took the time to teach me finance, and I think that has been the greatest single learning because a lot of people go through investment banking and it's kind of a machine and you know, they don't. No one really mentors them or takes the time to teach them, you know, more than just the spreadsheet they're working on or whatever, sometimes don't even do that. So I was very fortunate to have kind of actual mentorship and people who taught me the the trade and and how everything works. I'll just just one one closing thought, which I thought was neat as we were going back and forth in preparation for this. Maybe you could just discuss this idea of how to treat people that you will definitely pass on. I thought that that was like a really interesting idea when it comes to sourcing and would be a nice place to close. Sure. So we probably see let's call when we really turn on a couple of hundred deals a month across the firm. And that means that we probably are going to talk twenty four hundred founders each year. The best marketing tool we have is okay. So the twenty four hundred. We might do twelve deals. So that means that we have two thousand three hundred and eighty eight people who are fairly annoyed at us. The best marketing tool we have is those people that we passed on. And so it's our job to no matter what happens. Creatine incredibly positive experience. One of the things that we were inspired by we have, we had a company that was pitching sequoia and sequential passing, but sequoia data's. They said, hey, sent expert all your data and send it to us and they had a team of data scientists actually go through all the data, the cohort analysis, everything else, and they sent back the investment memo to the founder and say, here's all the things that we analyzed. Here's the things that could do better. Here's things that companies in our portfolio have done that have helped them grow faster. And we think these are things that you should implement within your own business. We will always send deal sequoias. Of course, you send deals with them, but like for business, that's already that great to have that kind of experience of the founder they passed on is a really, really powerful thing. We try to have something close to that with the founders that get pitched us. You'll never hear say, oh, it's too early for us. Thanks. That's usually sort of a nice way to say. I don't want to tell you exactly why I'm passing. What we try to do is be very, very specific just like you would do and you're managing one of your employees. Patrick, if someone does something wrong, you don't say you suck. You say, this is specifically what happened in. These are ways that you can make it better. We try to do that with the founders so that no matter what happens after that, they feel excited send one of their friends to us. It's a differentiator. It's done an order of magnitude difference in terms of how we market. And I'd say probably a third of our deals come through that channel which is plotting to us and exciting. In specifically this week, we saw three deals that had come from previous founders that we had passed on in just literally just this week in a lot of what we like to do is we say, hey, if this is not a right opportunity for us, we're happy to help advise you as you raise capital in say, we'll look at your. Term feet will help you think this through just because we feel like it's all you mentioned. It's really important to build out our reputation within this ecosystem, and we consistently see deals coming back from different founders. There's a high return on goodwill and you have the same thing when you meet somebody. Interesting. You also you feel like you have this internal obligation to connect them with someone else they get along with and you probably have this little spark in your head. You're like, wow, that's really fun on these two people meet and I don't need to have anything to do with it. It's just gonna be interesting when we meet a borrower who we think actually is a regime interesting type of credit. It just doesn't fit within our credit box. It almost feels like our obligation to tell one of our friends in the credit community who has a lending fund. They should meet the founder because it'll come back around like all the. I think that's the Jewish mother Gill. Well, thanks again guys. This has been informative as always thanks for your time. Thank. Hey, everyone, Patrick you again to find more episodes of invest like the best go to investor field guide dot com forward slash podcast. If you're a book lover, you can also sign up for my book club at investor field guide dot com. Forward slash book club after you sign up to receive a full investor curriculum right away and then three to four suggestions of new books every month. You can also follow me on Twitter at Patrick. Underscore Osieck o. s. h. g. if you enjoy the show, please leave a quick review for us on I tunes, which will help more people discover invest like the best. Thanks so much for listening.

Mark Ali Hamad Brian Horwitz Lee Patrick Shaughnessy Patrick O'Shaughnessy Patrick Leon founder Len Amazon INFINITI ex
Ben Savage  All Things Fintech Investing - [Invest Like the Best, EP.152]

Invest Like the Best

1:05:20 hr | 1 year ago

Ben Savage All Things Fintech Investing - [Invest Like the Best, EP.152]

"Oh hello and welcome everyone. I'm Patrick Shaughnessy. And this is invest like the best. This show is an open ended exploration ration- of markets ideas methods stories and of strategies. That will help you better. Invest both your time and your money. You can learn more and stay. UP-TO-DATE AT INVESTOR FIELD GUIDES THE COM- Patrick o'shaughnessy if the CEO of a Shaughnessy asset management all opinions expressed by Patrick podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management this podcast for informational purposes only and should not be relied upon on as a basis for investment decisions clients of Ashanti Asset Management May maintain positions and the securities discussed in this podcast. I guess today's Today's Ben Savage a partner at clock tower technology ventures. Ben Is focused on financial technology or fintech investing. which is the topic of our conversation? I've been making the FINTECH INTECH rounds of late and plan on making a few these conversations. Public Ben is the first and what might be a mini series. Because of the sheer amount of information. I learned in our discussion. We cover all aspects aspects of the fintech ecosystem. I hope you enjoy of Ben. We're just having a conversation. We figured we'd just record here which is about sort of the future state date of what we think about. Maybe thinking I from the perspective of an institution as the market portfolio. So you could just recap what you just told me about how this might evolve and how that relates to maybe investment opportunities today in the financial technology stat. Sure so I think an interesting way to think about markets and think about investing always kind of push things in time to extremes and so if you imagine the world one hundred years ago two hundred her years ago what did markets look like then and by contrast one of the Click. Today what's different. It seems unlikely to me that there's something fundamental that's changed about human nature Over those two hundred years and so while capital markets might have changed. It feels less likely that that change is deeply foundational. And it's got more to do with just some curiosity of the rules essentially shifted. You can have the same thing by imagining kind of one hundred years forward or two hundred years forward and one of the telling departures. I think over over the past hundred years or so is the idea of public and private markets which I don't think would have been a sensible distinction to somebody investing hundred years ago or two hundred years ago. Goer Isaac Newton kind of thing. It's really an artifact of regulatory regime that created following the Great Depression which was such an outlier in human history. The degree of suffering that occurs occurs in the Great Depression relative to what was at that point known by economists. Regulators was so extraordinary that we said wait a second. Let's put some rules around. How markets are they're gonNA work because essentially the crash destroyed the US economy and it was this feedback loop from markets? That had not really been seen in that kind of way before. So we created a regulatory architecture in the United States that stabilized capital markets but also stabilize the economy through the creation of the fat. And once you get sort of stable economic onomic volatility from the Fed. Says we're going to dampen the economic volatility and you get a statutory regime around markets which dampens market volatility. You get the creation nation of what we think of today as public markets which are really just liquid and exchange-traded markets. And I think it's a useful reference frame to stop talking about public and private markets and talk about liquid or liquid markets on one axis and then regulated and unregulated markets on the other end. So today we have. Liquid regulated markets as public markets gets and. It's a huge industry and it's created a spectacular amount of wealth for a lot of people and it's transformed the way Americans ultimately save and invest for themselves in their families over time and it's done wonders for capital formation in the United States. There's no sort of discreet with that. But if you imagine sort of a different end of the spectrum you have venture capital which which is essentially a less liquid historically and less regulated historically market and ventures also done a pretty good job of capital formation and driving innovation in this country and I think broadly in the future the world is going to move away from liquid regulated markets to what have historically been less liquid and less regulated markets. This will happen as a function of both regulations. Sort of getting weaker than we probably hit. Peak regulation sometime around the election of president trump and technology driving more and more liquidity to unlock what were traditionally sort of less liquid markets. It sort of moves the curve so all the stuff that used to be less liquid harder to invest in become slightly more liquid at the same time regulations matter less and less and so you get the opening up up for investors whether they're institutional investors retail investors of whole segments of risk that were sort of invisible and illegible before because they were stuck in this this quadrant of this imaginary grid drying of illiquid and less regulated. And if you're a big institution or if you're an individual you're gonNA look at the World I think in twenty years there's or fifty years and say most of what's actually interesting to me in terms of generating alpha and in fact over time. I think we're most of the quote market cap op will live or most of the value will actually end up is in what today we would think of as private markets and there are some pretty profound implications of that for you as an investor. Mr and whether that means individual trying to sort of save for your family and for your retirement where a very large institutional fiduciary responsible for that task for much larger sort of quantum of people and for US venture investor in Fintech. One of the things that were particularly excited about is trying to find businesses. That are kick-starting that that are finding asset classes that historically were sort of invisible illegible and making them accessible for people to invest in which is kind of been the trend. We were talking about four for a really long time. In public markets the rise of indexing and passive investing is in some sense about taking asset classes strategies ogies ways of making money that institutions had access to and democratizing them for individual investors first and then the institutions. Kind of catch. Back up to. It would be something very similar. Yeah very much. We were talking before about G. L. D. Gold. Imagine trying to buy gold twenty five years ago as an individual investor. It was a huge pain and you had to find some store that would sell you some physical gold. They would mark it up to some price. That wasn't actually reflective of the current market at that point in time they'd probably charge you a big fee in order to do it and then you're looking around a bunch of gold where turns out to not be the most convenient thing in the world today. You can touch something on your screen and boom you own in Jail D. as an ETF and what does it actually adds liquidity to the market for gold. It also dramatically opens up the number of institutions and individuals who can actually go buy the thing and it takes what was an asset that was in a specially legible for retail investors. It was hard to deal with hard hard. Even see it hard to see the benefit of in your portfolio and now millions of people in gold in their portfolios and are happy about that. And that's why didn't really good trade for them in the past little bit it's had had real diversifying power and improved ultimately the quality of their portfolio. There's several avenues. I want to explore first of which is the kinds of businesses that are basically surfacing legibility. Maybe you could give a few examples that are more cutting edge or very new to some people get a sense for kind of what that means in. Today's context of what's an example of a business. That's making legible. An investable asset that five years ago was illegible. Yes so I think. They're pretty broad range of these things so at one end you have lending club and prosper and the variety of businesses. That we think of as sort of peer to peer lenders. They originally started that way now. They're all essentially institutional platforms personal malone's as a category very rapid growing area of our debt landscape for the investors. Who are buying securitisations of these kinds of things? You you couldn't really do that. Pre credit crisis. To the extent that the assets even existed they were held on bank balance sheets and today. There's pretty robust here's Asian market and there's billions and and billions of dollars of these loans. That are being bought by institutions. Those aren't available that much anymore to sort of an individual investor but this kind of function of taking a set of risks and securitising them and making them accessible investors has been happening for a long time. Like Michael Lewis famously writes about it happening in the mortgage market in Liar's poker and that's a great example of love. Hey in the eighties. They took this massive market. That was fundamentally not accessible to institutional capital and they made it visible through securitization. You see the same function happening today. Today that's kind of Standard Fare Wall Street transformation of risk. But at the other end you see things like we were talking before stocks is an example or rally road owed. Were you can trade sneakers and you can. Trade fractional interests and collectible cars there are start ups that allow you to trade receivables on fresh produce from farmers and circle up which I know came on your podcast which weren't investor in allows institutions and accredited individuals to buy into small cap kind of private companies in the consumer market that are taking us out of risk profiles that previously weren't really available for institutions or individuals to easily. Get to and now. By those this kinds of things in trade those kinds of things add liquidity to it over time and even in virtually all of these things essentially require you to be an accredited investor in some way shape shape or form which is an example of what I mean by a huge regulatory distortion that exists in markets. Where the SEC said at some point in prehistory okay we're trying to define this group of people as accredited investors which is essentially a wealth test? It's not even a sophistication test ms of money. It probably means you're sort of sophisticated enough enough to lose money which is kind of on its face absurd and by the way the numbers haven't been updated. I mean there's all kinds of problems with these sorts of tests and so you have a distortion in the market. And those kinds of distortions will away whether regulatory pressure or technology solutions what. You're doing that in pretty real time. And it's these kinds of categories that we think can grow and I'm not seeing any one of those specifically we'll look back fifty years ago allowed. Sneaker trading is this massive asset class but it could be certainly fifteen years ago nobody thought trading of crypto currencies was going to be a fairly big asset class. And I think if you actually pitched what the crypto currency world today looks like to virtually anyone anyone in the investment industry fifteen years ago. They would've thought you were insane and yet today. There's a surprising amount of that happening. And it's happening all over the world which which is the other piece of this that we sort of didn't talk about earlier you could sell sneakers or collectible car interests to people not just in the United States in sort of wealthy wealthier places but literally all the world and so- value changes a great deal when you create a much more connected global market with more heterogenous genus sort of risk functions and preferences and you see this in the art market which is another example of the kinds of markets that are sort of unregulated very very weird liquidity and yet there's actually a lot of market cap in art. It's much bigger than most people think. And the trends of what's been appealing in. The art market have changed radically over the past fifteen years as wealth moves in Asia and so there are whole categories of art that suddenly people are paying attention to collectible category in that were not meaningfully. Collectible fifteen twenty thirty years ago and. I think that's another good example of what happens when you sort of add liquidity to what have historically been illiquid asset classes it kind of changes the collective preference function and so it ultimately ends up changing value. Because that's all all markets are there's more buyers and sellers the end of the day. Price goes up. I love the idea that technology or examples of where technology creates new markets or new places that you couldn't have conceived conceived before. Everyone always uses the uber example. We wouldn't have anticipated this. Massive market for random people's driving time and sort of interested in is where you see the most interesting things it's happening in that creation in the investment markets today. So I think one really big category that were far from the only people thinking about real estate and looted a little while ago to the sort of invention of mortgage securitization 's in the eighties in the sheer size of that market. One of the things. That's kind of funny about just taking the United States single-family the owner-occupied houses. It is a massive market every house in the United States that is individually owned and non investor owned. And you go. What's the capital stack back of a typical house? It's two classes of securities. It's a single tier of common equity. You own your equity in the house and then in a single tier of senior secured debt. which is your mortgage? And that's it for virtually every house you have some exceptions and things like he locks and second liens and stuff stuff like that. But it's a really simple capital stack by contrast if you looked at corporations and you said what's the typical capital stack of corporate. It is radically article more complicated. There's layers and layers of debt and there's layers of different equity securitisations and they've got mez pieces and there's options and there's this incredibly ornate elaborate superstructure of ways to address and refine the risk profiles inside big corporations. And you'd go okay. Well well that makes sense. Corporations have a lot of value. They're very valuable things so if I have something that's worth one hundred billion dollars ten billion dollars even a billion dollars I can kind of carve it up and it's efficient for me to carve it up into other slices of risk but if I have a house and it's worth three hundred thousand dollars or a million dollars or even a three or four million dollar our house. Is it really going to be efficient for me to take the time to kind of carve that risk stack up and create some Mez security on Patrick's house that's a certain amount of market cap. WHO's really gonNA trade it? Well it turns out if you have technology to do this it actually suddenly becomes efficient and if you imagine rolling up an awful lot of houses into goals of risk then suddenly they become tradeable. That's exactly what happened in the mortgage market and so that pool of senior debt. Intern downstream gets hypothecated enormously enormously. But what we're starting to see now through Fintech are companies that are changing the risk profiles at this point of origination at the asset level level rather than at the bundled level. So we're investors for instance in a company called landed. which would they fundamentally do? They allow schoolteachers to buy houses to buy their first home. The basic idea says you're a schoolteacher. You're actually a tremendous borrower from an underwriters perspective. If you WANNA give a mortgage because your local community you have a very stable job with very predictable income. We kind of know what you're going to do as a teacher so good buyer for a home but a lot of times you haven't been able to save up enough for a down payment especially in like a prime. I'm kind of real estate market. So let's say you're schoolteacher in Palo Alto House. Prices are expensive. What landed does that they say? Okay we'll match your down payment simple math so you WANNA buy a million dollar house. You need twenty percent down. You put up one hundred K.. We'll put up one hundred K.. As landed and then we'll help you find the mortgage into all that but it's pretty plain vanilla mortgage and bang now. You're a homeowner in that house. The differences landed doesn't get half the appreciation on your equity even though that's what they posted when you ultimately sell the house they get something nothing less than half and there's a little more refinement around this but this conceptually is like a piece of MESDAQ sitting in that capital stack so you've gone from a very plain vanilla thing of a senior secured debt instrument and a single tier of common equity. You've kind of added this Funky Mez Strip in the middle of it at the asset level. You didn't do this on a big pool. You did this at the single house level and this becomes efficient over time and landed. Isn't the only one that does this. There's three or four companies that are doing this and there's a a whole host of other ways that home buying is actually changing at the individual asset level which only becomes possible because technology. Both breath changes the way we can actually look at individual houses and value them it changes the origination process to make it more efficient and faster than what. If you walk into a bank can can try to get a mortgage. It's like a ninety day process incredibly clunky and inefficient and most banks actually lose money on the outright origination. They have to make it all up on the loan itself because they can't actually originate at a cost that make sense and on and on and you can imagine this kind of thing happening in lots and lots of asset classes. Where by by the way if you take this kind of mess strip that landed and others creating and they would hate that on Kalaiana messed up? But it's kind of what it looks like and you roll all those up. Suddenly you have a very very different risk profile than an institution can buy if you imagine thousands and thousands of these individual asset level risk pools being created. And suddenly. What you've done is you've actually unlocked? As an asset class single family owner occupied residential real estate. which by the way? If you're a big institution today you cannot cannot buy you. Can Buy investor owned single family residential but those properties have a slightly different risk profile because their rental properties than ones were owners actually actually live in it and those markets will trade differently a market. That's heavily owned by investors will end up trading through cycles overtime differently than a market work. owners are living there and that sort of make some degree of intuitive sense so again this is something that's been around a really long time. We have a lot of intuitions about how the housing market works. I mean I mean there's millions of Americans who think they're real estate geniuses because they happen to move into markets at the beginning of an interest rate super cycle and have made a ton of money in this. So we all have these kind kind of intuitions. About how the real estate market works. Most of them are wrong. It turns out but one of the deeply wrong things is that. Oh Yeah it's just GonNa work this way where people are going to buy my house. It's going to be an individual and the rise of buyers. The rise of investors. Buying these kinds of properties is a good example of weight our intuitions about how the housing market fundamentally works Kinda wrong. And there's actually lots of other things that can happen in that market. This happening not just in housing though but broadly across all of real estate so I think that's a really good example full of where you see technology changing the way people invest. I WANNA come back to this idea of Alpha which is kind of where we started our conversation before we recorded and how large professional professional institutional and other investors think about Alpha versus Beta kind of what those concepts mean. I think part of this is identifying new Beta and making a cheap and accessible and liquid would other than housing other other major asset classes that you think jump out is obvious candidates for this sort of trend. The trend being accessing new Betas Betas correct. I think are many talk about one that I find sort of curious. Frankly don't know that I have super refined thoughts on it but I think it's going to happen over the next generation and so it's worth talking about which is income share agreements. So ice says as they're called are kind of fascinating financial instrument and their experiments in on this thing for a while now the basic idea is typically applied to students. So you could imagine that I make student loan to you in the conventional way where I lend you money and there are some terms around that and then over time you pay back or you default on it in the US anyway. We have turned the student loan industry industry into this kind of horrible thing that ends up not really working for anyone over the long run and collectively all of us are going to be on the hook for it because so much of our student. Loan Industry has been essentially guaranteed by the government and it seems almost inexorable that will not get repaid and so as a policy matter just doesn't really work one one of the ways that people are thinking about trying to fix it is through an income share agreement. Were now as sort of lend you the money but it's not really a debt asset. It looks more like an equity type of investment. Because the way you're going to repay me is through some percentage of your income over time and what that means that I might get back significantly more money than I lent you I also might get back last so I'm taking more risk in the process of giving you some money but in aggregate because on some borrowers I'm GonNa make more than I ever lent through through the income share. It works out for better from public policy perspective. And from the whole into what happens when you shift from kind of a credit instrument to an equity instrument in capital markets you are mechanically accessing a different Beta we talk about an equity risk premium. That's different from something that you see in credit even something Corporate Brett credit where you're taking a duration bet spread. Bet You're actually transforming a little bit the nature of that risk profile and so here if you imagine that student loans if if they were priced accurately which we know because of the government distortion. They're not there was some kind of underlying bet on aggregate sort of economic health. That's kind of driving having it. And then some idiosyncratic thing that's through spread kind of tied to you which is not at all how these loans priced by the way when you go to income share agreements. It's just much cleaner. The people people who do it are actually underwriting. You their underwriting where you went to school what your major is what you tell them. You're going to try to do as a career. What grades you got? You can imagine a very extended data data set of things you get kind of higher resolution risk pricing and. That's a thing that I think. Technology does very very well as it creates a much higher granularity at which we can price arrest and so an ice says at least in theory you can see this where were underwriting an individual person and we're doing it in a way that is hopefully much higher resolution than you would get even just applying for a personal loan. This exposes investors at scale to like different kinds of Beta than you've been able to get before student loans pretty large part of the capital ecosystem. You can buy student loans. Kiernan's Asians you can buy student loan debt but if you imagine that I can buy different kinds of income share agreements across different geographies vs across different age groups across different majors. Different career choices. I could get exposure to a BETA. That was the earnings of doctors in the United States. Eight and what an interesting way to express a thesis about healthcare so today if I have some view of what's going to happen as an Alpha view with US regulations around healthcare. There's the basket of stocks. I can buy their mighty baskets bonds I can do. There's probably some exotic political derivative I can buy from an investment bank from Fisk kidded. Enough maybe I just say you know what I think Dr Turnings are going to go down. How would you ever play that? You couldn't but if isis existed you could at scale and I think there will be lots and lots of those kinds of things that will will be available to you and so you get both kind of the Beta of broadly. Speaking just wages wages turns out to be a weird thing. If you wanted to just say I think wages in the United United States are GONNA go up. How do you directly express that bat will? You're basically going to do it through some kind of inflation instrument and it's not perfectly linked to it again if you're short labor-intensive businesses along tech imagine a million of these kinds of things and that's actually a really good example. Let's say you wanted to bet on wage inflation in the San Francisco. Oh Bay area long in short it in New York you could never make that bet today. But if isis existed you could at scale and I think this will happen because it's almost every player in the student loan infrastructure doesn't like the way the system set up today from the colleges to the government debt providers the only people who've actually like are the servicers and even they are starting to realize that the business is starting to sort of topple over under their own way so I really liked Daniel of spotify's conception of seeing around corners business leader that his job was to anticipate the major state changes to three years down the road and begin preparing for them now so the next question is about professional investors. Let's say it's kind of as a category big institutions but also wealth intermediaries so are as or wire houses financial advisers that are managing your money on behalf of others. How would you grade them today? In terms of preparing for a lot of the things that we've discussed thus far and beginning to do the work so that they can position Shen their pool of investment assets in this sort of we'll call it next generation of investable things. Yeah I love that phrasing and it's actually freezing. We talk talk about internally of seeing around corners one of these work hung though is sometimes adventure you can almost see around too many corners and you get sort of too far forward because change can be continuous. Some things just kind of keep happening and twenty years on the trend has been the trend. I mean e commerce. It's sort of just this steady thing that's been happening happening for twenty years. Markets didn't price it continuously markets priced at right discontinue Asli but the underlying has been very continuous. Then you see other sorts of changes where you're just never expecting it and you sort of wake up a year two years later and there's been this enormous inflection. Social Media's probably looks more like that than something like ecommerce so one of the things I would say is the investment industry isn't actually responsible. I would say for seeing around two or three corners because unless you're actually running money on kind of thirty year timescale and there's very few people that even formerly charged with running money on a thirty year timescale and then there's a subset of that they're actually succeeding at that many of running money money name like all of them right. Their businesses and their job in some sense is just not that kind of timescale. So if you're talking about a five year return target which is already that feels like a really long time for most people actually think most of these players are not doing terrible job. I think they're doing okay because a lot of these changes that we've been talking about. I think really will obtain over a very very long time. And so unless you're in the business of trying to capture Alpha associated with those changes which we are in other venture investors are. It's less relevant for you. But I think let's say you're starting a career. You're in the investment management industry. I think it's very relevant for you. Because if you're saying hey I want to be an investment professional for fifty years of my life or thirty years of my life. Suddenly this stuff does matter in. There's not a lot of people today. who sort of are really excited to start a career as a discretionary effects trader on Wall Street those those jobs are vanishing? That was a great path to making a lot of money if you started doing that in the eighties and nineties today. All those people are being fired from their jobs. If you're a discretionary bond trader. No one is hiring you. No one's hiring you out of college do that job. No one's hiring you if you're ten years twenty years thirty years into a career and so if you're a young person thinking about starting career even if you're ten years at Yorker I think these things start to become relevant but if you're an ARA and your job is managing a bunch of money for those doctors. Wages ages may decline over the next generation. I think they largely do a decent job and I think the technology industry has delivered a lot of new solutions for them to access lots of asset classes classes. I think the challenge in those jobs has actually gone up because there's been such a proliferation of information and of opportunities downstream to people that the complexity city as an investor in those jobs actually gone up a great deal at the bottom of what most people actually want. Most people don't really WANNA beat markets. They just WanNa make sure that their neighbors burs not beating them. At the end of the day I mean that's really what dries most I think of retail investments and somebody's shadow cocktail party and their neighbors GONNA talk to them about this super hot stock therein or this Angel Investment there in or maybe it was buying gold when that was a new thing to do and maybe it will be buying income share agreements remits at some point. And that'll be the cocktail party chatter. And then you'll see it become a thing and Ra's will get hit with wait. Why aren't I in an ISO- fund and half the what's a nicer find? Ah Big funny you should mention it. I have one on the shelf through this platform and so forth but I think for most people. They're getting something decent they're just overpaying for it from Arias and technology will drive all those costs down and I think that's really the challenge for most of the investment industry. Is that the sort of fee extraction is really really too high for what most people are getting which is largely a commoditised kind of service and technology will drive that down for some people. They're happy to pay the fee. Because it's functionally like therapy. I mean so. I think they're doing an okay job but there's room for improvement. What do you think will happen? Interesting trends to use specifically in the asset asset management business. So we're GONNA come back to some of the other Fintech verticals but because that's my world. I'm always curious. How investors like you think about the landscape specifically through the technology allergy length in asset management specifically? Yeah so I think on the one hand things are moving very very quickly and on the other. It's unclear whether it seems to matter. The big thing I would say is the the convergence of traditionally discretionary investment strategies with more systematic and quantitative approaches. has happened much much faster than I would've predicted five years ago. Some of that's just been a function of younger people taking on jobs and anybody who graduates from college today can code effectively. They're getting jobs on Wall Street. And that is just a cultural shift in what is expected in any of these jobs across the board relative to the people who've inhabited those jobs for a a longer period of time. I sort of think back myself. I graduated college as a philosophy and political science. Double Major. Didn't know how to code not especially quantitative. I don't think I could get a job at an investment bank today although maybe because those jobs are a lot less desirable today that they were twenty years ago but the skills are quite different so that kind of combined with the the fact that most active managers have not done extraordinarily well over the past decade. I think has driven a search for will. What are we missing and it seems like most folks go oh it must be the data it must be the quad? That's what we're missing. Let's add some quotes. Let's add some data. Maybe that'll work. Maybe it won't but that seems to be a very real trend in the front office. What are the tools I can deploy to help? Surface things that are harder for humans to see that's kind of the big difference between discretionary and quantitative tatum and systematic approaches. Is that humans I think are always always longtime but for the moment are clearly better at the big thing that's happening. In markets the big trend break take the big themes that are going on but a system can do things that humans can it can identify lots of small things at scale over and over and over again reliably and the success of quantitative systematic managers over the past decade or two has really driven a mindset change. I think in the way a people who think about investing offically are approaching kind of the next generation of businesses. And you see it in really every asset class. I mean even in venture capital there are firms that are trying to be much more technologically forward fixated and they're attracting assets. It's a good story in addition till probably working so I think that's kind of the biggest change in the front office. I I would say in the middle and back office in asset management. One of the things. That's happened partially as a result of blockchain's being a meam over the past five years ears is that there is a renewed focus on wait a second there seems like a really inefficient and high costs stack here to just execute and settle transactions. Maybe we can drive a lot of cost out of that stuff and sort of free up. Capital for better productive uses within the investment management. Business kind of get back to this kind of war for Alpha in the front office that it seems like has largely not gone very well for most folks over the past few years and so you're seeing a tremendous amount of investment there technologically. And again. This kind of continued lift out of talent the financial services industry. It's a big chunk of GDP between fifteen twenty percent GDP. Part of that is because it's a really lucrative hi paid sort of sector historically and it's hard to know exactly why I was such a high paid piece of the system but it seems like you're GonNa see just just tremendous wage pressure in the financial services but our pressure downward pressure yet tremendous downward pressure across the board. Because technology kind of commoditised monetize is a lot of these functions. And you get the elimination of a lot of jobs and then you get a small number of much smaller number of humans required to kind of keep the machine running those people end up making a lot of money and they essentially in some sense will capture the wage that all the other people sort of had to lose but it ends up being the technology technology where I think most of that value goes over time more so than a lot of people kinda pushing paper and that's fundamentally what financial services has been as a lot of paper pushing and that's just one of the the big things happening in the venture world. Is it identify any human paper based process. That's GonNa go away through software. It doesn't even have to be fancy. Ai Machine Learning wingstop. It's just pure workflow. Software will kill those kinds of jobs and kill those kinds of processes overtime. You mentioned it so I have to ask your opinion. What is your take on the current utility Ian sort of state of the cryptocurrency and blockchain world and markets? Yeah you know I mean I would say we have been wrong about the stuff jeff from inception okay. So I'm always a little hesitant to give a stronger opinion. A high conviction view what I would say is as yet to hear and so I'm going to circle back to your question which was about cryptocurrency. I don't make a meaningful distinction between. There's some people like well. It's not about cryptocurrency. It's about the blockchain. I think that's kind of a silly. Elite distinction. Trading tradeable instruments on a blockchain is a specific use case for a blockchain. I think it turns out to actually be the best use case of a blockchain is some kind of tradable store value. And I say that because we have not heard a single pitch in our history and in fairness we don't focus that hard on this stuff. We've not I heard a single pitch where I kind of heard it. And somebody said we're going to do X Y and Z and were doing on a blockchain and said well if you didn't do it on a blockchain and you just did it in a sequel server. Is it really that different. What's actually better? Because you're doing this on a blockchain and that question seems to throw blockchain people sometimes but I find it helpful if you substitute due to the word blockchain anytime you hear it for alternative database technology which is sort of a cheat. Is Her magic in it. When you stop saying the word blockchain and suddenly you say alternative database technology and IT turns turns out? I don't think there really is because what you get with blockchain's the foundational idea is this idea of a trust Louis permission less permission list is maybe a better. There isn't a central troll of thority. That's going to be responsible can tell you what you can write to that database. That's right that's right that turns out though to be a kind of funny ideal I think of it in terms of markets markets. And you sort of go. Well what do you want from markets. Do you want a centrally cleared market or not and the interesting thing is centrally cleared. Markets are there's there's more liquidity there in some sense more efficient and they're safer places to trade you pay for that. There is a cost for that but there are a lot of advantages of centrally cleared markets and notwithstanding outstanding the point I was making earlier about public markets versus private markets. There is value in central cleared markets whether it's a card swipe on a visa the mastercard network or it's a futures trade there's value in this and so when you put things on a blockchain and it's a true trust lists permission list blockchain. It's not Oh yeah it's a blockchain but there's actually five nodes in their controlled by big companies which is just a distributed database. Not what the real sort of crypto people talk talk about. It's hard for me to see that many good use cases outside of actually okay. Maybe we WANNA have some store value that can be traded in that way and Bitcoin is actually not terrible for for that and I think there's a reason that bitcoin has the market cap in Crypto. Because that seems like a reasonable thing that there exists some digital gold that's outside the sort of Fiat currency system. That's outside the banking system. That is really hard to get access to short of having a gun to your head and forcing you to tell me Your keys which which is a whole other set of problems. This thing's been around a while now. Most of the time with technologies that are actually going to be foundational ten years or whatever we are you would start to see some use is cases and there are some the banks. Are doing things on blockchain's again I think they're versions blockchain's don't look like the kinds of blockchain's that were envisioned and in the beginning of truly permission list. Trust Louis Setups. They're still very very gated. And that might work. But that's just a distributed database with a handful of key masters as opposed to the idea of a truly permission list. You mentioned earlier. This idea of Robin Hood and maybe their brilliance was to take a very okay. Well established trend. Which is secularly declining commissions on trades? And just sort of jump start at two or three steps down the road to its natural conclusion which was zero. Talk a bit about at that idea as a business model for startups and whether or not there are other trends that are sort of inexorable that you think young companies could take advantage of in the similar way. Yeah Yeah I think it is a powerful way for startup to address a market essay. Take a big existing market and find a trend. That's already happening or has been happening. I'm for a long period of time and just push it in your mind to the logical conclusion. And then just make your business model. Just go right to sort of zero commissions totally free trading. I don't know exactly. I mean if I had a long list of these I probably should go build one of those instead of doing what I'm doing but I think within financial services. There are lots of these kinds of trends that you can think about and one of the ones that's already happened is just actually very similar thing. robinhood in banking where the fees on banking services have largely. Come way way down. And so you see a whole bunch of Challenger banks that have said none of zero fee banking and we'll make money in some other way on the payment scheme you've already seen that happen in certainly betterment while front and Robo advisors like them are examples of this to of saying wait passive. indexing is going to be a thing. It's already been thing for thirty years. Let me just jump to the end and and say I'll build those portfolios for you for a very low price. I think in insurance there are probably lots of these kinds of threads that have been working their way through the system mm-hmm which is more and more refinement of risk pools. I think is a good example of it so GEICO has been this sort of incredibly successful company because they have both a much lower cost of manufacturing premia enter there just a more efficient operating entity but they also select very specific risk pool to be Geico driver picking good drivers off out of the risk pool. I think technology is allowing us to put more and more precisely underwrite and define risk pools in sort of tighter tighter and tighter bands. And so I think you will start to see that happen more. Broadly in a set of insurance risks as an example of that I think the other thing insurance is distribution distribution costs. Where and you've already seen this by the way that everyone kind of looks at insurance and says wait? Why am I going to buy young? People are very confused about this Eddie of walking into a state farm branch to buy insurance from an agent and on the commercial side. People who run small businesses are really confused when a broker shows up and kind. I don't want to take them out for a steak dinner to sell them a small business policy and so you've seen tons of startups. Get form that they will. No one's ever GonNa buy these people are just never going to buy brokers let's try to distribute it totally online and give them that kind of direct to consumer Amazon like experience and that kind of stuff of distribution. Russian is a pretty good natural end point. I think financial services though are little bit resistant to some of these trends because just think about the word financial services to the extent. You're interested in it. You're paying for some kind of service at the end of the day and while the commission's May zero through Robin Hood and Schwab and whatever else I think Schwab can look at it and say all right we can take commissions two zero. We're still going to make money on a different set of people who are going to pay US something for the advice. The advice isn't free in. That's harder to make free so there are these kinds of trends. But I think it's just full path for entrepreneurs to go down one of the trends that certainly adjacent caused by. INDEXING is the fee reduction on the asset management side. One place where that really hasn't penetrative is in the private market so VC. And it certainly has happened. To hedge funds hedge funds average fees have come down but as far as I know private equity firms even very very large ones that have scaled. That could kind of Paul Van Guard and pass some of that scale onto their customers in the form of lower management fees. Let's say but certainly not. VC The kind of two and twenty model has been incredibly sticky and it's worked in twenty ventures like two and a half and beyond asset class at the right uh-huh and so that's worked because the underlying returns have been phenomenal. So you're taking a piece of a pretty large pie. What's your view on? Kind of the future of. We opened the conversation station by talking. About how much more important non-public markets are going to be. These are still very high fee hard to access places with very non normally distributed returns. A lot of the best returns come from a couple of firms so talk about those kind of two ideas on how you think about. Yeah so I think all of that is true and I think that will make feeding oppression in private private markets a little slower so public markets obviously tremendous decompression and we are involved in the hedge fund world wells prime markets world substantial compression. That's not going away way. I do think you're starting to see a clearer. bifurcation though in liquid markets where the premium Alpha's actually are going up in price. Interestingly because there's a scarcity value to it they're durable and so there's more demand than supply so people can charge kind of whatever they want for it. You might see the same thing happened on the private side. But I think discontinuity in the distribution of returns that you articulate is actually in some ways more extreme in private markets at the moment and so it's harder to identify what that durable all source of Alpha is going to be in kind of the dirty secret about the venture industry in particular is that there's almost no institution that's reliable and there's one in sequoia but very very few less than ten for sure institutions that have durably reliably delivered extraordinary results in venture over time. It could it just be that something about the asset class could just be people check out and retired. Who knows why that is so? It's hard to identify which firms could command real premium prices but I think the flow of capital into private assets and in particular private alternative managers will prevent that fee compression. One of the things that drives fee compression as money's walking out the door let me lower prices kind of attractive. I mean it's also blind man. There's a market for that just like anything else. But I do think you hit on one of my favorite ideas which is who's WHO's trying to build an index of these kinds of markets. And if you take venture capital as an asset class it's not a big asset class like one hundred billion dollars a year in the US us until you can kind of go well What would it take to really index that asset class and there are lots of allocators that are call it? Let's say I've actually had this conversation with a pension. That's like a two hundred billion dollar pension I was like. Let's say you wanted to index not the entire venture asset class but. Let's make a simple assumption. John and say you as an alligator can figure out whether or managers in the top half or the bottom half of the quality distribution and that is the only any assumption. That's the only prior. We're GONNA make that you can figure out whether manager a is in the top half or the bottom half of the quality distribution of the venture managers which feels like man. If you can't do that get out of the job so of all you did then was say okay. I can determine what the top half the distribution is our Banham at fifty billion. Okay so what would it cost to buy one percent of every manager of all that every year. Okay it's not that much money money. It's five hundred million dollars which is a tremendous amount of money. But if you're a two hundred billion dollar plan sponsor five hundred million dollars a year over a three year. Cycle Michael is a billion five. That's a one and a half percent position for you which is not a big position in your aggregate portfolio in fact if you look at the endowment models where they run anywhere from five to twenty five percent in venture as an asset class. It's still a tiny position and you could probably the execute on the strategy. I don't think it will be a manager. That does this kind of thing. Because the way the market works it would be too hard to actually get to the underlying assets but in an alligator could actually do the indexing work and buy an index adventure. And they can say we're GONNA get out of the manager. Selection business in this asset class is. We don't need to do it what we really I care about is actually just getting the underlying Beta of innovation and capital formation in this space. Now if somebody does that and you looked at that then over time you could go Maybe that could actually be a manager that accomplished that and said Hey I have five hundred million bucks a year. I JUST WANNA buy tiny pieces of all these companies companies and you could show up at startups and do that. I think in some sense the folks who in the early days of Y combinator were saying well backline every Y C deal. Were sort of. I'm trying to do this to us like they're angels tried to do it. I mean the challenges venture as an ESA class in aggregate. It's not obvious obvious that you'd want to own the Beta. Might the entire Beta but again if you could pick the top half of it you clearly want to own it and I think that's a reasonable assumption to make that. Somebody's fiscal could pick the top path. I mean it's such an interesting topic because in many ways it's the same topic of every kind of investing UNIFIL public markets indexing works and it's driven largely by a very small subset of doc of the returns come from there's a parallel distribution in public markets just like in privates the benefit public markets is no one can stop you from buying those stocks but if benchmark and sequoia and founders funded a few others have privileged access to that right side of the power law and an index fund can't get those then prospect of index fund adventure sounds lousy to me and so there's like a privilege of access problem that I think would be really hard to overcome because why would those firms give it up. I mean it's completely fascinating idea and probably is true for all of this stuff if you were talking about in terms of making stuff legible accessible liquid but it's I think an important topic for al Qaeda's one. I think the really interesting thing is that in a typical market you would go that sort of access privilege which describing I think is true. Would disappear in the face of a capital flow because somebody would just push the price enough and say yes. I understand that you. You Awesome Entrepreneur. Acts you don't really want to sell to me because I'm not as cool as other people. But what if I just pay you a heck of a lot more choices like okay now. Well maybe I'll sell to you but what's fascinating is that actually doesn't seem to work in the venture business and we have a founder in our portfolio who took money from venture firm at which he internally Arnold believed was a forty percent discount to the market to get that firms brand on his capital. It wasn't just getting the brand. He thought they were actually over the long run. I'm going to be more valuable. But what's fascinating as before he did that. He picked up the phone and he called a bunch of entrepreneurs that that same firm had also backed and they all said Yeah. You're going to take a forty percent discount here but you'll make it up on the back end because you'll actually get a premium when you raise your next round a couple now. I sort of hear this story. It's obviously mostly impossible to know whether this is true because there aren't good counterfactual out there in the market. Because it's always going to be a single idiosyncratic story. It sounds probably not true to me but the power of some of these brands is strong enough in the minds of entrepreneurs because it's not that transparent of a market. There's not that much Angela Quincy and you don't really know whether somebody's adding value or not that. There's some durability to these franchises even in the face of steadily increasing price it remains to be seen though if that power will persist as the flows get bigger and bigger and bigger and I believe were still in that period that the the net inflows to venture are going to get bigger and bigger and bigger and I think by analogy if you imagine the private equity world in like the early two thousands. Everyone had your private equity. Sounds like wow this has been really big. It's way bigger than we ever thought. And what's going to happen in sponsors or buying deals from sponsors and they're paying these crazy prices says fast forward to twenty twenty from two thousand two thousand one thousand two and I was doing private equity back then and it's way bigger than you could have possibly imagined at at that point in time all the limits that anyone would have said about. There's no way private equity can get that big. It's bigger and I think venture will do something similar. What other interesting verticals in Fintech have you most interested or excited for example? You haven't talked about really payments or something like that more specifically a little bit about banking what other verticals super interesting to you today. Yeah so we think about the landscape. As sort of five categories payments insurance capital markets and investment tax personal finance and then kind of banking lending credit and then we would add margins to that some things like e commerce infrastructure enterprise financial services and things like that at the big level. There's something something happening in kind of all of those categories. What tends to be more interesting to us are almost more horizontal themes that work across all these things so one big horizontal Donald theme that we think about is if you magin fifty years ago what it was like to run a big company and you think about the financial functions that that were involved? They're fast forward to today. A lot of functions that used to be reserved for just really big enterprises have trickled down to small businesses and ultimately only two gig workers and freelancers which is this real big trend that we don't think is going to change. The future of work is going to continue to be a kind of atomization of jobs where you're never going to work for someplace for forty years unless it's kind of your own thing most likely and people will move jobs more and you'll see more and more consulting in freelance type. Things things. And so the example we use his payroll fifty years ago. There was a payroll department inside big companies and there was sort of some warehouse full of people in the movies as you sort of picture. All these women with big glasses shuffling paper around and you'd call the payroll department and they'd send you paper checks and like this is complicated calculation. Now it's like you could imagine that you just software does it for you and everyone can run payroll doesn't matter what size your as an individual you can run payroll and do these things but there are more subtle things like counts payable corporations still have. AP Departments then companies do and yet technology is making that easier. Even at the level of a freelancer were. quickbooks can do this kind China stuff for you. So one of the things were kind of like what are the functions that still exist. Only big corporates can do from a financial perspective. That will eventually so you make their way down to individuals finance turns out to be one of those tax turns out to be one of those. That's kind of interesting. big corporations have released vindicated tax and rich rich people have released skidded tax advice and yet turbotax which is an unbelievably good product. Intuitive remarkable company. It's still not approximating the same degree of fixation. Education right just look at effective tax rates. The evidence yeah totally and so there's all kinds of weird inefficiencies that exist because you've needed historically a degree of scale to deliver these kinds of financial functions and I think all that stuff will evolve in we're invested in a bunch companies. That do this like health. Savings accounts is a good example of something that if you're a freelancer answer a gig worker. That's been sort of difficult for you to set up those kinds of things but now technology and startups will make things like that easy so future of work and all the permutations as it roles through all these kinds of things. All these categories is an area of interest for us. I think another area that we pay some attention to before you that just on future of work one of the things. We also think a lot about in regard to this idea of big corporates and so forth I mentioned payroll. So there's been a big thing infantile over the past couple years around essentially payroll all advances and you sort of go okay. In investing we can settle A- complex derivatives trade tepes four and yet most of settled payroll he fourteen fourteen okay. It doesn't make any sense. Might trade with my employer is. I'm giving them Labor. They're giving me back money for it and yet that settles t fourteen some kind of giving them float and I'm taking some risk associated with that but yet if I call up an investment bank in trade is sort of very exotic derivative it's still like T- three and so there's been all these things that are created to to try to advance money to you as a worker whole bunch fintech startups that do this were invested in one. There's something embedded in that that picks picks up a couple of these threads and in particular picks payments of saying. How do we make faster? How do we make more real time? A lot of transactions that historically you have taken a couple of days to clear and to settle and again back to the city of sort of central clearing and payroll is a particularly interesting category of this. Because it's such an important important part of our universe it's heavily regulated. It's massively protected. We've all these rules around employment that don't exist in any other part of society because collectively selectively we've acknowledged it is hugely important to the way the world works that people are GonNa go to companies and get paid. You get your health insurance through in this country. And so we can't discriminate and there's all these things you can totally discriminate in your own house but you can't the people in your house work for you. You don't have to be friends with people from other religions and races and so forth you don't want to but you can't do that if you WanNa hire people and very good reasons for that by the way that makes sense but yet you you don't have to pay people necessarily when you're supposed to mean in theory. You could run a company if you wanted to. And you chose to pay people t sixty it would be a weird state of affairs. I'm actually SORTA surprised at some of the investment banks haven't tried to do this yet where they would just say. Yeah you make enough money you can cover your whole life partners which is going to pay you once at the end of the year because why not anyway all the stuff that happens at that moment of we're gonNA transfer your earnings back to you. You could imagine a whole bunch of financial services that happened there at kind of the point where Labor in value are actually exchanged and I think uber and Gig economy is really good. Example of how this works where it's it's a much tighter transaction of I did the ride. I earned acts. I can get paid faster. We know exactly what's happening now. We're going to route that. Money becomes much clearer for knowledge. Workers where it's like there's a much looser connection between what is the work you did. And what is the compensation you earned. It makes it sort of doesn't feel as strange range that it shows up randomly every two weeks in the bank because the hours. I work today. The things I did today is a knowledge worker much less connected to sort of the value of my labor. But I think over time in this perhaps connects to some things we were talking about earlier around legibility and markets there's going to be more legibility around who's actually adding adding value in your company. And what are people doing on a day in day out basis. That's actually moving the needle and all of these things have the potential to really change financial services. You you can imagine a state of affairs where a company says okay. We can actually figure out in real time. WHO's driving our bottom line and we'll pay you much more tangibly tangibly in real time and there's something about getting paid faster that people like me and they're literally apps where you just get paid? You pay a fee to get your money faster even though that's kind of a rational in some way and so you could imagine it changes incentives in the workplace if you got paid a little bit faster so payroll and the moment where Labor in value kind of exchange change feels like an area of focus for us so that's one category the second thing I would say that we're interested in is what I would call emergent financial services and so what I mean by. This is as you can imagine software and we've talked a lot about software so far that offers financial services almost as an ancillary thing within that context and so a lot of what you're seeing in payments companies are embedded in some enterprise for one reason or another and then later I turn on a ping function and so actually the payroll advanced company company. That were involved in mechanically does this. They sell software to a particular category like restaurants and shift work things and then they're paid SAS revenue for that and it's a beautiful the software but then behind that they can turn on some payments functionality in incremental revenue from managing payments. And there's a lot of that that's happening in Fintech right now. The last horizontal nothing mentioned is actually what I would characterize almost vertical play. which is this idea that you can create through technology more targeted affinity groups as customers some of the things? I sometimes talk about as a bank for Yoga instructors so you could imagine that at any point ten years ago twenty years ago today. Somebody at J. P. Morgan could say we're going to go build a purpose built bank for Yoga instructors and whatever it is that the particular financial services needs of Yoga. Instructors are and they've bespoke needs. I mean there are software packages that exist for Yoga instructors. We're going to go build a bank that just serves yoga. Instructors perfectly and you can imagine you spend a bunch of money you build this bank and then over time you get all the Yoga instructors in the World Bank with you will. That's probably not a good business. The amount of money it would cost you to build. That thing is not going to be recouped because the size of the Yoga instructor market while. I'm sure it's growing very quickly is still not big enough historically to have warranted what it would it cost to build the Bank of Yoga instructors but what if my conscience. It doesn't actually cost that much money to build the Bank for Yoga instructors because you can outsource the ledger. That's going to take the deposits to whole fleet of infrastructure companies. That are being started and you can outsource the marketing and the cat cost to a bunch of players that are really really efficient at targeting yoga. Instructors I and you can outsource the user interface designed to some firm. That's GONNA cost you a little bit of money but you kind of get the joke that if you can build that thing way the way cheaper today than it would have cost a decade ago which is absolutely true. Maybe suddenly the Bank for Yoga instructors actually an economically viable idea and I I think. We're this becomes conspicuous as you go. We'll don't build a bank for Yoga instructors but building for healthcare providers. That's a big CAG- or build bank for first responders. That's a big category. Sorry build a bank for military professionals which guess what that turns out the big category and lots of people have done that or build a bank for venture capitalists which it has also been done and that worked out pretty well is that Silicon Valley Bank civilian first republic. Yeah Really First Republic and so I think this kind kind of idea you'll see this happen more and more and it changes a little bit of the risk profile if your city or Barclays or chase or wells that instead of worrying about the big big horizontal players that are going to set. That are gonNA come after you. Now you have to worry about death by a thousand cuts sort of thing and this is a little bit of a classic. Innovators dilemma approach there. Some some small group. That doesn't seem like a big deal. Where okay I can lose those customers but then realized that's happening at scale and you talked about investment management in our Arias and so forth doing a good job? This is a thing you could imagine where somebody says I'm going to build an. Ria just serves police officers lot. aww police officers in this country you can imagine the marketing campaign. That would work for that. And I don't even know what the investment strategies Taylor police officers would look like. I don't know if they're long gone on. Stocks are short gun stocks. But you can imagine somebody spends time in figures this out and figure out how to market to that demographic at scale how to serve that demographic at scale and that kind of thing thing. I think we'll be a lot of the future of financial services such an interesting set of thoughts. Maybe if I could summarize a lot of the things I've learned from technology investors over the last eight hundred fifty conversations I've had is focus and this affinity group kind of crystallizes the thought for me focus of the product and focus of the market that they can be smaller seeming winning at. I actually probably leads. The better business outcomes than try to cast a wide net super interesting. Some of it's a practical thing too about. How are you going to attract capital capital to keep going? Because you're not gonNA make money fast necessarily and if you start with something small and can show. It's working you can show faster growth a lot of the time which which then in turn unlocks incremental capital to let you kind of keep going down those paths and so yeah very much things start small and then there's the snowball that just starts compounding and in some sense the whole theory of venture capital is look. We're GONNA allow some business to grow significantly faster then it's kind of Roi we would otherwise let it grow if it retained earnings and just kind of compounding at that rate by just pouring money on the thing to let it grow at not the Roi but essentially the return on margin the return on marketing margin. Very very different kind of cost profile and in some sort of venture capital Fantasy Hennessy. You don't change anything about the cost margin of business and all you're doing with incremental money is just literally pouring into top line growth and marketing funnel that then just run through some economic waterfall at the bottom of anything using improving margins to allow the business. The sort of effective are we to go up on the business over time as a practical matter. What tends what happened with these things as you give them more money and actually are? We goes down because they invest more in product. Because they're not optimizing for the bottom line and that's very much a symptom of a a surfeit of capital capital that exists in the world today. But yeah if you start with a niche and you stay focused on it you kind of figure out what the true economics of the business look like in that category and then you go. Hey this worked in this thing maybe we can do something else so we talked earlier about landed. We start off focused on schoolteachers. That makes sense there. But you can imagine the adjacent agencies that start growing from that market and the best entrepreneurs the absolute best founders have a have almost speaking out of both sides of their mouth where they can sit across the table from an investor and say. I'm laser focused on this market. This is what I'm GonNa do but by the way if you just let your mind run a little bit. Here's all the other stuff off that once I've really crushed this thing takeover and that seems to work over and over and I love it raised cab. I feel like we could go on for hours but we both of other appointments. So I'll ask my closing closing question for everybody which is for the kindest thing anyone's ever done for you kind of thing that anyone's ever done for me by my wife for marrying a common one. It's hard to put like a a specific moment on it as I'm kind of reflecting on it I feel like I'm fortunate enough to have just been exposed to so many in different successful people throughout my life for lack of a better way of putting it whether that's personally successful financially successful spiritually successful accessible. Whatever it is we've just been willing to kind of share advice on what's mattered to them and what they've learned that? There's probably a constellation of these kinds of moments where someone said. Hey this thing you're doing that's working or that's not working and so I think there's probably a handful of moments I can think about where friends have been willing to say. Let me step out of a comfort zone and tell you something that you don't maybe no one's told you or maybe you didn't want to hear maybe you didn't know about yourself or something you're doing. And that ultimately as sort of act of kindness kindness is Kinda funky work what is actually even mean to be kind and one of these. I sometimes say as you learn the real truth about people when you ask them to do something in it costs them something like it really costs them something. That's when you really know what what somebody's about are they going to cost themselves something to help someone else. So maybe that's a good definition of kindness if kindness cost someone something and you're putting something at risk whether it's a relationship or some self image whatever it is and so I think most of the moments of kindness that can reflect on have been people willing to put their self image or our relationship at risk in some way. I don't know that I can come with specific one on the spot. Though I love it I don't think anyone's ever given Meta answer like that about defining kindness. So one hundred fifty six episodes in or whatever. This is really interesting take on it loved our conversation thank you so much thanks. Really appreciate it Everyone Patrick here. Again to find more episodes of invest like the best go to investor field guide dot com forward slash podcast. If you're a book lover were you can also sign up for my book CLUB AT INVESTOR FIELD GUIDE DOT COM forward slash book club after you sign up to receive a full investor curriculum. Right away and then three or four suggestions. Serb new books every month you can also follow me on twitter at Patrick. Underscore Osieck O.. S. H. G.. If you enjoy the show please leave a quick quick review for us on itunes which will help more people discover invest like the best. Thanks so much for listening.

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Chetan Puttagunta  Go Slow to Go Fast: Software Building and Investing - [Invest Like the Best, EP.156]

Invest Like the Best

1:20:24 hr | 1 year ago

Chetan Puttagunta Go Slow to Go Fast: Software Building and Investing - [Invest Like the Best, EP.156]

"Oh hello and welcome everyone. I'm Patrick Shaughnessy. And this is invest like the best. This show is an open ended exploration ration- of markets ideas methods stories and of strategies. That will help you better. Invest both your time and your money. You can learn more and stay. UP-TO-DATE AT INVESTOR FIELD GUIDES THE COM- Patrick o'shaughnessy if the CEO of a Shaughnessy asset management all opinions expressed by Patrick podcast guests are solely their own opinions and do not reflect the opinion of o'shaughnessy asset management this podcast for informational purposes only and should not be relied upon on as a basis for investment decisions clients of Shaughnessy asset management may maintain positions and the securities discussed in this podcast. I guess this this week is a good friend and business mentor of mine. Chafe and put a Gupta is a general partner at benchmark capital and has a remarkable track record of investing in early stage software businesses including several like like mule soft Mongo DB and elastic. That went on to be public companies Chafe and has been my key guide for understanding the world of enterprise software as we had shaughnessy asset management had built an investment asman platform called canvas. His advice has been critical to our early success in software in this episode we explore the history of software and software investing and go into the details on how to build and grow new software business. We discuss product sales and marketing recruiting scaling and everything in between police enjoy this great conversation with one of my favorite business and investing thinkers Jason. Let's start with a very specific story. WanNa benchmarks founders. ratcliffe is famous for this non consensus assists and right idea to make any money and everyone nods their head at that. I think it's hard to realize. What non consensus feels like in the moment so? I'd love to start with the story of how you found the company Mongo. DB which if you look today is probably like an eight billion dollar market cap stock. Let's start with that story. We're GonNa talk using that as a springboard about the history of computer databases databases some Wonky. Stuff start with the story Mongo DB and how you found it yeah look invested in Mongo DB in two thousand twelve and when I first met. Ah Elliott who's the founder of Mongo. DB I was funny enough twenty five years old and I had had a lot of experience building Consumer Sumer APPs. The APP store launched in the iphone of course famously came out no seven and it was really hard to build the applications at that time because the technology that were freely available or openly available to developers were frankly limited and and if you take a step back and looked at what the leading technology companies had at that time they had built all these incredible proprietary libraries and proprietary technologies Angie's. And if you ask your friends that were developers Google. They had access to all these fancy databases all these fancy tools. New Libraries talk to friends. That name Your Big Tech Company at the time. If felt like there was a distinct advantage between those that were trying to do something start a b the and trying to do something on their own versus working in a large company and at the same time there was a vast and and rapid growth rate in the number of developers coming online. Those were things that are always in my mind always felt like hey agility and productivity activity was really really important to developers and so when I met Elliot he had this huge vision because he himself came out of double click and Dan experiences himself of not being able to move fast enough to address. Customer needs in the customer in his mind was his internal company and so he he had this vision of building a database that was a general purpose database. That was super easy to get started. And that was the primary wedge into the market. which was that if you wanted to prototype something if you wanted to get started really fast if you wanted to see the initial version of something really quickly? Let's get it out there and once it gets traction we're GONNA in a figure out how to do replication and skill ability and all that stuff. We're not gonNA start with these Collett. Traction problems start with with. Let's get you to innovate faster. And this was really well before agile became something that was pretty instrumented across tech team team so that resonated with me immensely but if you hit ast and I did ask the best developers that you knew at the time asked ask them to play with Mongo. They'll tell you this isn't something I need. Have you tried my sequel. Have you tried. Have you tried the establish databases Mrs Route. They're here all the features that it has. Why would you ever have Mongo DB? I'm a database expert. I know how to make my school work for everything. There's no reason why you need this. But you missed the entire need of the entire class of developers that wanted something where they didn't have to think about Schema where they didn't want to have to plan how the database would look at scale because they had no idea whether the application they were working on was going to work or not. So I'll give you this example where I went down this rabbit hole trying to create a consumer APP and spent so much time on the Schema itself for a relational database. Put the APP out there. It was an absolute failure cared wasted. All this time on Schema planning you could have learned lesson far cheaper. Yeah exactly and so and faster and so when you have a fundamental piece of technology that every application needs a database that allowed you to have very cheap mistakes wchs and learn really cheap lessons it just really really resonated with me as something that could be fundamental in terms of where compute and application development was going to go and what you saw because it was an open source company very quickly you saw this huge grounds the momentum of Mongo DB where a lot of developers started using it to get started fast now what ended up happening actually was is it got to her and the population of developers started to use it in production and started pushing the limits of the database database itself and so there was interesting blowback. That happened where there was a period. That was actually quite rough. Where folks were really upset sat about what would happen with Mongo? DB At scale and classically. Everybody says that it takes about ten years to develop really mature database and the companies in. I commit code. Commit was in two thousand seven and so it took a bit of time to bake and by the the time you got to like two thousand fifteen twenty sixteen database was very mature and could handle scale and you could push it into production with millions of users with is transactional data and so there was a rough period that the company had to work through but when it got to the other side it ended up being right place right time and so the first real database challenger since frankly oracle which was started in the seventies. And if you go back and look at that it's all with this idea that development was going to get faster which in two thousand nineteen sounds like a very obvious idea. It's like yeah. Of course that was that was the thing and so going back to that. Non Consensus and right to bet on development going faster today is very consensus but to say in two thousand twelve. That was going to be primary. Driving factor of a developer focused database. That was very non consensus. You mentioned a lot of terms that maybe some people are like. I don't know if these guys are talking about even the basic idea of a database so it might be interesting even though at risk of getting a little wonky I just fascinated by the history of computing. And the sort of what I would call primitive pieces of that technology stack databases a key part of that. So maybe starting with the database who might even go into a few other aspects of the history of technology and computing but starting with databases. What are the relevant chapters of that history? I would conveniently say like a database. He gets thing. Think about a big excel spreadsheet or something might be a super simple database. But what the hell does that meet beyond columns and rows what other features matter of a database and who have been the big players in that historically starkly I think if you looked at simply the history of Oracle it would give you a very good sense of database business because they frankly built a much bigger business around the database and what that allowed them to do over time which is really interesting so one of the things that Oracle did was built a great database business and then moved into the application tier with applications that were built on Oracle database and so they served a crm application occasion which became a huge business. They served an HR business ish em business which is of course people saw which was a huge business so they had all these applications on top of the database that we're using the database technology to serve those applications so oracle was founded in nineteen seventy seven and oracle itself became a true database leader in the eighties and the way Oracle was structured. Is a relational database ace with columns and rows away. The thing about it is. That's the that's a table and row and it can be huge and one of the powerful things about an oracle database is that you can join really large data sets and then query against it. Using Sequel qual and one of the benefits of sequel is that it's actually a very widely known language for both technical and nontechnical on technical users. So not only developers no sequel I spend most makers exactly so analysts no sequel. It's become super pervasive. As is a query language to access the data that really propelled Oracle for a really long time. We're talking about a company that was founded in nineteen seventy seven and we're talking about Mongo in two thousand twelve. I mean think about that run. That's fairly unprecedented in technology allergy. That you had one company behind one technology concept that had that long a run of dominance and I I think that's because databases themselves a really tough technologies. Why well because developer can do whatever they want with the database and the databases? This is one of those things. It's a truly general purpose technology and you have to make a database accessible regardless of what you WANNA do at the application layer air and so making a database useful in such a general purpose form. There's a lot of things that happen once you start. You're putting data into a database around security and auditing and all the things that make it hypersensitive and hypercritical all the technology. The needs to wrap around. The database is really hard to build and making it scalable useful and there were a lot of attempts to build build very functional specific databases over time. So you saw analytics databases or you saw very high performance databases that were databases. Is that were geared very specifically to high end financial services for example but building the general use case applicable to anything. Anything you want to build is a really really hard problem. You have to have a new approach. The timing really matters. You have to have something that really is propelling it to how how people shift I think what helped Mongo was really two things. One people wanted to to move faster and to this is where relational databases unless you are a relational database expert. You started hitting. The constraints was because these databases were designed the seventies and eighties when there wasn't a lot of data the idea of throwing sort of an infinite amount of data into a database was not something that that people thought was going to happen or was reasonable. Because if you just think about the PETO bytes of data that's generated second-by-second basis today especially especially if you look at the amount of data that's being generated out of social for example it's unstructured data a lot of data that you didn't know when when you started the application that you wanted to actually store because user wanted it stored this trend of not knowing what the data is going to look like either the shape or the volume or the size is a fairly modern concept and so the idea of Web plus mobile changing how users and applications were pushed created this very specific moment in time the really allowed Mongo to run some market timing. Having has a lot to do with it you could have been right and predicted that this was going to happen and a few invested in something that was started in nineteen ninety-two if it wouldn't have worked it seems like since then there's cockroach. DB There's timescale DB. There's all these other database technologies that have come sense. This incredible run of dominance. What is that about? Is that just something that was cracked open by Mongo and realization. Like oh we can build more modern technology for more specific use cases. That's right I think that what has happened. Now is because of the cloud in developers being so open to understanding new database technologies. It's now become very much about okay. I'm building the specific use case. And I know what I'm GonNa Build when I start and I need for example if you needed a globally. Scalable database it's relational cockroaches. The best thing you can use. And let's you're building IOT application for time series. Data timescale is fantastic and highly performance for that use case. And so. What's become clear now for both entrepreneurs ars and application developers? Is that if you're going in and have a very specific use case there are now more specifically tailored open source databases basis for you to use. And I think the other thing that's happened is that as software becomes more predominant across industries and sectors and the use cases. These markets have actually turned out to be a lot bigger than what most people anticipated. It's really funny to read the initiating coverage which of salesforce when it went public in the early two thousands and to see what the estimates of sales forces potential addressable market are and then today salesforce itself has thirteen billion dollars of revenue and Sills. I would argue that. They're less than twenty percent penetrated into their markets and so so these markets the software markets actually ended up being orders of magnitude larger than what people thought they were. I think the people dreamed very progressive about what software could do and how pervasive software would be used but that dream was actually not big enough. which is surprising because that doesn't happen and so as software just pervades use cases? And you've had a lot of experience with this. In terms of bringing software into asset management. Went you're moving. Basically Manual workflows or things that were done on paper or accelerate whatever into specific software and that requires as a whole bunch of new thinking around the infrastructure and the application layers as these markets are actually orders of magnitude bigger than we. Soon they were talking about this from an investor's viewpoint you points this has been mostly from a user standpoint or something or technology standpoint your job is to be an investor threat and invest in mis-priced securities. He's maybe when they're not as appreciated as they once. One day we'll be. We're just turned two decades a fun time to talk about the future of all this. How penetrated? Do you think we are. Maybe talk a little bit about united discussed the number of developers and how that's growing the penetration of software generally speaking a lot of times. That's companies like this as bets on the proliferation of software for through other industries. What inning are we in whatever stupid sports snow you WANNA use? What your every on? How do you think about this as an investor? What is the opportunity set? Look like in the Twenty Twenty S. I think I go back to what our partner Makola often says. which is our job as early stage? Investors is to see the president very very clearly not now predict the future which is an odd thing to say as an early stage investors specifically. Because you would think well as a public investor that's obviously the case but as an early stage investor. I think that's very very really interesting to look at the world. You just have to actually watch what's going on in the world to understand what's going to work and what's not going to work. It's not about predicting ten fifteen years down the road because I think if you try to predict the future you're gonNA mess up timing and you have to see it actually like ground truth. What's happening today? And what's happening in today in enterprise software. Is that every single large enterprise no matter what industry you sell into or what. Vertical vertical useful and to realize their future of their business is going to be powered by software in some way companies that you may not have I've thought of as being big consumers of. It are now big consumers of it. For example Caterpillar buys a lot of software. The Pharma companies by a lot of software financial services companies by a ton of software shipping his now by a ton of software so the buyers of software are just increasing every single day. That's an interesting trend to pay attention to number two which you alluded to which is just. The number of developers in the world is still a tiny fraction of the number of knowledge workers in the world and so it feels like very very under penetrated in terms of the number of developers that are going to be in the future and then third which I think is particularly interesting is if if you look at the global. It spend which is on the order of a trillion dollars a year. A lot of it is still contained in the on prem world world so the move to the cloud were still very very early earnings of that cloud and then if you look at the number the amount of capital or dollars deployed against services against it. It's pimple. It's huge and so what that shows is that there's still a lot of energy expanded against custom manual point to point solutions. That's not the right way to build scalable systems and to date a lot of software has been solved by throwing either professional services against it or manual solutions that aren't particularly scalable and so when there is a startup or a software company that builds a general software application for that particular use case it actually increases the efficiency of every single customer. That uses that stuff so I think it's pretty clear to see today but it wasn't that clear. Twenty twenty years ago that salesforce building a cloud based system was way better than every single company building Sierra system on their own that was tailored to their specific need. Actually it's great to have a general purpose theorem system and what that then led to is viva built a serum system for the healthcare vertical incurred a multibillion dollar company out of it on top of salesforce. And so it's like you can create a vertical application on a generalized generalized application included multibillion dollar company on and so those are really fascinating things that are happening today and it's not not like the growth rates of the large cloud companies if you look at the application level like salesforce workday service now Alaskan those growth rates are still really high on very very large numbers and then you move one level lower into the infrastructure here and if you look at the growth rates of aws aws azure and Google cloud. We just saw the azure release from the last quarter and it was fifty nine percent year over the growth of a huge base for huge base. which is just astounding to think about? And what that means for the overall addressable market if if one of the top players can still grow nearly sixty percent year over year on large numbers. So I think it's we're still all very early in this and that's not to say that every enterprise software startup is going to work. I think that's far from what's going to happen. But there are still lots of opportunities cities to build really large meaningful enterprise software companies. So ask a series of selfish questions that also allows to recap our interesting relationship which is around building software. So hasn't come out yet or I guess maybe it'll come out by the time this is released in my annual letter to investors. Everyone's obligated to write in my industry. I talked about how I just feel like. Every company would benefit from building client facing software mostly because of how intimately at it allows you to know your customer in a way that you just can't do if you just ask them questions if you show them the system. That's helpful. I find they start to project their real problems that they wouldn't reveal to you otherwise onto the software so I'd love of some general advice for you about to business owners. Let's say about how to think about building piece of software from the product side. I want to talk about go. Go to market. You've seen a lot of examples of people trying to do this for all the reasons you just laid out. I think this is a white space for a lot of businesses to introduce softer into their your business model. So let's start with the dues. We'll also do. The dotes would be some general product advice that you'd give for a firm that's got some edge in some way and wants to build some software. We talk about this often. which is that if you think about the customers that you could potentially serve? They have a job to do every single day. They come to work every single eight to do a task whatever it is and so their job is to accomplish that not to become an expert in your system and I. I think that's often forgotten. which is that? I'm going to build this amazing solution and a user's going to be able to figure this all out no they don't have the time for that and it's often I think really interesting to examine ourselves and how each of us individually interact with software. We each get into sort of our own. workflows closed accomplish our day to day activities and when a new tool is introduced into that workflow. They're only so many walls you're willing to put up with before or you just say this isn't making me faster. I don't have two hours to learn this. I'm out and so if you have have that context in mind which is that whoever you want to put software in front of has a job to do and their job is not to become an expert in your solution. I think creates another level of empathy around user design and how to build products. That are good at accomplishing pushing something. And if you listen to the Kevin System my career podcast you did. They often talk about. We were building something inside of Instagram for consumers to do the job I think that's very applicable to enterprise software as well which is that if you're building and platform or an application or tool or infrastructure software. It's being and built to do a job for the customer and it's being built to let the customer accomplish what they're doing day to day faster or easier or with less effort effort but it offers some clear value proposition and clear benefit for the consumer that spying software itself. So I think it all comes back to your building solution. That's solving a problem. And not the other route. You're not building a solution. That customer then wants to become an expert in so have if you have that sort of macro empathy point of view it solve a lot of decision making along the way. It's clarifying instantly. He just know certain things. You won't do do. How have you seen companies that have done? This call. Empathy lead product building or something. What are the tactics? What are the specific ways that this can be effectively done an versus just saying I'm GonNa make sure it's easy to use? It's easy to say. Probably hard to actually flesh out. So how long does that often take the companies working with real customers. There's some of the things I've been surprised by talking. Just the sheer length of some of these timelines would have been the actual effective methods of doing this yet. There's two methods that we've often often talked about which can be encompassed by a simple phrase which is go slow to go fast in this form takes two very specific approaches one at the very beginning. If you're building a software solution really focus on a very small number of relevant users and build product against those relevant users and their needs and so if you're working in a vertical industry for example you can call them lighthouse accounts or major George counts or focused customers or whatever you want in that could be as few as five or as many as ten and you're addressing the specific needs of those customers except you're addressing them to the point that are generally applicable to everybody else in that focused market and not custom to the very very single customer. So there's a point at which soffer devolvement goes from software development for the platform to custom services services to the customer. And if you're building custom services for the customer that's not extensible that's sort of like a very clear demarcation line of where you can build functionality up to and then that's professional services on the other side of that and so this idea of user lead software development is super powerful software because ultimately in enterprise software you have customers that are buying your product to do a job and more than not. They're willing to tell you. Exactly what job they WANNA hire you for and hire your software for so. That's a great place to start the idea of focus customers slash lighthouse accounts and building to the line of generalize -able application the next approach which that I think has surprisingly gone out of favor in the world. Enterprise software is delivering professional services early on to your customers. So if your customers members are running software on prem or have manual workflows. They're going to need help. Migrating all of that onto a software system and professional services is a great way to hold your customers hand as they transition from whatever their workflow is to your system mm-hmm and oftentimes more than often. Customers want to engage with an early stage company with a services contract initially versus a software contract attract. And I think it's become the norm to turn down the services engagement because services revenue is seen as bad revenue or low quality revenue. The new. But what I often encourage entrepreneurs to think about is a services contract is actually a commercial engagement with that customer. You're that then allows you. To build a trusted vendor relationship with that customer and then over time you can transition that services revenue into subscription revenue again. If you use this construct that you're only going to deliver services then benefit your platform. You're not becoming an outsource software development shop for your customer former because that's not the end goal hopefully for your if you WanNa be a service shop great or if you want to be an outsource development shop great but if you're trying to build a general software platform whether it's an application or infrastructure you can deliver services to serve as the initial customer engagement point for your customer to build a trusted relationship with you and get them trained and exposed to your system so that then becomes software opening in two examples that I think are really instructive are one workday and Viva which in the early days of both companies. His nearly fifty percent of their revenue was from services and it was because they were going into enterprises that had very entrenched systems for example in workdays case there were running large installations of on premise. Software called Peoplesoft and Vivas case. There were either running custom homegrown systems or using some other on prim technology to do crm and so to Migrate Migrate from that into a cloud application required a lot of hand holding card a lot of training required a lot of data migration and these professional services contracts actually allow you to build these customer training tools and customer migration tools then can be used against the next customer to help that migration process and training process. Let's go much faster so going back to it. I think that services done right for startups is a huge advantage. That simply should not be ignored. Got A couple. Oh questions on both those kind of general strategy so I on the user lead innovation I get the idea of not building below a line of extensive ability. Meaning just the acid test of love with this also be useful for the other nine customers in my initial cohort of the answer's no don't build it. But how do you know or have you seen companies manage the problem build Steve Jobs thing. The ones going to tell you what to build you kind of need to figure it out any thoughts there on literally just asking what to build versus sort of trying to build a ven diagram of your expertise and their questions winds and sorting it out that way. Yeah this is the really interesting part that we see every day in funding early stage businesses. Is that these entrepreneurs or is that come up with a very unique insight about a market and that unique insight either comes from having fresh is a market and saying. Why is this being done this way? or it's someone that has a lot of experience building solutions in that market. That says okay. This is totally upside down. It doesn't make any sense and I have come up with a very unique insight as to how to address this problem. So there's two approaches the. I've often seen as entrepreneurs that come Komo put really novel ideas to address the problem. And so in the first case where it's a pair of fresh eyes that look at a problem and say. Why is this being done this way way? What is pretty clear that as soon as you forgot that new approach they're gonNA be a set of early adopters? The completely agree with you. It's almost sounds like you ask the question. Why is it being done this way? Shouldn't it be done this other way and you'll find a set of early operas that say yeah you're right that's exactly ACLU right. We should be doing it that way. And we haven't been doing it that way. A very specific example of a company that we're involved with call duffle is exactly this which is there's there's industry called Jesus it's a global distribution system for airlines to sell their inventory eventually to consumers but the current system of how an airline sells a ticket or a seat to an end customer is extraordinarily convoluted looted and the number of players that touched the system and the number of flows that go through it is just simply astounding and so you had these entrepreneurs who came from the payment industry which has a lot of analogies to the travel industry in terms of how convoluted those systems were and we've seen a lot of innovation around payments simplifying those systems with API's and micro services and they looked at the travel problem and and said why is it being done this way. Couldn't we solve this. And then they came up with a unique insight and went to a set of early adopters that were airlines themselves and said should the system work this other way in immediately you had a couple of airlines said yes. It should work that way. We absolutely agree. And those were your early adopters then propel you to create a new industry standard. There's a lot of thought of approaches but one of the things that you can always fall back on is when you accomplish something for a customer where you're allowing them to make their business ultimately better you will always always find opportunity in enterprise software ultimately every business wants to become bigger and more profitable. That's why they're in business. And if you have that understanding and and you go and have a solution that will either increase revenue or increase castle. Whatever it is you will find find adopters that are open to new ideas and then as you start getting customer proof points as you start getting real case studies the momentum then builds olds and allows you to really redefined an industry which is super unique one of the things that we've talked about also how this can require patient capital behind it because go slow fast part one of that go slow? And that's not exactly the I. Guess the revenue growth curves that typically later stage venture investors investors investors in general would wanNA see stock about that importance of combining the right capital. Hopefully you're providing that and that's an edge. We've talked little about investing edge but I think this is one source of it talked about how important that is. I think that there has been a shift towards this very formulaic driven growth in enterprise software which is very unhealthy. There's a calculation of well. Here's my cat. Here's my al-tv here's my period. Murray to sell let me hire fifty the sales reps and let's push this into the market and three years down the line. All the assumptions that went into that formula of growth to start falling apart. Your burn gets really high and then and then and then you get into a situation where it's really hard to reengineer yourself out of it and one of the things is that often happens in this evolution is that I find that folks forget that the reason they got into the business was they want to develop new technology and then go from my what I call a technology of business to a spreadsheet driven business. It's like when did you decide to become a spreadsheet driven business. You got into this because you wanted to develop Philip software and so that's the part that is the go slow to go fast. which is once you sort of crossed that curve and are able to have a super efficient business you can do really incredible things and Greg shot the CEO of meals to? I know you know if you look at what they did. At scale terms of capital efficiency. It's remarkable they. Burn something like eight million dollars to go from one hundred million dollars of revenue into a little under two hundred million dollar title revenue and then burnt formerly dollars to go from two hundred million dollars in revenue to three hundred million dollars of revenue and ultimately salesforce acquired them for six six nine billion dollars. And if you look at the salesforce public filings inside of salesforce companies actually accelerated top line growth because they had built such a capital fishing go to market system that was product. So if you take these lessons of But sure companies and how they got to where they got to which and if you rollback history and you just look at where they started and we talked about Mangalore earlier. It's two thousand nineteen eighteen. Mongo's I committed code in two thousand seven and they didn't really have real revenue until like two thousand eleven and two thousand twelve. nope that's quite a bit of time from the initial sort of Prague Development Code commits so it's developing the product maturity that then allows you to minimize your cost of customer acquisition and ultimately if you're building great software. Lt should be infinite and so suffer businesses. This is working really well when you build mature products that customers then continue to renew and cost of customer acquisition or CAC approaches zero and that's a really challenging mental exercise. which is how can you build technology products? Let's that have a zero takes a lot of time to figure out the most impactful thing you said to me when we first talked about this was basically the answer that question which is it has to be product correct and customer experience using that product. The only way for something to spread organically enough that has close. Zero is just an absolutely outstanding thing itself Alpha. There's no tricks to get you. There just has to be authentic kind of user lead perfect not perfect as close to perfect product for these cases possible. And when you think by that way it's just incredibly clarifying. Its becomes very clear what you need to do. And then the race at least in my case is not getting worried about what looks like competition or what looked like faster growing revenue curves or things like that that seems like a huge scaling challenge. Would you agree that that's the case absolutely and oftentimes there's there's a completion of competition because if you're building a brand new software system. It's unlikely that someone else's building what you're building and I think the great example is in two thousand four when salesforce was selling crm. Their main competitor was Siebel. SALESFORCE is average customer. Ashmore contract was two thousand dollars per year in they were on average selling fifteen licenses at a time Siebel at the same time had an average contract value of four hundred thousand dollars. There's and was typically selling a thousand licenses at a time so yes they were competing in the broader crm market. But I guarantee you. They rarely saw each other. And so I think when you look at competition that way which is somewhere your competitors aren't and go go deal with Sibel in large enterprises when you have a super mature product and have thousands of customers are successful on your customer platform and then you can actually have a really compelling story story of why you're better than the biggest competitor in your market versus assuming that that competition is there from day one and using Emmanuel selling techniques against that to convince customers that you're better than a competition that actually doesn't frankly exist so why why not go build a solution or go build a platform that is selling the customers that aren't looking at the incumbent for example and this goes back to the original point which was that these software markets are actually much larger than anybody assumed. And so the idea that you're going to run into competitors from day one Is probably not accurate. We'll you're probably going to run into objections to your own system because the system itself is incomplete and doesn't address the needs for the customer to do a specific job and until later stages when you're going into bake off for a million dollar contract or ten million dollar contract it's very rare that a customer is baking off to solution's very very rare in the early stages if you're selling a ten thousand dollar contract or twenty two thousand dollars contract there frankly valuating you against whatever custom solution. They&