No.18: Spring-loaded Management Starting Conditions, JP Morgan Acquisition Spree, Arm NVIDIA Deal, Moderna Business Breakdown
“Having an investing edge” basically means having access to some uncommon and useful advantage that helps someone earn supernormal returns. It comes in many forms – and some of these forms can be downright simple, yet profound.
It’s often said that investors need to be contrarian or independent thinkers. To some extent this is true – but can I still outperform if I am unable to think independently? I would say this is possible. A way to hack this is to change the crowd that I hang around. If I end up in a crowd that has some special insights, I can benefit from those insights and invest behind them. In this way, having drinking buddies in different walks of life can allow me access to deals that others wouldn’t get unless they were ‘in the know’.
Therefore, part of developing an edge for a social, non-independent thinker like myself is seeding and feeding a network of relationships that curate information and occasionally toss out a home run. I try to invest back into this network as much as possible. Capital Buddha and Twitter are great, in that they let me share ideas at scale. And if that helps someone in my network avoid a dumb decision, or make a great one occasionally, then it’s worth the time investment for both writer and reader.
So if Capital Buddha helps you as a reader, why don’t you share it with a few friends who might also find it useful? Go out and have a drink with the money you earned from avoiding losses and making some good decisions too :)
Spring-loaded Management Starting Conditions
I have very rarely seen someone rising through a large company and then magically create value when they become CEO - unless the business itself has massive tailwinds. The company machine is usually too well-oiled to tolerate an insider rising to the top and then violently shaking things up. And depending on the age of the person doing the job, they might be out to milk stock options rather than create structural, long-term change that’s good for the company. After all, if I was 58 and had recently climbed to the top, 3-5 years away from retirement, I’d probably not rock the boat too hard or take any risk that alienates me from my golf buddies. In other words, the starting conditions were not right for me to truly outperform as CEO.
On the other hand, if an energetic teenager like Mark Zuckerberg succeeds early, he gets power, resources, buy-in, and therefore latitude to take more controversial gambles. He also gets the unfair advantage of learning at a highly accelerate rate, versus a standard corporate executive. Success breeds more success, and later he ends up with backing to chase an ambitious vision. He’s only 37, so he has a long tenure ahead, and still has time to make new golfing buddies later. Therefore, he’s probably better positioned to take ambitious bets rather than pandering to a wide array of stakeholders.
One of the things that’s most important in sizing up investments is gaining some understanding of how networks of people stack the starting conditions for the management team. It’s not a question of whether a management team is bright – usually they are - and they understand the limitations of their role and setting. It’s more a question of whether the management team has the buy-in, latitude, insights, as well as fortitude and energy to make contrarian decisions to create long-term value.
It’s very hard to judge management quality – and most are generally quite capable and knowledgeable, as well as lucky. But context in which management operates is equally as important as talent in determining how much value can truly be added. There’s nothing inevitable about it, however, and you do get the odd exceptions. But the way a network of management relationships is set up can either stack the deck for or against the team.
JP Morgan Acquisition Spree
This article talked about the acquisition spree from JP Morgan in H1 of 2021. They purchased around 30 different companies, large and small – primarily Fintech assets. What’s interesting to me is that it shows how the ecosystem is likely to evolve.
Big US banks are cash-rich sugar daddies who can help the young Fintech founders cash out after years of burning VC cash. On the other hand, by acquiring Fintech startups, banks can not only shut down competitive threats, but spread the acquired Fintech’s technology, platform, and talent across the bank’s entire distribution network. In this way both acquirer and acquired company benefit.
It’s tempting to make binary statements like “banks are going to disappear because Fintechs are superior”, or on the other side “Fintechs are cash-incinerating frauds”. However, the truth is somewhere in between – as always. Banks play an important part in making sure that Fintechs can scale to their potential, and that early tech companies can be monetized. On the other hand, the Fintech startup scene is very important for financial innovation, as banks probably can’t move fast enough or attract the right people to develop tech on their own. I expect more Fintech deal-making sprees in the coming years.
The result is that banks might have to plan in an annual cash pile to acquire Fintech companies. And assuming the overall industry profits don’t change dramatically (after all, the US market is already very credit-heavy), this means banks take a haircut on their ROE. After all, they earn the same but make more acquisitions just to protect competitive position. Same earnings, combined with higher baseline capital requirements to tread water results in lower ROE.
An interesting parallel is the CPG ecosystem. Large CPGs at this point are primarily distribution machines. On average they are not great at developing new brands or products from within. However, they are good at buying mid-size brands with potential and giving them access to shelf space which the small brand would have never been able to obtain otherwise. I’ve seen smaller brands struggling to list anywhere apart from small, local stores to later listing at Target or Walmart after being acquired by large CPG sugar daddies. This is a win for the large CPG firm, being able to buy a brand that otherwise becomes a competitive threat. But it also provides a win to the emerging CPG firm, letting them scale faster than they might have on their own. The effect is clear though – the rapid emergence of CPG startups lowers returns on capital for the incumbents and for the industry overall.
Arm NVIDIA Deal
A brilliant note on why NVIDIA’s acquisition of Arm is a good idea – and value-accretive for Arm versus the IPO route. In essence it comes down to the fact that NVIDIA can invest deeply into Arm and leverage its own AI capability – where else an IPO might pressure Arm to meet short-term profit targets at the expense of the long-term.
Moderna Business Breakdown
This episode of Business Breakdowns was mind-blowing. I never realized the potential of the MRNA platform of drug development. If Moderna used the COVID vaccine windfall to invest heavily behind MRNA, it might create an order of magnitude shift lower in cost, speed as well as efficacy of drug development. Worth a listen – though I had to play this one at normal speed rather than my usual 1.5X as there was a lot of terminology I wasn’t used to hearing.