Buy Now, Pay Later: Putting the Credit Card out of business

Buy Now, Pay Later

Buy Now, Pay Later (‘BNPL’) services offer consumers a way to split payments for purchases over an extended period of time, often for zero interest. Whilst the US retail market is worth an estimated $800m, BNPL services only account for 4% of sales currently. In the e-commerce market, BNPL penetration is even lower (at 2.1% in 2020), making the US a laggard compared to other developed economies where BNPL accounts for over 10% of online payments. With 70% of millennials preferring to shop online and e-commerce retail sales expected to account for nearly a quarter of all sales by 2025 (from 17.8% today), BNPL is the fastest-growing e-commerce payment method globally.

US BNPL still has low penetration compared to other economies

BNPL replacing Credit Cards

The problem that BNPL companies are trying to solve is the distrust that the younger generation of shoppers have with traditional credit cards. According to TD Bank’s Annual Consumer Spending Index, approximately 25% of Millennials do not carry credit cards and 64% of Americans would consider purchasing or applying for financial products through a technology company’s platform instead of a traditional bank.

Affirm (Tickr: Afrm)

‘Building honest financial products that improve lives’ is the mission statement for one of the leading BNPL service providers in the US, Affirm. In practice, this means no late fees, no hidden charges and a seamless tech-enabled shopping experience for users.

Affirm was founded in 2012 by Max Levchin (who was also a co-founder of PayPal). It filed for IPO in late 2020 and began trading on the Nasdaq Stock market on January 13, 2021. Whilst Affirm is the first-mover in the US BNPL space, it has pivoted its business model away from initially targeting larger purchases that would typically be put on credit cards (e.g. travel, auto) to every day short term purchases (with resultingly lower interest costs). Currently, loans with a term length greater than 12 months account for only 22% of its outstanding loans (versus 43% last year).

Affirm Business

Why is BNPL a superior form of payment?

Naturally, the key question I had was how Affirm’s services offer anything fundamentally better than credit cards i.e. does Affirm offer a truly disruptive technology or is this just a replacement to something which already (sort of) works?

  • Smarter Loans

The key advantage Affirm believes it has over rivals is (unsurprisingly) in its technology platform to generate loans. By using Artificial Intelligence models that detect affordability, monitor shopping habits and financial prudence, Affirm believes that it can facilitate more effective loans i.e. higher approval rates and lower default risks.

There is proof in the pudding here. Despite growing users rapidly over the last few years, delinquency rates for Affirm have been falling (just over 1% currently), showing that the company is clearly doing something right.

  • Merchant Integration   

The second key advantage to using Affirm’s platform is in its integration with merchant providers. US companies spend over $1tn annually on user acquisition costs. By providing an effective payment platform which leads to higher retail sales conversion, Affirm is driving these costs down.

To improve its offering, Affirm has gone one step further and launched its own merchant vendor network (think of an e-commerce site hosted by Affirm). This proprietary network, with 29,000 total merchants, is now driving a third of total transactions on its platform; cementing Affirm’s business moat.

How does Affirm make money?

What I like about Affirm is that the business model is very easy to understand. The two key revenue generators are 1) Merchants and 2) Loan Revenues/Banks.

44% of total revenues come from Merchants who pay a fee to Affirm for sales converted on their platform. 47% of total revenues come from interest income/sales of loans to banks.

Unlike credit card companies, Affirm has no vested interest in ripping off customers with late fees as most of the loans are passed on to banks, for which Affirm collects a fee from the originating bank. (Equity capital used to fund loans has been decreasing 19% despite Affirm more than doubling GMV).

Affirm is in Hypergrowth Stage

Affirm is currently is currently a ‘hyper-growth’ business. In its last quarter, the business increased the number of vendors on platform more than fivefold, more than doubled Gross Merchandise Value, and its number of active customers grew 97% y/y. Today, Affirm is now offered as a payment option for merchants representing more than half of the U.S. e-commerce market.

What is impressive about these numbers is that this is despite interest rate costs increasing on its platform, which indicates user stickiness. In its last quarter, only 38% of GMV came from 0% APR products vs 54% for the same quarter the prior year (due to fewer zero interest travel merchants).

Affirm as a Hypergrowth Business

More partnerships required to reduce concentration risk

The biggest issue with this growth right now is that Affirm has significant concentration risk with its key customer, Peloton. Peloton accounts for 20% of Affirm’s total revenues currently (28% in 2020, 20% in 2019) and the companies top ten merchants represented 25% of total 2021 revenues (35% in 2020, 30% in 2019).  In order to diversify the business, Affirm needs to continue to strike partnerships with new merchants, which it seems to be executing on well, so far.

Affirm is the exclusive partner of Shopify and is still in the process of enrolling all of Shopify’s merchants onto its own platform. Affirm has also been made available at Walmart and Target, which account for ~20% of the US retail market. In August 2021, Affirm agreed a non-exclusive partnership with Amazon. As Amazon serves over 300 million active customers worldwide, the partnership will expand Affirm’s total addressable market significantly. In late 2021, Affirm also added American Airlines to its list of vendors which becomes especially important as travel spending begins to increase on the back of easing travel restrictions.

Affirm’s increasing merchant network is a competitive advantage

User retention will require further downstream integration

Affirm is up against two large competitors; Klarna and Afterpay, in the BNPL market. So for continued hyper-growth, Affirm will need to achieve high levels of user retention on its platform.

So far, Affirm has done well on this front, boasting a dollar-based merchant expansion rate that has consistently exceeded 100% since 2016. In order to continue to achieve this however, Affirm will need to integrate with downstream retail functions and banking needs (e.g. returns, debit cards, savings products).

In 2021, Affirm completed the acquisitions of PayBright (Canada’s leading buy-now-pay-later provider) and Returnly (a leader in online return experiences and post-purchase payment). Per management, “PayBright’s complimentary merchant relationships and first-mover advantage in Canada will enable it to expand its scale and reach across North America’. As for Returnly, 8m people have used this successfully to date.

In February 2021, Affirm announced plans for the Affirm Card, the first U.S. debit card that will allow customers to make installment payments on any purchase at any merchant. Management expects that “as it launches unique new offerings such as Affirm Debit+ and activates exciting new merchant partnerships, it sees a very bright long-term future for Affirm.”

Additionally, Affirm has launched a Savings Product for customers (in 2021) which has raised deposits of $300m without any promotion so far, allowing the business into the broader Fintech market.

Affirm Retention Rate

Valuation

Affirm is NOT a cheap stock. Most promising growth stocks never are but the valuation is clearly already baking in a lot of growth.

Using management estimates for 2022E Revenues and assuming the business continues to grow (revenues) at 20-30% CAGR over the following four years (also from mgt estimates), pegging long term (optimized) margins of 20-30% and assuming the company is valued at a multiple of 25-30x earnings, I struggle to get excited about Affirm at current levels.

Arguably, the biggest upside risk to the below forecasts will be Affirms integration with Amazon, which management has not accounted for in any of their financial projections.

Conclusion

The BNPL is a growing space and Affirm has a proven track record. Not only is this business a first mover in this market, but it has also shown that it can execute exceedingly well at striking long term partnerships with the largest retailers in the US and cementing a business moat via integration with other retail and banking functions. Yet despite this, the stock is valued dearly on the back of this proven success and I will be waiting for a pull-back to more attractive levels (< $130) before starting a position.

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Ticker: AFRM
Stock Price (when post published): $164.23
Verdict: Neutral at Current Price
Timeframe: +5 Years

The Anti Bubbles

Book Title: The Anti-Bubbles – Opportunities heading into Lehman Squared and Gold’s Perfect Storm

ISBN: 1631579827

How strongly I recommend it: 3/5 Stars

An easy read which I was able to read in one sitting. This book is basically a structured critique on modern monetary theory with practical applications on how to trade an eventual market correction.

The central premise in this book is that we are going to (eventually) see somewhat of a doomsday scenario because Central Banks have taken monetary policy to extreme levels and they are not infallible. Fortunately, there are ways in which investors can trade the ‘anti-bubbles’ that will show up.

I liked the application of economic theory to real world investment ideas but this book did feel a little poorly written with a lot of repeating and quotations from notable investors without enough explanation.

Amazon Page Link: Click Here

How I discovered it? The Ultimate Masterclass for Macro Investing (Youtube Link)

Who should read it? Aspiring Macro Investors


SUMMARY

Starting with Ben Bernanke’s decision to cut interest rates to zero in response to the 2008 financial crises, Central Banks across the globe have become addicted to low rates, Quantitative Easing (buying Government Bonds) and direct monetary injections (buying high yield credit). Parrilla argues that these tools are extreme applications of monetary policy which have created bubbles in the economy that will need to eventually correct.

As a result of these extreme policy responses, Parrilla argues that; 1) Currencies have become over-valued due too much money printing, 2) Volatility is underpriced as Central Banks continue to prop up markets and 3) Due to the widespread impact of monetary expansion, assets are going to be increasingly correlated to one another.

So how do you trade this? Parrilla offers three trading strategies to respond to the above. 1) To be long Gold (preferably through ETF’s), 2) To be long implied volatility through long biased options and 3) To be long tail risk by betting on contrarian outcomes (e.g. being long Gold and short non-USD currencies).


KEY TAKE-AWAYS

  • Currency Wars

It is not possible to look at monetary policy in a single country, in isolation. The reality is that when countries devalue currencies, this basically exports deflation to other countries. In turn, other economies need to either lower their own currencies (via reducing interest rates) or become uncompetitive. This incentivizes currency wars and even more extreme policy action which creates a destructive cycle.

  • The Search for yield

‘Risk-Free interest’ has been turned into ‘Interest Free, Risk’ in a zero interest rate environment. In other words, in the search for yield, money managers have lended to worse borrowers, for longer maturities. This search for yield in an extremely low yield environment, has benefited the weakest borrowers the most and has encouraged speculative bubbles.

  • False Diversification

Money managers have incorrectly assumed they are diversified because they own different asset (e.g. equities, property, credit). However, when Central Banks are effectively propping up asset prices (through the ‘Central Bank Put’), this is not diversification – everything will go up and down together.

  • Low Implied Volatility

‘Central Bank Put’ puts a floor under prices and insures the market that the Central Bank will step in as soon as things go wrong. This then artificially lowers implied volatility in the market. As most VAR models use implied volatility to calculate risk, it then encourages more leverage and risk taking.

  • Ways out of this financial predicament

There are three ways out of this monetary mess we have got ourselves in. First option is for Central Banks to reverse policy as the economy begins to improve and we see inflationary pressures. However, the problem with this is that the sequence and extent of reversal will be harder the most unconventional policy becomes.

The second option is for Central Banks to hold Government Bonds till expiry and then decide what to do i.e. basically just buys the Central Bank more time to make a decision.

The third and most likely option is that eventually, all this debt will need to be monetized and therefore, there will be a massive devaluation of currencies and a rebasing that will need to happen. This will prop up real assets such as Gold.


FAVORITE QUOTES/STORIES

‘Paper currencies eventually converge to their intrinsic value: paper’ – Voltaire

The official Gold Reserves of the Bank of Japan would buy less than 5% of Apple’s Market Cap

Currency Experiments

Currency experiments have tended to give bias towards monetary expansion and Central Bank excessiveness.

In 1933, the US decided to go off the Gold Standard and gold was no longer accepted as legal tender. By 1934, most private possession of Gold was outlawed, forcing individuals to sell it to the treasury.

In 1944, the Bretton Woods system fixed currencies to the USD which was effectively, tied to Gold but once again, in 1971, due to worsening balance of payments, depleting Gold reserves and the financial burden of the Vietnam war, Nixon put an end to the coverability of the USD to Gold, which basically ended the Bretton Woods system of fixed financial exchange.

Reflexivity Theory – George Soros

Fundamentals dictate prices but prices also dictate fundamentals – it goes both ways.

In contrast to rational expectation theory that only real world fundamentals drive real world supply/demand, reflexivity theory argues that it is actually expectations that drive real world behaviors which then lead to new expectations. This explains financial bubbles and excessive speculation.

Gold Equities as an ‘up and out call’ on Gold

People normally think that buying Gold Equities = being long Gold. They are not one and the same. A good way to think about Gold equities is that they are an up and out call option on Gold – if the price rises too high, then Gold equities are likely to underperform e.g. they face extreme political risks especially in politically sensitive countries or companies with Gold hedges may actually end up distressed due to margin calls. So Gold equities basically cap your upside on Gold and it’s much better to buy ETF’s or calls.

Think Like A Monk

Book Title: Think Like A Monk

ISBN: B07YF3VPSP

How strongly I recommend it: 2/5 Stars

Fame, money, glamour, sex – in the end, none of these things will truly satisfy us. We’ll simply seek more and more, and in the end, we’ll live in a circuit that leads to frustration, dissatisfaction, unhappiness and exhaustion. In light of this, Shetty tries to solve a common predicament – how can we train our minds to find peace, calm and purpose?

Overall, I thought this was an average read with a bit too many quotations and anecdotes. Shetty doesn’t necessarily have an original message (I found a lot of similarities between him and other motivational writers, like Tony Robbins), but maybe that’s a sign that this way of thinking, really does work.

Amazon Page Link: Click Here

How I discovered it? Christmas (2020) Present

Who should read it? Broad based appeal. Easy read.


SUMMARY

This book is centered around three key steps the reader needs to take to embark on this journey; Letting Go, Growing and Giving. Letting Go is about finding authentic goals and motivations in life. When reading this chapter, it was a surprise for me to realise how many of my desires are being fed by external factors (e.g. what will make my parents proud or what I should be doing at my age).

The next step in this journey is to ‘Grow’. By this, Shetty means turning your goals into a purpose (or ‘Dharma’). This is like a mission statement for what you want to achieve – the best ones, will be something you’re passionate about, you’re good at and is useful to the world. Once you have a Dharma, you need to build a routine around it i.e. wake up early, be uniquely focused and frequently visualize where you want to be.

The final step in this journey is to ‘Give’. Shetty argues that the highest purpose in life is to live in service to others. This doesn’t necessarily mean giving everything away, but trying to make the lives of others better, will help to remove some of the negative emotions that you can have about yourself.


KEY TAKE-AWAYS

  • Always try to be Authentic

Only when you tune out OEO’s (Opinions, Expectations and Obligations) will you realize what you truly want. So many of our desires are a reflection of what we think other people expect from us, that we live in this trapped identity.

  • Monk Mind – Find time to reflect

Shetty refers to two parts of our minds. The first is the ‘Monkey Mind’ which is pre-occupied, chaotic and selfish. Then there’s the ‘Monk Mind’ which is  thoughtful, objective and detached.

By creating spaces for reflection such as daily journaling and meditation, you can use the ‘Monk Mind’ to find balance, especially after long, stressful days.

  • Cause of fear is attachment. Cure for fear is detachment

When you disassociate yourself from things, you become less fearful. This is a very stoic way of looking at the world but can help manage some common setbacks in life.

  • Be Present: Single-task whenever I can

Studies have found that only 2% of us can multi-task effectively. Single-tasking is about focusing on one thing and doing it well. Ways to incorporate this in our daily lives include, blocking out time to not use any technology, being present in every moment and training our minds to do mundane tasks really well e.g. brushing each tooth for 4 seconds.

  • No single person can be a complete package

Expecting one relationship to provide everything you need in life, is unrealistic. Instead, you should look to build a unit of people around you that can service your different needs; e.g. having someone for emotional support, someone for career support, someone for intellectual discussions.

  • You have nothing to give as it is not yours in the first place

Interesting perspective. Most things you supposedly own, don’t truly belong to you. Your material wealth is just a function of things you cannot truly control (e.g. upbringing, intellect, luck). When you die, all of these things are left behind. Therefore, losing things or giving them away, does not truly cost you, anything.


FAVORITE QUOTES/STORIES

I am not what I think I am. I am what I think, you think, I am

Asch experiment – ‘Group Think’

Individuals were asked a basic question with an easy answer. Actors in a group were intentionally told to choose an incorrect answer. 75% of the time, the real participants in the study, would be influenced by the incorrect answers given by the actors.

Group think is dangerous. You are what you surround yourself with. So if we are surrounded by gossip, negativity and conflict, we will see the world in those terms

Our fears are more numerous than our dangerous and we suffer more in our imagination than in reality – Seneca.

Kevin O Leary – before he goes to sleep each night, he writes down three things he wants to do the next morning before he talks to anyone besides his family.

Multi-tasking and the dopamine hangover.

Multi-tasking releases dopamine in our bodies. This is an addiction pathway so we want to stimulate it more in order to get more dopamine. Too much dopamine however means that we don’t produce serotonin, the contentment chemical.

Story of Brian Acton

He worked at Yahoo for eleven years. Applied to Twitter for a job and was rejected. He tweeted about it and accepted that it ‘was ok as it would have been a long commute’. Then he gets rejected by Facebook. He Tweets, “It was a great opportunity to connect with fantastic people’. Ultimately, he ends up building Whatsapp and sold it to Facebook for $19bn. Express gratitude in life as you never know what will happen next.

Most common regrets of the dying

I wish I’d expressed my love to people I care about

I wish I hadn’t worked as much

I wish I’d taken more pleasure in life

I wish I’d done more for other people

The Black Swan: The Impact of the highly improbable


Book Title:
The Black Swan: The Impact of the highly improbable

ISBN: 978-1400063512

How strongly I recommend it: 2/5 Stars

The central premise of this book is that random, profound events, or ‘Black Swans’, occur frequently, and we are pretty bad at dealing with them.

The ideas discussed in this book are extremely valuable and they have far-reaching implications. I can relate to a lot of what Taleb has to say about human biases. However, this was by no means an easy (or enjoyable) read. Taleb has a tendency to go off on tangents, spends way too long emphasizing particular points and at times, the book reads like more an academic text with limited real-world applications.

In short, a good book but probably 150 pages longer than it needed to be.

Amazon Page Link: Click Here

How I discovered it? I often come across the term ‘Black Swan’ in a financial setting. I bought this book because I wanted to understand what that term actually meant from the person that coined it.  

Who should read it? Anyone interested in probability, markets and portfolio construction.


SUMMARY

Taleb starts with outlining human biases that encourage us to neglect or misunderstand Black Swans. The fundamental problem is that the real world is too complicated to rely on solely past data, to make inferences about the future. As a result, we will continue to experience dramatic, random events (good or bad) that our models fail to predict.

Taleb then moves on to explain that the optimal way of handling Black Swans is to target uncapped returns with limited downside (‘lottery tickets’). In other words if you know you’ll experience a Black Swan at some point, you should set yourself up to benefit from it by having extremely high pay offs when and if it occurs. Some examples include living in a busy city because of the higher likelihood of a serendipitous encounter with someone else, choosing a career path where you can scale infinitely and barreling your portfolio between extremely risky and extremely safe investments. More on those ideas below.


KEY TAKE-AWAYS

  • What is a ‘Black Swan’?

Black Swans are (1) Outliers (2) Profound and (3) Retrospectively predictable.

In simple terms, they are extreme events which have a big impact and appear to be predictable, but only after they occur. Classic examples could be 9/11, Black Monday and Covid19.

  • The problem of Induction

The way we formulate knowledge is by inferring from past events e.g. I know burning is a painful sensation because I recall what it felt like to touch something hot.

In a similar fashion, most predictive models use the past, to predict the future. However, this process inherently ignores Black Swans because it assumes that the past is representative of the future, yet extreme events can drastically alter future outcomes.

  • Just because it happened, doesn’t mean it was going to happen

The only way to determine causality is by conducting experiments (and observing the alternative outcomes). A fundamental failure of traditional schooling is that you’re generally taught to infer causality from backward looking history. Whilst it’s not always possible to consider alternative scenarios, when it is possible, we should focus on doing that.

  • Key Human Biases to keep an eye out for

Taleb covers a number of human biases which weigh on our thinking. The one’s I could relate to the most, are below. I want to be more aware of these biases in my own thinking going forward.

Confirmation bias – applying greater weighting to data which confirms our original view

Narrative fallacy – creating stories with causal relationships to explain things (even when causality isn’t proven to exist)

Ludic Fallacy – thinking of relationships in linear terms e.g. Every 1 inch of rain increases road traffic by 10minutes

Silent evidence – drawing conclusions based on evidence which survived, only e.g. using odds of getting rich at a casino from the vantage point of winning gamblers only but excluding all those who started in the cohort.

Tunnelling – focusing too much on what we know but don’t want to focus on what we don’t know.

  • We live in Extremistan

Taleb distinguishes between two types of worlds; (1) Mediocristan (2) Extremistan.

Mediocristan is a pretty simple world where the more information you have, the better you will be at predicting things. This is because the law of large numbers applies here i.e. the more data you collect, the more information you will have about the data set. Examples of data sets which fall into this category are things like the height of adults living in the UK.

Extremistan is more complicated. More information doesn’t mean better predictability. Outliers exist and have a huge impact on the average e.g. average wealth in the US.  Most human made data sets fall into this bucket.

  • Most real-life events don’t fit the Bell Curve

If you believe that daily stock market returns follow a bell curve (or normal distribution), then returns should hover around a mean and extreme events become infinitely less likely. Under this assumption, a day like Black Monday in 1987, where the stock market declined by 23% in a single day should only occur once in several billion years. Clearly that doesn’t hold up. The same applies for most real world events. (The scary thing is that normal distributions are assumed for many risk management models like VAR calculations to determine trading risks)

  • Aim for Convex Returns!

Black Swans will happen and you don’t know how they will impact you (they can be positive or negative). In investing therefore, you should try to set yourself up for as much convexity in returns as possible. In simple terms, buy (cheap) options with limited downside and uncapped upside. The only thing you know is that something unpredictable and profound will happen (but you don’t know what that may be).

One way to do this in investing is by barreling your portfolio. Keep 80-85% in extremely safe, low volatility investments like Treasuries. Then put the rest in extremely risky, speculative investments (like call options). This is how Taleb made his fortune.

Another way to do this is to have a speculative portfolio but to insure it against a large drop (of say 15% of losses). This is something I need to think more about applying to my own portfolio.


FAVORITE QUOTES/STORIES

Turkey on Thanksgiving Day

Knowledge gained from observations has weakness when we live in Extremistan (see above) where extreme events take place. Take the example of a Turkey being fed everyday in the run up to Thanksgiving. The day prior to Thanksgiving, the Turkey will think humans are extremely generous and caring (to give it so much food). On Thanksgiving day, the Turkey will have realized this was not a good prediction!

What you know, cannot really hurt you. It’s the stuff you don’t know, that can really hurt.

Knowledge is built on falsification not on verification.

(Non) Scalability of returns

Taleb uses the example of choosing a profession to emphasize the power of having infinitely scaleable returns. If you choose to be a prostitute, you will be inherently limited in the amount of money you can earn, as this is directly a function of your time. However, if you decide to create a software business and then lease that out to companies, you have uncapped potential returns as this is not a function of your time (i.e. you can sell the same software to multiple businesses).

Happiness

Anecdote in the book but interesting experiment. Happiness depends on the instance of happy feelings and not on the severity of that feeling. In experiments, people who earned $100k/year over a period of 10 years, were happier than those who received $1m in one lumpsum payment in Year 1.

Think outside of the box

A good example of the Ludic Fallacy (people thinking inside of a box, using theoretical models of Mediocristan to predict outcomes in Extremistan, which then means they end up missing the complexities of real life problems).

Imagine you’re told that a die has been thrown 100 times and it has landed on heads 99 times and on tails once. Now you’re asked to predict the odds of landing on heads. Most people will say its 50%. The out of the box thinker will argue that the chance of landing on heads 99 times in a row is so small, that clearly this is not a fair die.

Evolutionary bias

A lot of our biases in thinking come from evolutionary traits. One such trait is to assign causality to events by creative stories linking things together, even if they are not actually causal. This is referred to as the Narrative Fallacy. Evolutionary biologists think we do this because it’s a lot easier to hold stories in our heads than just random data.

3D Printing Stock to BUY and HOLD for the next 5 years

In my previous write up, I looked at how 3D Printing is set to revolutionize manufacturing, particularly in developed countries. Since my post, we have seen very wild price action in the stocks of the most popular 3D printing stocks. Over the last six months, ‘3D Printing’ (DDD) is up 244% YTD, ‘Desktop Metal’ (DM) is down 33%, ‘ExOne’ (XONE) is up 114% and ‘Stratasys’ (SSYS) is up 13%.

In this article, I want to tune out the noise and take a closer look at these 3D Printing companies. In doing so, I pick out the 3D printing stock which I think will benefit most from this secular growth trend.

Recap on 3D Printing

Firstly, a quick recap on why I am bullish this sector. For the full overview, see my previous article.

Additive Manufacturing (AM), also known as 3D Printing, refers to the process of building products layer by layer, using specialized printing machines. These machines are integrated with computer models which ultimately allow the user to turn digital images into physical objects.

This is in contrast to traditional manufacturing methods where objects are either formed by; (1) Subtraction, whereby you take a block of material and subtract the bits that you need, or
(2) Forming, where molds are injected with material to produce a specific object.

Advantages of AM

The Benefits of 3D Printing

There are a few key benefits associated with AM. These include:

Personalization – Unlike with traditional manufacturing, AM lets you create niche and specialized products at any scale. Even the smallest of changes to design can be programmed directly into the production process and this doesn’t require new parts. This is particularly advantageous in industries where parts need to be tailor made (e.g. medical devices)

Speedy Prototyping – In a similar vein, 3D printing allows new products to be created effortlessly without waiting on parts to be made prior to production. This makes it quicker to prototype and to test designs which is vital during the early stages of production

Complex engineering – 3D Printing can create more sophisticated designs than traditional manufacturing methods (which generally tend to be block shapes). Some of these designs include complex lattice structures (like the one below used in an automobile gear box). Such shapes ultimately allow for lighter (and more cost efficient) structures to be created

3D Printed lattice structure used for Automobile Gears

Supply chain optimization – Traditional manufacturing is either very labor intensive or very land/material intensive (and sometimes both). This has made it more prevalent in developing countries which are generally more cost competitive on both fronts. Whilst this can be a good thing (especially for consumers that benefit from cheaper prices), it does pose supply chain issues, which we all felt during the COVID pandemic as cross border flows were negatively impacted. Ultimately, the mobility of 3D printing means that supply chains can be shored up in developed countries, especially for time critical supplies (such as medical and industrial equipment).

3D Printing is set to grow exponentially

Although the technology has been around for over 30 years, 3D Printing is still in it’s very early stages of growth.

The Global 3D Printing industry is only worth around $13bn currently (measured by printing machinery and service revenues) but it is expected to grow at a 60% CAGR for the next five years (and at 25% CAGR for the next 10 years). (Even the lowest growth estimate I found online was assuming 20% CAGR for the next 10 years). This ultimately means that the industry is going to grow from being worth $12bn today, to over $125bn by end 2025.

3D Printing Growth Trajectory

Additive Manufacturing 2.0

The reason this industry is set to grow so fast is because it is going through a disruptive phase right now. Whereas initially 3D printing was used exclusively for prototyping (complementing traditional manufacturing), it is only now starting to compete with mass production. This is what is referred to as ‘Additive Manufacturing 2.0’.

This competition with traditional manufacturing is being fought on three fronts:

  • Mass production technologies
  • Expansion in materials inputs
  • Production of end-user parts

Resultingly, the most successful 3D printing company will be one which has the best technology to mass produce parts, has the widest selection of materials and that can be used directly in the creation of end-user parts.

3D Printing has low penetration with end-use parts
3D Printing Addressable markets

Market Players

There are many companies operating in the 3D printing space. However, the biggest pure-play 3D printing companies that are publicly traded are: 3D systems (DDD), Desktop Metal (DM), ExOne (XONE) and Stratasys (SSYS).

Whilst these companies have a lot of similarities, this is how I would characterize them versus one another.

3D Systems: The Dominant Player

3D systems is the largest company (by market cap) and is the self-proclaimed leader in the 3D Printing space. They have been around the longest (around 35 years) and are generally considered a legacy producer with a metals, polymers and plastics 3D printing businesses. In recent years, they have tried to build out their regenerative medicines business and have signed numerous partnerships to do so in this space. They have 100+ materials under patent.

ExOne: Legacy Binder Jetting Printing

ExOne is the market leader in legacy Binder Jetting 3D printing technology (which uses a binder to effectively glue together the different layers of material used to create parts). They have been in the industry for 20 years. They have 230+ materials and have the largest market share of Binder Jetting based 3D printers, globally.

DM: New kid on the block

DM is the disruptor in the industry. Whilst initially a metals focused 3D printing business, they have developed their polymer business through acquisitions this year (Envision Tech and Adaptive 3D). They also boast the fastest Binder Jetting technology in the market, which they refer to as ‘Single Pass Jetting’. This is about 7x as fast as the legacy system (used by ExOne). They have 225+ materials and very strong VC backing (Ark Invest, Social Capital, Ford, Google Ventures).

Stratasys: Legacy polymer 3D printing

Stratasys is focused on polymers (mostly plastics) printing (and not metals printing). As a result, they use slower (legacy) technologies for their 3D printing machines (FDM technology) and have a more limited customer base. They have been around for 30 years.

Financials Comparison (COB July 5th)

Financials Comparison

Revenue Growth

Firstly, all four companies are expected to grow revenues considerably this year. That being said, the Revenue CAGR for the largest players has actually been negative (over 3-5 years). This tells me that they are conceding market share to new entrants (and likely at a considerable rate given how quickly the industry is growing).

Cash Rich

Second, all four of these businesses have a lot of cash. The cash on balance sheet covers free cash flow for these companies for at least the next 4 years. This means that despite having negative Free Cash Flows (due to high capex spend and lower revenues), these businesses can likely maintain operations without dilutive equity fund raising rounds.

EV < Market Cap

Finally, I see a lot of people look at Price to Sales (or Price to Earning) multiples for stocks. With businesses like these which have a lot of cash on the balance sheet, this is the wrong approach. Enterprise value (which accounts for market plus debt minus cash), gives a more accurate picture of how these companies are valued. Intuitively, the enterprise value is what you’d pay for a company if you tried to buy it entirely (i.e. you own the equity and the debt). On this basis, all four companies trade still trade at a sizeable premium to forward expected revenues (but this is no way near as overvalued as typical P/E multiples would imply).

My Stock Pick: Desktop Metal (DM)

DM appears to fit my requirements the best. Financially, they are experiencing the fastest revenue growth and although they trade at the highest multiple of sales (EV/Sales), their growth is coming at the expense of the legacy entrants (that likely cannot compete with DM’s proprietary technology, such as the Single Pass Jetting System).

DM also has the strongest balance sheet. This is a reflection of the strong VC backing DM has (which has allowed it to achieve a sizeable valuation very early on). This protects the business from likely continued negative Free Cash Flows as it invests in its business during this growth phase. At this rate, DM has at least 7 years of cash to fund it’s Free Cash Flows.

Investment Risk/Reward

Assuming DM can achieve revenues in line with market consensus estimates for the next two years, continue to grow in line with broader industry growth (circa 60%), and achieve optimized margins of 20-30% (its competitors are already achieving 40% Gross Margins), I do think DM has the potential to achieve 90% return in the next five years (assuming a relatively low 20-25x earnings multiple).

It is worth highlighting that a lot of these assumptions are ‘de-risked’ as due to its order back-log, DM can already have a high level of confidence in its Forward Revenue Guidance (which is to clear $100m this year and achieve $1bn in revenues by 2025). In fact, the company has already sold out its printing machines until the 1H of 2024 (making me more confident that these revenue figures will be achieved). In the bear case scenario where growth rates and margins lag , I see 29% downside from the current share price.

Conclusion

3D Printing is still in its very early stages of growth. However, DM offers an opportunity to invest in the future and to achieve outsized returns versus it’s competition. Given that there is still a lot of growth to be felt, the price action is likely to be extremely volatile until we see continued revenue growth (likely Q4 of this year when DM’s new printers begin shipping). That being said, for the long term investor, I think DM offers an unrivalled investment opportunity.

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Ticker: DM
Stock Price (when post published): $10.87
Verdict: Moderately Bullish
Timeframe: +5 Years

The 4-Hour Workweek

Book Title: The 4-Hour Workweek

ISBN: 0307465357

How strongly I recommend it: 5/5 Stars

One of the few books that have made a permanent impression on me. The 4-Hour Workweek makes me question whether up until this point, I simply misunderstood life. I will say it is hard to see things the same way as I did before I read this book and for that I’m immensely grateful for the book suggestion.

The question this book tries to answer is how you can structure your life to maximize freedom of time and money (i.e. doing what you want, when you want). These are deemed to be the two key instruments of a rewarding life and Ferriss lists practical steps on how the reader can achieve this, in the same way that he has managed to do over the years. In doing so, Ferriss turns the traditional model of study-work-save-retire, on its head.

Understandably for such a large audience, this book isn’t always relevant and for me, it was the section on remote work which I found to be less useful.

Amazon Page Link: Click Here

How I discovered it? Recommended by friend

Who should read it? Anyone and everyone.


SUMMARY

The classical template for life is that you work hard, earn money and then retire to do all the things that you want to do. Ferriss dismisses that idea as lazy thinking; the reason most people stick with that plan is because they are uncertain about what they want to do in life, are insecure about their abilities or fundamentally misunderstand life itself.

Ferriss’ four stage plan (D-E-A-L) is based on firstly defining your life goals, eliminating the obstacles/noise to give yourself time to achieve them, automating the process of generating income to service those goals and finally liberating yourself from the office to be able to have maximum mobility. The ultimate goal is to be free do what you want, when you want and where you want. Those that pursue this freedom of time, money and mobility to realize their life goals are considered part of the ‘New Rich’.


KEY TAKE-AWAYS

  • Define life goals and revisit these regularly

Most people don’t know what they want from life. This puts you in this anxiety fed rat race where you just work for the sake of working, without stopping to achieve the things you really wanted to achieve. Goal set regularly, have a time line for what you want to do (and model out how much money you need to generate in order to do those things). Do these things regularly to avoid life passing by.

  • Don’t sacrifice unhappiness in your good years for happiness in the bad

There is no point sacrificing unhappiness in your early years to be able to spend the last remaining years of your life being happy. No matter the size of the pot of gold that you have in your worst years, it’s a bad trade and it is not worth it.

  • Experiences formulate desires

Most people don’t actually want to be rich. They want to experience what they believe that wealth can buy them. Those experiences are more accessible than most people think.

  • Plan more ‘mini retirements’

The classical retirement model is flawed. Most people get bored when they retire and you are much more limited on the experiences you can have in your old age. Mini-retirements are necessary to balance between work and rest and to have the experiences you want to have, before it’s too late.

  • Use the 80/20 Rule to increase free time

80% of outcomes are generated by 20% of inputs. Use this rule to de-clutter and eliminate inefficiencies holding you back from your ultimate goals.

  • Batch tasks together

Being busy isn’t the same as thing as being efficient (normally they are inversely correlated). Create simple processes, good systems and reduce noise. Some good examples are to batch email reading (instead of trying to keep up to date every second), focus on one major task per day and do it well and to use daily news summaries instead of frequently reading the paper to spot the stop stories.

  • Create a system that can replace you

The ultimate goal is to create a system of generating income that is bigger than you, so that you can leave when you want to do the things that you want, and you have cash flows that support those goals.


FAVORITE QUOTES/STORIES

Fable of the Fisherman

One day, an American businessman on vacation in a small fishing village in Mexico, see’s a local fisherman’s boat docking in the early morning. He asks the fisherman how long it took him to catch all of his fish and the fisherman replies that it was only a little while. When pressed why he didn’t catch more fish, the fisherman replies that he has a busy day; he plans to take a siesta with his wife, stroll the village, play with his kids, sip wine and play the guitar.

The businessman is in shock. He suggests the fisherman consider buying a bigger boat to fish in, and then with the proceeds from the extra fish he would catch, to invest in more boats. Ultimately, the fisherman could expand into the distribution of the fish in the US and then eventually IPO the business and make millions.

The fisherman asks the businessman, what he would do then (after making said millions). The businessman replies, he would be able to move to a remote fishing village in Mexico, fish a little, take a siesta with his wife, play with his kids, stroll the village, sip wine and play the guitar.

Never forget that money is a means to an end.

Freedom multiplier

Most people look at freedom in terms of financial freedom whereas in fact, it is a combination of 4 W’s – the freedom to do; what, when, where and with whom you like.

Retirement Planning

Retirement planning is like Life Insurance. It should be viewed as nothing more than a hedge against the worst case scenario; that you become physically incapable of working and need a reservoir of capital to survive. It should NEVER be the GOAL.

In fact, the very concept of retirement planning is flawed; it assumes that you either dislike what you’re doing now (so you’re trading off the present), most people won’t have enough to sustain their same lifestyle in retirement (i.e. most will fall back into a lower middle class lifestyle which isn’t particularly exciting in the first place) and if you do have sufficient savings, you’re probably so driven that you will be bored when you retire, so whats the point of planning for it anyway!

Worst case scenarios

One contributing factor for indecision is trying to get the timing right. In reality, there is never the perfect time for anything. The stars will never align and the traffic lights of life will never all be green at the same time. You MUST take a chance.

One way to avoid indecision is to think in terms of worst scenarios. Ferriss used this when he was considering taking an extended time off in Europe. If you start with the absolute worst scenario, you will realise that most things are generally not that bad and the unlimited upside potential on your life, far outweighs the potential downside risks.

Parkinson’s Law

Tasks will swell in perceived importance based on the time allocated for their completion. So they will naturally take longer, the more time you allocate to them. Instead, use the 80/20 rule to get things done sooner. Ask yourself daily, if I only accomplish one thing today, what would it be?

Time value

Work out a daily rate for yourself. Anything that you can do below that rate, you should outsource.

Curiosity Stream: Changing the way we watch TV

I have a confession – I rarely watch TV. Unfortunately, I have the attention span of a 5-year-old which means that I can barely make it through a movie without checking my phone (or falling asleep). When I do watch something on TV, it’s nearly always factual content (streamed from an app on my phone). Though my habits may be somewhat peculiar, it has get me thinking about the broader TV-on-demand market and how it’s being disrupted in a major way.

TV-On-Demand is a fast growing market

The TV-on-demand market is projected to reach $171bn by the end of this year, boosted by apps such as Netflix and Prime, that have made our TV watching less painful. The market for TV Streaming has been growing at a spectacular 30% compounded rate over the last nine years and it isn’t stopping there. By 2025, it’s expected to more than double in size.

TV Streaming Revenues 2011-2019

Stealing market share

What is interesting is that Total Revenues in this market are not actually getting much bigger. Instead, TV streaming services have been stealing market share from Traditional TV broadcasters, as more people ditch scheduled TV programs, in favor of on-demand shows they can simply watch/stream on their Smart TV’s.

TV Streaming Revenues/Traditional TV Advertising Revenues

TV Streaming as a secular growth trend

Surprisingly, watching TV on demand is not something that’s unique to a certain age group. TV streaming has penetrated all age groups and approx. 50% of people use TV streaming services on a daily basis (and for most, at least several times per week).

For a bit of context, every month during quarantine, US Netflix subscribers alone were streaming six billion hours worth of TV content. That’s 16 hours per month, per person, living in the United States. In fact, six major new streaming services were launched during the quarantine period alone.

How often respondents use TV Streaming Services (Statistica)

If you’ve read my previous articles you will know that this is a type of industry that I like to invest in. TV streaming has shown both that it is disruptive and that it is experiencing secular growth. And resultingly, we can see that nearly all major TV streaming services have experienced phenomenal growth over the years.

Viewership by major TV Streaming Business

Competing for content

Traditional TV broadcasters have seen the writing on the wall and have launched their own competing TV streaming apps (e.g. HBO+, Disney+, Peacock). Resultingly, the new form of competition in this market is about who can get the best content (and exclusivity) on their platform.

We’ve seen this play out with businesses like Comcast (NBC)  and HBO Max (Warner Media) taking exclusive content away from Netflix to host these on their own TV streaming subsidiaries. In the last year alone, Netflix lost ‘Friends’ to HBO max and then ‘The Office’, to Peacock. Amazon has spent $1.2bn/pa to get exclusive access to live stream the NFL and companies like Disney + have taken away nearly all proprietary content from competing platforms.

Niche content providers

Unlike in the last few years where we have seen ‘Tier 1’ providers that provide streaming services experiencing the greatest share of growth (e.g. Netflix, Prime, Hulu), I think the future of this industry belongs to ‘Tier 2’ companies that instead, focus on producing the best content (to stream).

This is when I came across ‘Curiosity Stream’ (Ticker: ‘Curi’).

Curi is a media streaming platform, with a focus on factual entertainment (such as documentaries and seminars). Their business model is focused on creating (and licensing) factual based entertainment and incorporating these onto TV streaming platforms.

As it stands, they have +16m paid subscribers (of which over 75% are on annual plans), host +3,000 titles and have been growing at over 100% CAGR over the last couple years.

Why is factual entertainment the perfect niche?

Before drilling down on Curi’s business model, I must say that I think that factual entertainment is probably the best niche to be in if you’re competing over content.

This is because documentaries don’t have the same problems that other types of programs have; they have broad based appeal across age groups and language groups (as they don’t’ rely on scripted content that’s hard to localize), they stay relevant across a longer period of time (documentaries take a lot longer to age) and have much lower costs of production.

As a point of comparison, one of the most expensive documentaries ever produced was BBC’s ‘Planet Earth’, which cost ~$2m per episode ($25m over five years and eleven episodes).  Meanwhile, in the final season of HBO’s hit series ‘Game of Thrones’, each episode was costing $15m to produce. Yet despite costing 7x as much, both shows had a similar average viewership across all episodes.

Curiosity Stream’s Business Model

Unlike other TV streaming providers such as Netflix and Disney+, Curi does not rely solely on Direct-To-Consumer (DTC) subscriptions. Instead, Curi is tapping into the market for ‘Bundled Distribution’, which means that it sells its subscriptions to a larger service provider, such as Sky, who would then combine this with other TV services and then sell these directly to the consumer (as a bundled package).

Arguably this is a lower margin business but it is a vastly bigger opportunity and de-risks the platform from the same issues that Netflix has experienced competing against Disney+ and Comcast. This is because contracts for Bundled Distribution are multi-year (multi-million-dollar contracts) and allow Curiosity Stream to focus on it’s core business of creating the best content, leaving the distribution to larger players.

Content Creation

As of right now, over one third of Curi’s 3,000 titles are home produced content whilst the rest is licensed. This is above the industry average of 22%/78%. What is more impressive is that Curi is beating the industry average at such as early stage of its growth trajectory, where arguably cash is likely more constrained (due to less paid subscribers). For context, Netflix spent 17x Curi’s entire market cap in original content creation just last year.

Management edge

The reason I think Curi has managed to cement such a strong grounding is because it has a very solid management team. The Founder of Curiosity Stream was the ex-founder of Discovery Channel, John Hendricks. He launched Curiosity Stream in 2015 to be the leader in factual content streaming. The COO and CEO both have nearly 50 years of experience between them and are also ex Discovery Channel employees so it’s safe to say they know the business well.

Curiosity Stream Management Team

Business Strategy

Curi’s strategy is to first create superior content and then increase the amount it charges for it’s products (through Bundled and Direct-To-Consumer packages). As such, it is still significantly cheaper than it’s competitors and I expect it will continue to gain market share from its rivals during this phase of growth (though still with sizeable Gross Margins, which I will discuss below). Ultimately, this should only serve to generate more cash flows to put back into content creation and cement Curiosity Stream’s unrivalled value proposition.

Financials

In 2020, Curiosity Stream had an average 61% Gross Margin (and 58% in Q1 2021). By way of comparison, Netflix, the biggest TV-on-demand provider, has 39% Gross Margins. These are outstanding margins particularly when most of the economies of scale are still largely untapped for Curi.

The second thing that stands out to me is that Curiosity Stream’s business model relies on annual/multi year subscription plans. The advantage this has is that it makes forward revenues much more predictable (as management have a good sense of what they will earn in future months based on these ‘locked-in’ subscription plans). In their last report, management claimed to have 90% visibility on all future revenues, which allows for much better financial projections.

Stock Price Model

On that note, management forecast revenues of ‘at least $71m for the current financial year’. This would imply at least 80% y/y revenue growth (and 120% revenue growth the year prior).

Assuming Curi is able to achieve growth of just 45%-55% over the next five years (at a compounded rate), and optimized margins of between 18-23% (management expect closer to 22%), a price to (implied) earnings multiple of between 15-20x in year five, Curi stock looks to have 40% upside at current levels. In the worst-case scenario (assuming bottom of those ranges), it has 40% downside.

Arguably, this isn’t the best risk/reward (especially when compared to the companies I have analyzed in previous posts) and this is largely because the stock price has been running significantly higher the last couple weeks.

Nonetheless, there are two key catalysts here which I think have provided an excellent entry point for new investors.

Catalysts

During Curiosity Stream’s first quarter results, the company reported revenue of $9.9 million. Management reaffirmed guidance that they will hit $71m for the financial year (see note about visibility above) but investors bailed and the stock was down 27% at one point following the earnings release. The sell-off was a clear overreaction since management reaffirmed its full-year guidance for $71 million in sales. Since then, the stock has bounced back from it’s lows but still remains significantly down for the year.

This year, Curiosity Stream acquired One Day University, which is a platform featuring over 500 unique talks and lectures from professors at over 150 colleges and universities. I think this is a great addition to the platform (at very little cost) as it allows Curi to move into e-learning verticals and we are yet to see this reflected in their financial projections.

Conclusion

Admittedly, I have been a bit late in sending this report out. I came across this business a month ago and decided to buy a combination of stocks and call options after the post earnings sell-off (I have now liquidated my call options positions), before I got the time to put out this report. I’m also a sucker for documentaries and I do have a strong preference for buying stocks in businesses where I personally love the product.

However, despite this recent run, it does look like there is still sizeable upside based on management estimates and using very conservative financial projections (on multiples and revenues growth, as I have above). As a result, I will be looking to add to my position around here, and will dollar cost average on any pull backs in the share price (which would get me to a >1 Risk/Reward on this position).

Ticker: CURI
Stock Price (when post published): $15.15
Verdict: Moderately Bullish
Timeframe: 3-5 Years

Beware of the Reverse Repo

I’ve been seeing a lot of headlines about the Federal Reserve’s ‘Reverse Repos’ and the impact they are having on the broader financial markets. This all sounds complicated so here’s a quick explainer on what they are, what’s happening now and why I think it’s important.

The Fed sets the Federal Funds Rate

People normally assume the Fed sets interest rates. What it actually does is set the ‘Fed Funds Rate’, which is the rate that inter-bank lending occurs. This then has a secondary impact on the interest rates that normal consumers are charged (on things like car and business loans).

The Federal Funds Rate is determined by the demand for cash reserves (by banks). The Fed controls that through two key operations:

(1) Overnight Repo’s

(2) Interests on reserve balances (IORB)

Overnight Repo agreements are the way the Fed injects money into cash balances that banks hold. Banks can sell assets to the Fed overnight, with an agreement to repurchase those securities the following day. This temporarily increases the supply of money in the economy.

The Fed also holds reserves for major financial institutions. It can directly set the interest rate on those reserves balances (IORB). The net impact of this is to increase/decrease available money supply in the economy.

What is the Reverse Repo Program (RRP)?

The Reverse Repo Program is the opposite of the Overnight Repo (mentioned above). Instead of injecting money into the system, it takes money out. The Fed would sell Treasuries to eligible firms (banks, money market funds) and then agree to buy them back at a later date for a fixed return.

Why does the RRP exist?

The RRP is a short-term solution to their being too much money in circulation and resultingly, prevents the Fed Funds Rate from falling below the Fed’s target (Remember: if there’s too much money in circulation, then the supply of reserves overwhelms demand and banks end up lending to each other at even lower rates).

What is happening?

RRP Volumes

The volume in the RRP has gone up considerably and is hitting near record highs, despite the effective interest rate on these transactions being 0%. The volume in the RRP on Tuesday of this week, was at a staggering $433bn. That’s more than the entire GDP of Ireland. This is the highest transaction volume we have seen since 2019 and the third highest on record.

The irony is that the Fed is pumping $120bn/mth into the US economy and is effectively taking out three month’s worth of this in these overnight RRPs.

What does this indicate?

In short, that there is simply too much cash circulating in the banking system. For context, the Fed has spent $2.5tn since the pandemic (buying US Treasuries amongst other assets). The issue is that whilst this has added liquidity to the financial system (as sellers of Treasuries now get cash to sell their assets to the Fed), they then need somewhere to put that cash, other than effectively giving it back to the Fed.

The worrying thing about this cash going into RRP’s is that it means that (1) banks are simply not finding enough attractive places to park this cash (outside of the Fed) and/or (2) they are stepping down purchases of the US Treasuries (which is leaving them longer cash balances).

Bank Reserves held by the Fed

Why am I concerned?

What is concerning is that this is simply not sustainable. If there is too much cash going back to the Fed (even at 0% interest rates), the Fed is going to be forced to taper it’s purchases of securities and/or look to increase interest on reserves it holds.

The second issue is that with so much cash, there’s less money flowing into US Treasuries. Whilst this isn’t necessarily bad, the impact of banks buying less US Treasuries is that the yields/interest rates on those Treasuries go up.

At this point, it is almost certain that the Fed will need to take some sort of action. They will either raise the IORB or increase the overnight rate on the RRP (to keep it in line with their targets). Unfortunately, those efforts will likely attract more money back to the Fed = take more money out of the financial system. It therefore makes it impossible for the Fed to continue pumping more money into the system (if that is basically being returned back to it).

Rising rates and tapering will undoubtedly have a direct impact on the US financial system and the prices of assets that are particularly rate sensitive, such as houses, cash flow negative stocks and bonds.

What is next?

Whilst I don’t think we’re due for a large scale market sell off on the back of Fed tapering (mostly because the idea of tapering has been frequently discussed), it does make me more wary that short term corrections and pull backs are going to be more frequent, particularly in large cap tech (which has, so far, been shielded from a major correction).

As a result, I will be looking to expand future posts to cover some larger names that I will be looking to add positions to, particularly if those companies come under pressure in the run up to the next Fed meeting on June 15th.

Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future

Book Title: Elon Musk: Tesla, SpaceX, and the Quest for a Fantastic Future

ISBN: 006230125X

How strongly I recommend it: 4/5

Marked down because the writer flip-flops between Musk’s businesses and resultingly, it is somewhat difficult to keep track of the chronology.

Amazon Page Link: Click Here

How I discovered it? Youtube (credit to Ali Abdaal)

Who should read it? Anyone trying to make sense of Musk’s sometimes erratic behavior. Focused on Musk’s trials and tribulations in his businesses and less his personal relationships.


SUMMARY

The story of how Elon Musk became who he is today.

Most of the book is dedicated to Musk’s experiences with Tesla, SpaceX and Solar City (his three current and largest businesses), but it also covers some of Musk’s early days of moving to the US (along with his brother, Kimbal) and his earlier ventures, Zip2 and Paypal.

In sum, this is a story of how one man, takes a series of high risk (typically all-in), bets and managed to pull it off. It’s refreshing to hear about Musk’s struggles, often under-reported, and how close he actually gets to failure.


KEY TAKE-AWAYS

  • If you believe in something, just go for it

Musk pockets $22m from his first venture, Zip2. He puts most of that money into Paypal. He then makes $180m exiting Paypal and puts $100m into SpaceX, $70m into Tesla and $10m into Solar City. At one point, he’s so heavily invested to his companies he’s living off his credit cards.

  • No exit without proof of concept

I’ve read too many stories about multi $m exits. Reality is that you need to have proof of concept and scale before that’s even remotely possible.

With Zip2 (Yelp-like business), Musk exited with $22m after about five years. But to get there, he needed VC funding, was actively hiring staff and was still hustling with his brother.

At the time of exit, Zip2 was worth $307m (purchased by Compaq Computers).

  • Don’t compromise on vision

Musk was booted from his company’s multiple times. At Zip2, he was replaced as CEO by a VC backed manager. At Paypal, he was booted by Peter Thiel (whilst Musk was on his Honeymoon in Australia).

Since then, Musk remains committed to maintaining control of the ultimate vision of the company and to never lose that.

  • Not knowing about a certain industry is often a blessing

Musk knew very little about rockets/space before founding SpaceX. Same for his knowledge of auto manufacturing prior to Tesla. This allowed him to come up with more creative ideas and ask the right questions, like; why did the US rely on the Russian space program to get to space and why can’t you make a car out of Aluminum instead of steel.

  • You will hit rock bottom multiple times

Musk went from flying in his private jet, to having to take Southwest commercial flights between LA and SF. He lost a child, got sacked on his honeymoon, got screwed over by investors/friends and was openly mocked for his ideas.

  • There are strong network effects in the start up space

A lot of Musk’s success can be attributed to having a good network and a brand image. Any venture he backs today is instantly credible and he’s used his network to further his business interests. Building something small first, makes it more likely that you will be able to build something big later.


FAVORITE QUOTES/STORIES

Buying Russian ICBMs

Musk has $20m to buy three rockets. He goes to Russia to buy ICBM’s (Inter-Continental Ballistic Missiles) to retrofit (with the help of an ex CIA operative). The Russians want $8m each, he offers $8m for two. In the end he storms out, gets on a plane back and then decides he’ll just make the rockets himself. He puts together his own plan and undercuts the market by huge margin.

Tesla bankruptcy Deal

Tesla was on the verge of bankruptcy. One of the main investors, ‘VantagePoint’, would not participate in another round of funding because they felt it undervalued Tesla but in reality, they were hoping it would go bankrupt and they could then sweep in and sell its business segments for a profit. Musk raised as a debt round instead (which Vantage Point could not block), and the deal to raise $40m closes hours before Tesla would have gone bankrupt (on Christmas Eve).

Google takeover (2013)

Tesla built it’s Model S but it wasn’t a huge success as it had multiple operational failures and was expensive to build. Musk makes a huge drive into marketing and convinces everyone at Tesla that they need to start selling more cars. He reaches out to Larry Page (friend) and Google Co-Founder for a buy-out, and Google was set to buy Tesla for $6bn (with Musk remaining in charge for eight years). A few sticking points held up the deal and that gave Tesla just enough time to boost sales…the deal subsequently fell apart. Tesla in May 2021 had an Enterprise Value of $710bn.

Mary Beth Brown story

One of his closest assistants asks for a pay rise (in line with board member pay) because she is working just as hard. Musk ask’s her to go on vacation for a couple weeks so he can understand how taxing her job is. When she comes back, Musk fires her as he realizes he didn’t actually need her services.

Energy inefficiency

Conventional cars are only 10-20% efficient at turning fuel into kinetic energy. EV’s are 60%+.

In one hour, there is enough solar energy pointed at the earth to fuel an entire years worth of energy consumption.

China’s Robinhood

The rise of Retail Investing

Retail Trading has gone ballistic. In the US equities market, Retail Trading accounts for almost as much volume as Mutual Funds and Hedge Fund Trading volumes, combined. The ease (and gamification) of stock investing has opened up a new asset class to many ordinary people and has democratized the process of buying and selling stocks.

Retail Trading accounts for Approx. 25% of total traded volumes

Retail Investing as a Secular Growth Trend

The post-Covid Retail Investor is a new breed of investor that is here to stay. She/He is younger (Median Age 35 years versus 48 for Typical Investor), more optimistic (72% are bullish) and has increasing disposable income to put to work (43% plan to invest more in the stock market). Whilst speculative euphoria may have burnt some new investors, more of these new investors (+70%) are now looking at buy and hold strategies (versus only 56% a year ago). Companies like Robinhood have pioneered this change and with ‘Zero Comission’Trading, the barriers to entry are as low as they have ever been.

Robinhood Trading App – User Growth

Chinese Retail Investing Market

This has got me thinking about where else this sort of rapid disruption in investing could take place. Boasting the second largest aggregate household wealth in the world (after the US), I was surprised to find that Chinese Retail investing pales in comparison to the US. Only 13% of China’s Households invest in equities, compared to over 55% in US.

Burgeoning Middle Class

From 2015-2030, the share of the Chinese Population with ‘High Incomes’ (>$35k/pa) is expected to grow by 5x (from 3% to 15%). Those with incomes greater than ($11k/pa), the ‘Upper-Middle Class’, are expected to grow to 35% of China’s population compared to only 10% in 2015 (all numbers normalized for 2021 Prices).

This rapid rise in income per capita as people move into the middle class, is expected to open up Total Addressable (Retail) Wealth of ~$30tn by 2030, with over 500m Chinese Clients falling into this ‘Upper Middle Class’ Income bracket with money to invest.

China’s burgeoning Middle Class

One further catalyst is that Chinese households have a disproportionate amount of wealth tied up in Physical Property. As per capita wealth increases, this should start to favor Financial Investments as households diversify their holdings (to be more in line with other developed countries).

Chinese Household Wealth Distribution

China’s Demographic Problem

Unfortunately, alongside greater wealth has come a greater willingness to buy unproductive assets (e.g. Louis Vuitton handbags, Tech gadgets and International Travel). Ten years ago, the average Chinese worker saved 39c on every dollar of income. Today, it is 33c and many young Chinese save nothing at all.

Chinese Savings Rate experiencing decline

This depletion in savings is coming at the same time that China is heading towards a demographic nightmare. By 2050, China will have one of the highest ratio of elderly citizens (as a proportion of it’s working population) in the world and a massive pensions deficit to accompany that. Reports estimate that the Chinese Government Run ‘Basic Pensions System’ will deplete all of it’s assets by 2035. The more Chinese wealth that gets squandered away in unproductive assets, the more of a (social and economic) problem this is going to become.

China on track to have record high Old-Age Dependency Ratio

Chinese Retail Investing: Ripe for disruption

In this regard, Chinese Investing Platforms are not just in the business of democratizing finance like their US counterparts, but they are solving an underlying macroeconomic problem; they are creating the right incentives for households to invest.

To put things into perspective, the Shenzen and Shanghai Composite indices contain just 10% of the world’s equity by value (even though China contributes about 16% of Global GDP). Meanwhile in the US, the Nasdaq & NYSE have about 50% of the worlds equity value. Unlike in the US, Retail Holdings (as a % of market cap) inside of China have steadily been decreasing, speaking to a lack of incentives to invest in domestic markets. As a result, it is common for top tier Chinese companies to completely neglect domestic IPO’s in favor of Hong Kong or US listings.

Chinese Domestic Markets do not appeal to the Chinese Retail Investor

Given the scale of the problem, I think the market is not just prone to disruption but if executed well, Chinese investment platforms can ride the tailwinds of (1) have the backing of the Chinese Government to solve a deepening macroeconomic crisis (2) exposure to a rapidly expanding middle class and (3) ride the broader growth trend in Retail Investing taking place in other countries.

China’s Robinhood’s: Futu & Tigr

The top two brokerage firms in China are ‘Tiger Brokers’ (Ticker: Tigr) and ‘Futu Holdings’ (Ticker: Futu). They surpass their competition by a wide margin due to their online only presence, reduced fees and established technology platforms. Both of these companies boast retention rates of approx. 98% and can be seen as the ‘Robinhood’s of China’.

Their three key revenue drivers are:

(1) Brokerage Commissions

(2) Interest Incomes from Margin Lending/Cash Sweeps

(3) IPO’s and Share plan services

Both companies generate over 60% of their revenues through (1) but this has been steadily decreasing this share through diversification into (2) and (3).

Futu

  • Futu has two main investment apps; Futubull and MooMoo.
  • Revenues from Brokerage Fees: Approx. 64%
  • 1.4m Registered Clients, 516k Paying clients
  • Paying Clients Growth: 60%, 84%, 137%, 160%
  • Total Trading Volume: $150bn
  • User median age is 34, mostly affluent Chinese (40% work in technology)
  • To attract clients, Futu has a social networking element, ‘NiuNiu’ community. This allows investors to find new investment ideas (think Wallstreetbets but without the hype). The average user spends 38minutes per day on this in 2020 (versus 25mins in 2019)
  • Founded by an ex Tencent employee. Tencent owns a 30% stake in the company

Tigr

  • Revenues from Brokerage Fees: Approx. 60%
  • 975k Registered Clients, 215k Paying Clients
  • Paying Clients Growth: 29%, 53%, 76%, 110%
  • Total Trading Volume: $63bn
  • Initial focus is on US equities with international presence
  • 72% of Tigr’s users are under 35 years old.
  • Acquired US baked broker in 2020 to build out in-house clearing functions
  • Interactive Brokers has 8% stake in the business (with Xiamo having 12% stake in the business)

Valuations

Both Tigr and Futu deserve to be considered explosive high growth stocks, growing revenues at an average of 130-150% over the last few years (alongside paying clients – see above). Importantly, they are both also profitable and have sizeable Free Cash Flows.

On paper, Futu does look like the better business given that it has grown faster and has shown that it can monetize this growth better; with 76% Gross Profit Margins and Net Income Margins at 38% (in 2020). Tigr has Gross Profit margins in the 40% and Net Margins around 12%.

Using analyst expectations for 2021 Revenues, both businesses should grow revenues by over 120% y/y. Assuming a conservative growth rate assumption (Futu 40-55%) and (Tigr 25-40%) over the next five years, adjusting for a 15-20x P/E multiple in 2025 and assuming they can hold Profit Margins in line with where they are now (also conservative given that as businesses see more user growth, they should experience higher margins due to scale), I think both of these stocks are trading at very attractive entry points for new investors with over 100% upside in five years in the most optimistic scenario.

Ticker: FUTU, TIGR
Stock Price (when post published): Futu – $118.89, Tigr – $16.79
Verdict: Moderately Bullish
Timeframe: 5 Years