Finance Related Links

1. A valuation expert thinks about What's App from a valuation and from a trading perspective

Damodaran's trading perspective of looking at cost per user sounds plausible, but I wonder if the calculation was as simple as "Facebook messenger is going to be worth X% of the company in the future. Buying Whatsapp at least doubles Facebook's chance of dominating the message space, and X > 22% so it is worth paying almost 11% of the company for Whatsapp."  Also, from a valuation perspective Facebook doesn't have to monetize users more than 1 dollar a year in the short term, they can keep Whatsapp's promise to be ad free for 5 years and only later start aggressively monetizing a greater user base.


He's trying to teach the idea of margin of safety, a long term perspective and investing in what you know, but it's interesting that in doing so he is highlighting investments that definitely underperformed Berkshire's book value as a whole. The farm is worth 5 times the amount it was bought in 1986, Berkshire stock is up over 5000% since 1987.  The actual calculation is more complicated than that since the farm gave off earnings in the meantime, but the difference is still quite notable.

3. MTGOX, the original bitcoin exchange, is down right now

It could be that they are insolvent or they are just particularly incompetent, but it is probably a combination of both.  The coins on the exchange, which could not leave MTGOX custody, were trading at less than 30% of the value of bitcoin on other exchanges.  It would be amusing, but highly illegal, if they were actually buying these discounted coins and arbitraging the difference on other exchanges to make it back to solvency.

Facebook is Buying Continued Relevance

When Facebook was going public they bought Instagram for around a billion dollars. Instagram was succeeding at something Facebook was trying to do - get teens to engage with a photo-sharing and social network app on mobile. Facebook paid about 1% of its market capitalization to own this emerging company. Later data revealed that it was definitely a good move - people really like Instagram.
   
More recently, they paid a lot more for Whatsapp, a messaging app founded in 2009. They paid $16 billion, or $19 billion dollars when restricted shares that will paid out as retention bonuses are included. That works out to over 10% of Facebook's current market capitalization.  Whatsapp was starting to beat Facebook in the messaging space - in most of the developed world outside of Japan and Korea Facebook and Whatsapp are the number one and number two messaging apps (It's unclear if counting Apple's iMessage as a separate app would change the math significantly).

There is no question that owning the messaging and mobile photo sharing spaces is what Facebook needs to do. And the mobile messaging space in particular appears to be very profitable. Line has been monetizing their user base quite well recently. But the big question is whether or not these nascent competitors that Facebook bought will continue to dominate the market for the foreseeable future.  

Zynga tried to implement the strategy that Facebook is applying when they bought Omgpop, the company behind the popular app Draw Something. Zynga wanted to get a foothold in the mobile gaming space but found out that success was not repeatable. While the analogy is worrying considering Zynga's subsequent troubles, Facebook is in a signficantly better position. With Whatsapp the network effects are stronger and there is no pressure for Whatsapp to create any other hits - they just have to outcompete other messaging apps and monetize their current business. 

But if consumers move on to other methods of communication in a few years, Facebook will have to buy the new competitor in the space if they are unable to innovate successfully. The social space is adapting to new technologies and is changing much more quickly than other areas. If Facebook needs to continue to buy competitors to keep their mindshare with consumers constant they will dilute their shareholders before they are able to deliver significant value. They might also start to attract the attention of the FTC.

One thing that this acquisition highlights is just how technology companies are threatened by the changing technology landscape. An investor who is bullish on technological innovation should be wary when buying the current technological incumbents - these incumbents risk either be outcompeted by new entrants or having to buy them at inflated prices.

Any press is good press, right?

The current story with Under Armour and the US Olympic speed skating team could test that hypothesis. There is a lot of speculation about whether or not the suits, which have vents that might be making them less aerodynamic, are holding the team back from winning the medals they were expected to win.

Under Armour, the only thing holding the US Olympic speed skating team back.

I'm guessing that wasn't the message the marketing executives were going for when they decided to sponsor the speed skating team. In actuality it should probably work out okay for them since their name is being mentioned in a lot of places. Also, the product that isn't working optimally, olympic speed skating suits, isn't something that is or could generate significant earnings for the company. This doesn't seem to be anything like the Lulu Lemon bend over test situation where consumers were starting to notice their favorite brand was declining in quality. As strange as it might sound, this is probably a case where Under Armour does a little bit of damage control and benefits from the free press. It will be interesting to look at this issue again in a year or so and see if there was any noticeable impact.

Russians officials are bad at propaganda

The sorry state of the hotels the media are staying in at Sochi have themselves become a major story of the Sochi Olympics. It's a sad story because the hotels were probably fully funded, and it is likely that the extreme level of corruption innate in the workings of Russian government and business led to their current incomplete and dilapidated state.

What makes this story even more of a tragicomedy is how Russian officials have responded to these stories. The WSJ article on this, titled Russian Officials Fire Back, is quite peculiar.

First, Dmitry Kozak, the deputy prime minister in charge of Olympic preparations implied that foreign journalists are making the whole thing up out of bias against Russia. Not only that, but he has proof they are making up stories because they have surveillance video from the hotel rooms which show journalists doing things that would destroy the showers before they take pictures to post online.  When asked directly about surveillance video (which he implied was aimed at the showers of the visiting media) he was pulled away by an aide who apparently realized that their boss was going down a path where he was admitting to much worse wrongdoing in order to cover up general incompetence. 

In a later press conference, Kozak said something un-ironically that is quite scary.

"The realization of such a project is an enormous victory for the entire country," he said. "As we say in Russia, victors don't get blamed."

In the West there is also a saying, "Winners write the history books." But when it is said by a prospective winner they are admitting that they are being evil but will be able to cover up their misdeeds due to the lack of influence of the losers. Apparently in Russia, government officials still take the attitude that they won't be held accountable as long as they achieve certain primary goals. 

And with the exception of Vladamir Putin's spokesman, who shows up at the end of the article, none of the officials quoted seem to worry about sounding like corrupt despots who think they can change reality just by lying enough.

If it is this bad when the world spotlight is shining brightly on Russia, it's scary to think about how corrupt and broken things are on a day to day basis.

Negative EV Superbowl Betting

Bloomberg had an article before the big game on how amateurs and professional bet on the Superbowl.  Amateurs like lottery ticket type payouts - bets that pay off in low probability situations. The two trades highlighted in the article were "Will there be a safety" and "Will there be overtime?" 

Thanks to the first play of the game, amateurs made out well if they bet the first score would be a safety (or even if there would be a safety at all). But it was yet another game without any overtime. The amateurs pushed the overtime odds from a 13 to 1 payout to a 6 to 1 payout - and despite a small point spread it didn't even come close to paying off.

In general, the favorite trades of retail "investors" are either even odds or ones in which they risk a little capital to make a lot. In general, risking a lot of capital to make a little bit just doesn't seem fun or safe - even when the probabilities are in the investor's favor.  It's also a lot more fun to make or even read about high payoff bets than it is to look at all of the bets that didn't pan out. 

And while these bets are often negative expected value, they can sometimes make money. Plus, having money riding on random events can turn a boring game into something interesting. So while retail bettors are going to lose money on average, maybe the bets aren't negative expected value after accounting for psychic benefits.

Some Links, Some Comments

1. The Cult of Overwork by JamesSurowieki. It's interesting to note that overwork generates cognitive dissonance where employees will be more dedicated to their job after working long hours because their actions indicate that they have been dedicated. Cialdini calls this form of influence "commitment and consistency."

2. NFL treats is cheerleaders quite badly if they are thought of as employees. If instead the NFL made clear that cheerleaders were joining an elite club and not a job, it would be interesting to see if the quality of cheerleaders fell significantly.

3. Some historically bad forecasts. It's interesting to note that Samuelson wasn't alone in his bullishness on the U.S.S.R. - most economists after World War 2 believed that planned economies, which could generate far more savings and investment, would win out in the end.

4. The Bill Gates 2014 letter. It's an interesting read that highlights some of the good that foreign aid does, but it is obviously biased in favor of what Mr. Gates has been spending billions of dollars on. One amusing part is in which Bill Gates uses the general population's cognitive bias of anchoring as a rhetorical flourish: 

"When pollsters ask Americans what share of the budget goes to aid, the average response is “25 percent.” When asked how much the government should spend, people tend to say “10 percent.” I suspect you would get similar results in the United Kingdom, Germany, and elsewhere." 

The actual amount is below 1%, and if Americans knew this they still might think it should be slightly lower. The 10% figure was only mentioned because it was within an order of magnitude of the erroneous 25% estimate. While foreign aid definitely saves lives in the short term, the letter definitely overstates their positive long term impact.

A Ballsy Strategy

Step 1: Create a portfolio of 25 companies to hold for the year. Make it public.

Step 2: Create a fund around this portfolio of 25 companies - companies that will not change. The fund will be equal weighted.

Step 3: Charge investors 3.5% for the privilege of investing in this fund, because buying 25 equally weighted stocks and holding them for a year is really hard

Step 4: Wait and see if anyone chases the -3.5% underperformance. Sell them all of the other high fee products you can! (Step 4 is speculative)

Outside observers: Wonder who would actually invest in this fund. Check to see if those investors are managing their own money or are pretending to act as fiduciaries.

I'm not using the company or fund name in this post. I'm not sure if the actual fund will be equal weighted and exposed to the same 25 stocks throughout the year, but that is what the news stories suggest. Even if it was a harder strategy to replicate, 3.5% in fees is a high cost for any long only US equity strategy.  And there are many funds that charge really high fees for simplistic strategies - the difference is they usually aren't mentioned in top Bloomberg stories.

Cocktail Signaling in Vietnam

Those who are used to Western style cocktails and prefer to drink their alcohol in the form of cocktails should tread carefully in Vietnam. A general rule of thumb is that drinks will be worse than you expect them, regardless of the venue. Even in the States, a bar with live music, a dance floor or other entertainment expected to have worse then average drinks. But in Vietnam, even a nice hotel bar with a long cocktail menu will mess up anything more complicated than a rum and coke - and that's if they have rum in the first place, more often than not they'd only be serving whiskey or vodka.

This should be expected - in a country with a GDP per capita of under 2000 US dollars, liquor from the Western world is an expensive luxury. Those in a position to afford the liquor will be more likely to drink it straight, and have an expensive bottle to signal how wealthy they are to their friends. One of the principles involved in finding good food, taken from Tyler Cowen, is that the quality food rises or falls to meet the quality demanded by the consumers. Expecting to find good cocktails in a place where no one drinks them is akin to hoping to find good Chinese food in a community with no Chinese residents. 

And even in the United States, appreciation for well made cocktails only really heated up in the past decade or two. Vietnam's cocktails might most closely resemble those made in the US in the 80's, "...when artificial flavoring and sweeteners were introduced, and fresh squeezed juices and class liquors deemed "our Grandfather's booze" were pushed to the side."

Still, there are some places that put effort into making cocktails according to modern Western sensibilities. Hiring a bartender who actually knows what they are doing and providing them with fresh ingredients is relatively expensive compared a getting bartender whose comparative advantage is just their foreign language skills and giving them off the shelf mixers, so the bar wouldn't just lay out another cocktail menu and expect people to know that their cocktails are going to be good. They show that they have some really interesting stuff going on.
The above bar, Angelina, is attached to one of the most expensive hotels in Hanoi. They have a few very involved cocktails on the front of their menu that cost between 150% to 200% the price of the rest of their drinks. When ordered by someone not sitting at the bar, the waiter will invite them to the bar to look at how these cocktails are made (it's a drink and a show). These drinks are relatively labor intensive and the process is relatively complicated - and sometimes dry ice is added around the drink for no reason at all. The final result is a drink that both costs and tastes like it was made in NYC. The important thing is that the other cocktails at this bar are also made very well. By showing that they are serious about cocktails the customers can order the cheaper classic drinks off of the menu without worrying that about being stuck with a random green sickly sweet concoction. 

Regarding the Seahawks Restricted Ticket Sales

There is some controversy around the way the Seahawks are selling tickets to the AFC title game. They aren't letting fans from the state of their opponents, the 49ers, buy tickets. They are only being sold locally.

"...fans wanting to cheer on the Niners in the January 19th NFC Championship Game in Seattle will not be able to buy tickets through the Seahawks, as the team is restricting sales to only zip codes in Washington, Oregon, Montana, Idaho, Alaska, Hawaii, and parts of Canada."

This ticket ban is aimed at keeping both distant ticket scalpers and opposing fans out of the ticket buying process. The tickets would sell out either way, so this is unlikely to impact the Seahawks organization financially - if anything the slight increase in home field advantage that this generates helps raise their longterm value. What the restriction really does is gives more consumer surplus to Seahawks fans. People who buy tickets are getting something worth much more than face value, as suggested by the inflated price of tickets on secondary markets, so keeping tickets local means more Seahawks fans will benefit.

One of the big selling points that sports teams arguing for stadium subsidies use is that it brings in tourists for local businesses. Seattle's stadium, CenturyLink Field, was publicly funded after a long debate. And this game will surely bring in fans from outside of Seattle, but there is no question that making the visiting team's fans buy tickets on the secondary market will mean fewer visitors. It will be interesting to see if this gets brought up the next time an owner threatens to leave a city without public funding (especially if the Seahawks need a new stadium at some point in the next few decades).

Unfortunately that probably won't be the case - there has been agreement among economists that subsidies are a waste of public money for some time, and yet subsidies persist almost every time a team threatens to leave a city without a team. Maybe proponents of public funding for stadiums should just come out and admit that the subsidy is for local sports fans and isn't about economic development.

Indirect Spending and Uber's Self Interested Surges

The farther people get away from handing over cash, the less inclined they are to count their dollars closely.  Nowadays stores need to accept credit cards because very few people carry sufficient amounts of cash, but when stores started to accept credit cards and agreed to pay the fees it was because they realized that customers would buy a lot more when cash didn't change hands right away and utilizing a credit card was more convenient than offering and managing store credit. Academic studies have long found this to be the case as well. The introduction to a 2001 paper by Prelac and Simester, Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay, lays out some of the history.

"Since the 1970's there has been growing evidence supporting the frequently heard conjecture that credit cards encourage spending. For example, it is known that peoplewho own more credit cards make larger purchases per department store visit (Hirschman  1979), and that restaurant tips are larger when payment is by card (Feinberg 1986). There  is also evidence that credit card users are more likely to underestimate or forget the amount spent on recent purchases (Soman 1999). Perhaps the most compelling evidence, however, is that offered in an experimental analysis of the effect by Feinberg (1986). In that investigation participants were asked how much they would be willing to spend for various consumer products in a setting where credit card paraphernalia ostensibly unrelated to the task were displayed on the experimental desk. He found that by so decorating the experimental setting, he could boost hypothetical willingness-to-pay estimates by 50± 200%, relative to the estimates of a control group. We refer to this increase as the credit card premium."

If the mechanism for increasing the willingness to pay isn't liquidity but the indirect nature of the transaction, then making the transaction even more indirect should increase the willingness to pay even more. It's a large part of why subscription models and cellphone based payment systems are so popular these days. Consumers like the convenience and companies like the additional spending. The most talked about startup taking advantage of indirect spending is Uber, in which consumers just call a car on their phone and don't have to deal with inputting their credit card after the first time. They don't even have to look at the final price of the service as they leave the car if they don't want to look at their phone - the bill still settles.

However, things sometimes come to a head when the indirect spending is so high that consumers feel ripped off afterwards. Uber calls their prices during periods when supply is low relative to demand "surge pricing."  After NYE and a few snowstorms, times when prices need to rise for supply to meet demand, the consumer hangover has been enough to generate articles about the issue in the NYT  (Hat Tip: Huey K), among other places. Uber's justification is that without their dynamic pricing there would be shortages. But as the NYT mentions, an entity moving pricing up and down to accommodate demand in real time is very different from facilitating a real market where the bidding price of the consumers and the asking price of drivers are transparent to each other. Exposing just how much a price increase brings in new drivers would go a long way towards reducing consumer anger over high prices.

And given that Uber takes a 20% cut of their 7x surge prices (Lyft's cut remains the same when they raise prices), they are anything but a disinterested broker trying to optimize supply and demand - surges mean profits. The combination of consumers being disconnected from the payment process and pseudo monopoly pricing power is a dangerous one, as many people have found out the day after NYE. Frequent users of Uber should hope that competitors such as Lyft remain viable in the face of Uber's price cuts to their discount service. It would be interesting to see how profitable a business utilizing convenient indirect payments could get in the absence of effective competition.