What We’re Reading (Week Ending 07 March 2021) - 07 Mar 2021

Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 07 March 2021):

1. The Cost of Convenience – Max Kim

Coupang — a portmanteau of coupon and the sound of one going off: pang! — was launched in August 2010 by Kim Beom-seok, a Korean American in his early 30s, as a daily-deals “social commerce” venture modeled on Groupon. Launched with backing from Clayton Christensen’s Disruptive Innovation Fund, it was turning a modest profit by 2012, when Kim — who goes by “Bom Kim” in English — decided to take the company public on the Nasdaq.

The weekend before the listing was due, Bom Kim pulled the plug. His vision, he had said in numerous interviews, was to create something that left customers saying, “How did I ever live without Coupang?” — and his company wasn’t that. From then on, the company would model itself not on Groupon, but on Amazon.

By 2015, Coupang had built something that surpassed even Amazon: a long, unbroken supply chain, whereby products moved seamlessly from warehouse to driver to customer, with 99% of orders delivered within 24 hours, all year and 7 days a week. (Amazon has since made a similar delivery network.) In 2016, Coupang was named one of the 50 Smartest Companies by MIT Technology Review. The same year, Bom Kim appeared on Forbes’ “Global Game Changers” list with the tagline “beating Jeff Bezos at his own game.”

Like Bezos, Bom Kim had rightly predicted that faster and “frictionless” delivery — not just competitive pricing and wide selections — would be the future of e-commerce. And with its dense, smartphone-friendly urban populations, South Korea was close to a perfect market. At the time, a slate of third-party marketplaces and Groupon imitators made up most of the country’s e-commerce sector.

“In modeling itself after Amazon by investing aggressively in its own logistical infrastructure, Coupang swooped in and set an entirely new standard for e-commerce [in South Korea],” says Im Il, a professor at the Yonsei University School of Business in Seoul. “It eventually sparked both a price war and a delivery war across the entire market.”…

…To cement Coupang’s control over the last mile, Bom Kim did something that few others in the industry wanted to: he hired his own drivers.

In March 2014, the company launched what has since become its crowning achievement, Rocket Delivery, starting with 50 “Coupang Men” — full-time drivers in branded trucks — who guaranteed next-day delivery of packages, which the company calls “gifts.”

Referred to internally as “spreaders of happiness,” Coupang Men were the spiritual ambassadors of the company. To win over female customers in their 20s and 30s — a key demographic — Coupang Men handed out flowers and handwritten cards, snapped photos of packages to confirm delivery, and would know not to ring the doorbell at homes with babies.

Bom Kim called them “the weapon that Amazon doesn’t have.” And unlike local shipping companies, which hired fleets of drivers on precarious temp contracts, Coupang Men were given a fair wage, full insurance coverage, annual health checkups, 15 vacation days a year, and company trucks and gas…

…The toll of this rapid growth is not only financial. The pace of expansion and the demand for maximum speed and efficiency have placed an enormous burden on the people who work fulfilling Coupang’s orders…

…Tae-il, who is stocky with shaggy hair, is wearing his Coupang polo and navy-blue wraps on his arms and knees. He has just picked up the 300 or so packages he will be delivering today from the nearby delivery camp. These apartments are his first stop.

“I have 180 homes today,” he says by way of greeting. His truck is one of the newer models, which supposedly eliminate dead space with sliding side doors that open into three horizontal shelves. The truck is packed to the brim, with boxes squeezed into even the passenger seat. When Tae-il yanks the sliding door open, an avalanche of stuff spills out. Asked how the AI system that orchestrates the loading process works, he answers with an exasperated laugh: “AI? It’s humans that do this work.”…

…Far from the idealized image of the Coupang Man as a “spreader of happiness,” Tae-il, who works 52 hours, five days a week, has a beleaguered air about him. When asked why he’s not writing any personalized letters or dropping off candy, Tae-il sneers. “Not a single person does that anymore. If you do, you get called an idiot. And you will probably get written up for not making deliveries,” he says.

2. How Does the Stock Market Perform When Interest Rates Rise? – Ben Carlson

But it’s also worth remembering the stock market generally holds up well when rates are rising…

…Surprisingly, growth has performed even better than value in large, mid and small cap stocks when rates have risen in the past.

It may also be instructive to look at some historical examples of rising rate environments.

From 1954-1960, the 10 year treasury yield went from 2.3% to 4.7%. In that time, the S&P 500 was up 207% in total (17.4% annualized).

Then from 1971-1981, rates went vertical, rising from 6.2% to 13.7%. This period included sky-high inflation and the brutal 1973-1974 crash, but nominal returns were still pretty decent, at 113% in total (7.1% annual).

From 1993-1994, rates shot up from 6.6% to 8.0%. The S&P 500 was still up nearly 12% in total despite some carnage in the bond market.

At the tail-end of the dot-com bubble, rates rose from 5.5% in 1998 to 6.5% in 1999. Didn’t matter. Stocks were up more than 55% (although that was followed by a 50% crash beginning in early-2000).

From 2003 through 2007, rates went from 3.3% to 5.1%. The S&P rose nearly 83% (12.8% annualized) before the onset of the 2008 crash.

And the latest rising rate environment saw the 10 year go from 1.5% in 2012 to 3% by 2018. Even with the mini-bear market at the end of 2018, stocks were still up 131% in total.

Could rising rates lead to a stock market crash? Yes, that is possible.

Do we know what level of rates will potentially cause a crash? Nope.

Should the stock market care if interest rates are rising for the right reason? Time will tell.

Are tech stocks being propped up by extremely low interest rates? We’ll see.

The problem with the current rate environment is we’ve never experienced interest rates this low before. Maybe investors will become spooked at lower rates than they have in the past. Maybe markets will be given the benefit of the doubt if the economy is chugging along.

3. Google’s Latest Chess Move is Great News for the Open Internet – Jeff Green

Yesterday Google made yet another announcement regarding its approach to the future of identity. And in the 24 hours since then, I’ve fielded dozens of calls about what this means for the open internet and for The Trade Desk.

The short answer? Not much has changed. But what has changed, will ultimately prove positive.

To be clear, Google’s announcement went a step further than they had previously. Specifically, Google stated that “today, we’re making explicit that once third-party cookies are phased out, we will not build alternate identifiers to track individuals as they browse across the web, nor will we use them in our products.”

On the surface, that may not seem like news. Cookies are going away after all. Nothing new there. You already knew that. And, of course, cookies only impact the browsing internet. That’s about 20% of data-driven ads today. 20% is meaningful, but the open Internet has already created an alternative to third-party cookies — Unified ID 2.0. Additionally, cookies don’t matter much to the fastest growing areas of the digital advertising ecosystem, such as CTV. With CTV, consumers log in with an email or phone number and that login helps create everything from customized viewing recommendations to a better ad experience that features fewer, more relevant ads. And this is critical for content owners, who rely on advertising to pay for that expensive content. In this new golden era of TV content quality, ad revenue is crucial to almost every content creator except for Netflix.

Rather, the new revelation is that Google will not rely on any identifiers that they don’t own.

Why is that important? In any chess match, eventually you have to let pieces go. You trade a less valuable piece for those that matter most. Google is making a trade. With this announcement, Google is doubling down on its own properties, such as search and YouTube and adding bricks to the walls around those properties. The trade-off is that Google no longer values serving ads on the rest of the internet as much — certainly not as much as they once did. DoubleClick, the ad server and the ad exchange, will be operating at a small disadvantage going forward. DV360 will likely be in a similar position. On the open internet, they will not use alternative identifiers to cookies, but everyone else will.

Those alternatives, especially Unified ID 2.0, eliminate the cookie syncing problem that once hurt the open internet’s ability to scale. But perhaps most important, Unified ID 2.0 has been designed with the consumer in the driver’s seat. The consumer’s information is not identifiable. The consumer controls how their data is shared. And the consumer gets a simple, clear explanation of the value exchange of relevant advertising in return for free content. With this approach, Unified ID 2.0 has the best opportunity to become a new common currency of the open internet. It’s already beginning. It is a common currency that pays off the value exchange of the internet in a way that benefits publishers, advertisers and consumers. It is also one that cannot be controlled by any one company, including Apple or Google.

4. Twitter thread on the future of the cable TV industry – Matthew Ball

1/ I want to talk about cord cutting and how current forecasts/models are fundamentally flawed (in the technical sense)

I’ve been tracking this for years, and faulty estimates have always stemmed from a focus on cutting rates rather than leading indicators: usage and investment

2/ I describe the disruption-era Pay-TV ecosystem in three waves. It is critical to differentiate in order to prognostic. We are going into a fundamental new state, one never seen before.

I wrote about this here a year ago. Jan-Feb solidified it.

3/ Wave #1 is 2007-2015.

During this time, Pay-TV actually became MUCH better.

It’s VALUE got much better, too. 

Enormous surges in original TV quality (Mad Men, Breaking Bad, Thrones) + volumes (150 to 400 original scripted series per year) + RSN rights…

…5/ Wave #2: 2015-2019.

The Pay-TV ecosystem was still getting better (quality x volume) and now, finally, prices were coming down via vMVPDs. 

So we see a lot more/better content, plus lower prices. 

Two-sided value growth..

…7/ Wave #3: 2019-Present. 

For the first time ever, the Pay-TV ecosystem is getting *objectively* worse, defunded, underfunded, harvested. Disney takes half of FX’s slate and makes it exclusive to Hulu. Remaining half goes next day to Hulu with no/low ads, as does Hulu library…

…14/ This will not have a standard effect on cord cutting. It will not get steeper. Eventually, the floor will start to drop out

Live news/sports are the primary value drivers in the bundle today, true, but Paramount/Peacock now diverting these en masse too

15/ And the very companies that own the live sports/news networks are, for the first time, those driving the decline of Pay-TV too. They cannot do this while unaware of the harm being done to their other pockets, or without planning for further change

5. China’s “Semiconductor Theranos”: HSMC – Kevin Xu

China’s semiconductor ambition just had its first ponzi scheme fully exposed: Wuhan Hongxin Semiconductor Manufacturing (HSMC).

The HSMC ponzi scheme was led by a trio of characters, who have zero expertise in semiconductor (or anything tech related), but are experts in manipulating local government subsidies, construction contractors, a renowned but gullible former TSMC executive, and China’s desperate need for homegrown chips to pull of a heist so large it makes Theranos look amateur…

…Let’s first summarize the major elements of the HSMC heist that unfolded between late 2017 and early 2021 (which may read like a movie script, not real life):

Part I — the Trap:

• Throughout 2017, a man by the name of Cao Shan traveled across China looking for a local government to invest in his semiconductor scheme. (“Cao Shan” is actually a fake name this person uses, because his real name is already tainted by the scams he used to do back in his hometown.)
• Cao eventually found an accomplice, Mr. Long Wei, who worked his connections to get the City of Wuhan’s East-West Lake District Government to provide land and investment.
• Long brought another close friend into the fold: Ms. Li Xueyan, a small business owner who has opened restaurants and sold Chinese rice liquor.
• The trio — Cao, Long, Li — formed the board of directors of what became HSMC.

Part II — the Money:

• Throughout 2018, the trio worked to secure two sources of “income”: direct subsidies from the East-West Lake District Government (aka taxpayer money) and deposits from construction contractors who want to build the HSMC factory.
• Sourcing both government subsidies and contractor deposits is a strategy for scam factory projects to increase the amount of money to be scammed.
• The East-West Lake District Government decided to invest in HSMC partly because of its jealousy of a local rival district, which attracted and incubated a successful flash storage manufacturer.
• To make themselves look important and powerful, the trio would spread false rumors about their personal background. Long was rumored to be the grandson of some high-level official, while Li would pretend to be the sister of some other political figure.
• By May 2019, HSMC has received 6.5 billion RMB (~$1 billion USD) of investment from the district government. Cao and Long have quit the board, giving Li and her cronies full control. Cao began going to other provinces to set up similar ponzi schemes.

Part III — Chiang Shang-Yi, TSMC, and ASML:

• By June 2019, the trio targeted and successfully persuaded Chiang Shang-Yi, the legendary founding CTO of TSMC, to join HSMC as its CEO.
• To convince Chiang, HSMC spread false rumors publicly that it has already attracted 100 billion RMB (~$15 billion USD) of investments. They also took advantage of Chiang’s gullibility and professional insecurities. (At the time, Chiang was a consultant at SMIC, China’s largest chip foundry, with relatively little influence.)
• Using Chiang’s aura, HSMC started aggressively poaching engineers from TSMC with salary packages worth 2 to 2.5x more than what they were earning.
• Chiang also used his industry reputation to convince ASML, the Dutch company and world’s leading manufacturer of lithography equipment, to sell one DUV equipment to HSMC. (DUV is not the most advanced equipment, but this is still a huge coup given heavy US pressure at the time on the Dutch government to not sell to China.)
• December 2019, the ASML equipment was delivered to HSMC amidst huge fanfare. The company also secured more investment due to this accomplishment from the district government, totaling 15.3 billion RMB (~$2.4 billion USD).
• One month later, the same equipment was offered as collateral to a local Wuhan commercial bank for a 580 million RMB loan (~$90 million USD) — another new source of “income” for the heist.

Part IV — HSMC Collapses, Heist Completed:

• During the first half of 2020, while Wuhan was ravaged by the coronavirus, the trio began siphoning HSMC money away.
• One of its primary methods was conducting employee training programs with a company run by Li’s younger brother.
• HSMC also refused to pay its construction contractors money, owing tens of millions of dollars.
• By July 2020, it became clear that HSMC was a scam. Chiang left the company. The Wuhan city government started leaking news that HSMC is running out of money.
• By November 2020, Li was pushed out of the company and the East-West Lake District Government took full ownership of HSMC.
• By January 2021, Chiang rejoined SMIC. HSMC furloughed all its employees for 40 days and reduced salaries across the board.

6. What Is Quantum Computing? – CB Insights

Quantum computing is the processing of information that’s represented by special quantum states. By tapping into quantum phenomena like “superposition” and “entanglement,” these machines handle information in a fundamentally different way to “classical” computers like smartphones, laptops, or even today’s most powerful supercomputers.

Researchers have long predicted that quantum computers could tackle certain types of problems — especially those involving a daunting number of variables and potential outcomes, like simulations or optimization questions — much faster than any classical computer.

But now we’re starting to see hints of this potential becoming reality.

In 2019, Google said that it ran a calculation on a quantum computer in just a few minutes that would take a classical computer 10,000 years to complete. A little over a year later, a team based in China took this a step further, claiming that it had performed a calculation in 200 seconds that would take an ordinary computer 2.5B years — 100 trillion times faster.

Though these demonstrations don’t have practical use cases, they point to how quantum computers could dramatically change how we approach real-world problems like financial portfolio management, drug discovery, logistics, and much more.

Propelled by the prospect of disrupting countless industries and quick-fire announcements of new advances, quantum computing is attracting more and more attention from players including big tech, startups, governments, and the media.

7. When Everyone’s a Genius (A Few Thoughts on Speculation) – Morgan Housel

The end of a speculative boom can be inevitable but not predictable. Unsustainable things can last a long time. Identifying something that can’t go on forever doesn’t mean that thing can’t keep going for years. Years and years and years.

Part of it is emotion. During the Vietnam War Ho Chi Minh said, “You will kill ten of us, and we will kill one of you, but it is you who will tire first.” Emotional trends aren’t beholden to logic, which can keep them going far past any point of reason.

Part is storytelling. Unsustainable trends have life support if enough people think they’re true, and once people believe something’s true it gets hard to convince them it’s not. Or put differently: If enough people believe it’s true it’s just as powerful as actually being true.

Every investor is making bets on the future. It’s only called speculation when you disagree with someone else’s bet.

In hindsight there was as much speculation in the 1990s that Kodak and Sears would keep their market share as there was that eToys and Pets.com would gain market share. Both were bets on the future. Both were wrong. It happens.

Of course there’s a speculation spectrum. But let’s not pretend that others speculate while you only deal with certainties…

…Jim Grant once put it: “To suppose that the value of a stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.”

Optimism is the best long-term mindset. And it requires a certain level of believing things that can’t be verified, either because you don’t have the technical skills to verify them – nobody knows everything – or because something hasn’t happened yet but you think it will happen in the future. Not enough speculation is just as dangerous as too much speculation.

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Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Alphabet (parent of Google), Amazon, Apple, Netflix, and The Trade Desk. Holdings are subject to change at any time.