What We’re Reading (Week Ending 12 May 2024) - 12 May 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went 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 12 May 2024):
1. From Blueprint to Therapy: The Evolution and Challenges of Nucleic Acid Interventions – Biocompounding
Nucleic Acid Therapies (NATs) offer a targeted approach to rectify these underlying genetic issues. By employing strategies like antisense oligonucleotides, mRNA therapy, RNA interference, or CRISPR-based gene editing, NATs can directly modify or regulate the expression of genes responsible for the disease. These therapies can repair or silence defective genes, replace missing genes, or modulate gene expression, thereby addressing the root cause of the disease at the molecular level. This precision in targeting genetic defects makes NATs a promising and revolutionary approach in modern medicine, potentially offering cures or significant treatment improvements for numerous genetic and acquired diseases.
The modalities of NATs vary based on their mechanism of action, type of nucleic acid used, and therapeutic goals. Here’s an introduction to the different modalities of NATs:
- Antisense Oligonucleotides (ASOs): These are short, synthetic strands of DNA or RNA that are designed to bind to specific RNA molecules within a cell. By binding to their target RNA, ASOs can interfere with the process of protein production. They can inhibit the expression of a gene, modify RNA splicing, or promote the degradation of the RNA molecule. ASOs are used in conditions like Duchenne Muscular Dystrophy and Spinal Muscular Atrophy. Example: Sarepta Therapeutics
- RNA Interference (RNAi): This modality uses small interfering RNA (siRNA) or microRNA (miRNA) to silence specific genes. RNAi works by degrading the mRNA of a target gene, preventing it from being translated into a protein. This approach is particularly useful in diseases where inhibiting the expression of a certain gene can be therapeutic. RNAi has been explored for various applications including cancer therapy and viral infections. Currently FDA-approved siRNAs are used in conditions such as Hereditary transthyretin-mediated amyloidosis. Example: Alnylam Pharmaceuticals
- AAV Gene Therapy: Adeno-associated virus (AAV) vectors are commonly used in gene therapy. AAVs are small viruses that can deliver genetic material into cells without causing disease. In AAV gene therapy, the therapeutic gene is packaged into an AAV vector, which then delivers the gene into patient’s cells. This modality is useful for treating genetic disorders, such as Hemophilia A, by providing a functional copy of a defective or missing gene. Example: Spark Therapeutics
- mRNA Therapy: mRNA therapies involve the use of messenger RNA to produce therapeutic proteins inside the body. Unlike traditional gene therapy that alters the DNA within cells, mRNA therapy delivers mRNA that is translated into the desired protein, offering a temporary but effective treatment. This approach has gained significant attention, especially in the development of COVID-19 vaccines. Currently there are several attempts to develop cancer vaccines by the key players in this space. Example: Moderna, BioNTech, Pfizer
- CRISPR/Cas9 and Genome Editing: This revolutionary technology enables precise editing of the genome. CRISPR/Cas9 can be used to add, delete, or alter specific DNA sequences in the genome, offering the potential to correct genetic defects at their source. While still in the experimental stages for many applications, it holds promise for treating a range of genetic disorders. In Dec 2023, the first ever FDA-approved CRISPR-based gene therapy was used to treat sickle cell disease. Example: CRISPR Therapeutics, Vertex
2. China Is Still Rising – Nicholas Lardy
Those who doubt that China’s rise will continue point to the country’s weak household spending, its declining private investment, and its entrenched deflation. Sooner than overtake the United States, they argue, China would likely enter a long recession, perhaps even a lost decade.
But this dismissive view of the country underestimates the resilience of its economy. Yes, China faces several well documented headwinds, including a housing market slump, restrictions imposed by the United States on access to some advanced technologies, and a shrinking working-age population. But China overcame even greater challenges when it started on the path of economic reform in the late 1970s. While its growth has slowed in recent years, China is likely to expand at twice the rate of the United States in the years ahead.
Several misconceptions undergird the pessimism about China’s economic potential…
…A second misconception is that household income, spending, and consumer confidence in China is weak. The data do not support this view. Last year, real per capita income rose by 6 percent, more than double the growth rate in 2022, when the country was in lockdown, and per capita consumption climbed by nine percent. If consumer confidence were weak, households would curtail consumption, building up their savings instead. But Chinese households did just the opposite last year: consumption grew more than income, which is possible only if households reduced the share of their income going to savings…
…Another misconception concerns the potential for a collapse in property investment. These fears are not entirely misplaced; they are supported by data on housing starts, the number of new buildings on which construction has begun, which in 2023 was half what it was in 2021. But one has to look at the context. In that same two-year period, real estate investment fell by only 20 percent, as developers allocated a greater share of such outlays to completing housing projects they had started in earlier years. Completions expanded to 7.8 billion square feet in 2023, eclipsing housing starts for the first time. It helped that government policy encouraged banks to lend specifically to housing projects that were almost finished; a general easing of such constraints on bank loans to property developers would have compounded the property glut…
…By 2014, private investment composed almost 60 percent of all investment—up from virtually zero percent in 1978. As private investment is generally more productive than that of state companies, its expanding share of total investment was critical to China’s rapid growth over this period. This trend went into reverse after 2014 when Xi Jinping, having just assumed the top leadership position, aggressively redirected resources to the state sector. The slowdown was modest at first, but by 2023, private investment accounted for only 50 percent of total investment…
…But here again, the pessimism is not supported by the data. First, almost all the decline in the private share of total investment after 2014 resulted from a correction in the property market, which is dominated by private companies. When real estate is excluded, private investment rose by almost ten percent in 2023. Although some prominent Chinese entrepreneurs have left the country, more than 30 million private companies remain and continue to invest.
3. The Cloud Under The Sea – Josh Dzieza
In the family tree of professions, submarine cable work occupies a lonely branch somewhere between heavy construction and neurosurgery. It’s precision engineering on a shifting sea using heavy metal hooks and high-tension lines that, if they snap, can cut a person in half. In Hirai’s three decades with Kokusai Cable Ship Company (KCS), he had learned that every step must be followed, no matter how chaotic the situation. Above all else, he often said, “you must always be cool.”…
…The world’s emails, TikToks, classified memos, bank transfers, satellite surveillance, and FaceTime calls travel on cables that are about as thin as a garden hose. There are about 800,000 miles of these skinny tubes crisscrossing the Earth’s oceans, representing nearly 600 different systems, according to the industry tracking organization TeleGeography. The cables are buried near shore, but for the vast majority of their length, they just sit amid the gray ooze and alien creatures of the ocean floor, the hair-thin strands of glass at their center glowing with lasers encoding the world’s data.
If, hypothetically, all these cables were to simultaneously break, modern civilization would cease to function. The financial system would immediately freeze. Currency trading would stop; stock exchanges would close. Banks and governments would be unable to move funds between countries because the Swift and US interbank systems both rely on submarine cables to settle over $10 trillion in transactions each day. In large swaths of the world, people would discover their credit cards no longer worked and ATMs would dispense no cash. As US Federal Reserve staff director Steve Malphrus said at a 2009 cable security conference, “When communications networks go down, the financial services sector does not grind to a halt. It snaps to a halt.”…
…Fortunately, there is enough redundancy in the world’s cables to make it nearly impossible for a well-connected country to be cut off, but cable breaks do happen. On average, they happen every other day, about 200 times a year. The reason websites continue to load, bank transfers go through, and civilization persists is because of the thousand or so people living aboard 20-some ships stationed around the world, who race to fix each cable as soon as it breaks.
The industry responsible for this crucial work traces its origins back far beyond the internet, past even the telephone, to the early days of telegraphy. It’s invisible, underappreciated, analog. Few people set out to join the profession, mostly because few people know it exists…
…Once people are in, they tend to stay. For some, it’s the adventure — repairing cables in the churning currents of the Congo Canyon, enduring hull-denting North Atlantic storms. Others find a sense of purpose in maintaining the infrastructure on which society depends, even if most people’s response when they hear about their job is, But isn’t the internet all satellites by now? The sheer scale of the work can be thrilling, too. People will sometimes note that these are the largest construction projects humanity has ever built or sum up a decades-long resume by saying they’ve laid enough cable to circle the planet six times…
…The world is in the midst of a cable boom, with multiple new transoceanic lines announced every year. But there is growing concern that the industry responsible for maintaining these cables is running perilously lean. There are 77 cable ships in the world, according to data supplied by SubTel Forum, but most are focused on the more profitable work of laying new systems. Only 22 are designated for repair, and it’s an aging and eclectic fleet. Often, maintenance is their second act. Some, like Alcatel’s Ile de Molene, are converted tugs. Others, like Global Marine’s Wave Sentinel, were once ferries. Global Marine recently told Data Centre Dynamics that it’s trying to extend the life of its ships to 40 years, citing a lack of money. One out of 4 repair ships have already passed that milestone. The design life for bulk carriers and oil tankers, by contrast, is 20 years.
“We’re all happy to spend billions to build new cables, but we’re not really thinking about how we’re going to look after them,” said Mike Constable, the former CEO of Huawei Marine Networks, who gave a presentation on the state of the maintenance fleet at an industry event in Singapore last year. “If you talk to the ship operators, they say it’s not sustainable anymore.”
He pointed to a case last year when four of Vietnam’s five subsea cables went down, slowing the internet to a crawl. The cables hadn’t fallen victim to some catastrophic event. It was just the usual entropy of fishing, shipping, and technical failure. But with nearby ships already busy on other repairs, the cables didn’t get fixed for six months. (One promptly broke again.)
But perhaps a greater threat to the industry’s long-term survival is that the people, like the ships, are getting old. In a profession learned almost entirely on the job, people take longer to train than ships to build.
“One of the biggest problems we have in this industry is attracting new people to it,” said Constable. He recalled another panel he was on in Singapore meant to introduce university students to the industry. “The audience was probably about 10 university kids and 60 old gray people from the industry just filling out their day,” he said. When he speaks with students looking to get into tech, he tries to convince them that subsea cables are also part — a foundational part — of the tech industry…
…To the extent he is remembered, Cyrus Field is known to history as the person responsible for running a telegraph cable across the Atlantic Ocean, but he also conducted what at the time was considered an equally great technical feat: the first deep-sea cable repair.
Field, a 35-year-old self-made paper tycoon, had no experience in telegraphy — which helps explain why, in 1854, he embarked on such a quixotic mission…
…“When it was first proposed to drag the bottom of the Atlantic for a cable lost in waters two and a half miles deep, the project was so daring that it seemed to be almost a war of the Titans upon the gods,” wrote Cyrus’ brother Henry. “Yet never was anything undertaken less in the spirit of reckless desperation. The cable was recovered as a city is taken by siege — by slow approaches, and the sure and inevitable result of mathematical calculation.”
Field’s crew caught the cable on the first try and nearly had it aboard when the rope snapped and slipped back into the sea. After 28 more failed attempts, they caught it again. When they brought it aboard and found it still worked, the crew fired rockets in celebration. Field withdrew to his cabin, locked the door, and wept.
Cable repair today works more or less the same as in Field’s day. There have been some refinements: ships now hold steady using automated dynamic positioning systems rather than churning paddle wheels in opposite directions, and Field’s pronged anchor has spawned a medieval-looking arsenal of grapnels — long chains called “rennies,” diamond-shaped “flat fish,” spring-loaded six-blade “son of sammys,” three-ton detrenchers with seven-foot blades for digging through marine muck — but at its core, cable repair is still a matter of a ship dragging a big hook along the ocean floor. Newfangled technologies like remotely operated submersibles can be useful in shallow water, but beyond 8,000 feet or so, conditions are so punishing that simple is best…
…Debates about the future of cable repair have become a staple of industry events. They typically begin with a few key facts: the ships are aging; the people are aging; and it’s unclear where the money will come from to turn things around.
For much of the 20th century, cable maintenance wasn’t a distinct business; it was just something giant, vertically integrated telecom monopolies had to do in order to function. As they started laying coaxial cables in the 1950s, they decided to pool resources. Rather than each company having its own repair vessel mostly sitting idle, they divided the oceans into zones, each with a few designated repair ships.
When the telcos were split up at the turn of the century, their marine divisions were sold off. Cable & Wireless Marine became Global Marine. AT&T’s division is now the New Jersey-based SubCom. (Both are now owned by private equity companies; KCS remains a subsidiary of KDDI.) The zone system continued, now governed by contracts between cable owners and ship operators. Cable owners can sign up with a nonprofit cooperative, like the Atlantic Cable Maintenance & Repair Agreement, and pay an annual fee plus a day rate for repairs. In exchange, the zone’s three ships — a Global Marine vessel in Portland, UK, another in Curaçao, and an Orange Marine vessel in Brest, France — will stand ready to sail out within 24 hours of being notified of a fault.
This system has been able to cope with the day-to-day cadence of cable breaks, but margins are thin and contracts are short-term, making it difficult to convince investors to spend $100 million on a new vessel.
“The main issue for me in the industry has to do with hyperscalers coming in and saying we need to reduce costs every year,” said Wilkie, the chair of the ACMA, using the industry term for tech giants like Google and Meta. “We’d all like to have maintenance cheaper, but the cost of running a ship doesn’t actually change much from year to year. It goes up, actually. So there has been a severe lack of investment in new ships.”
At the same time, there are more cables to repair than ever, also partly a result of the tech giants entering the industry. Starting around 2016, tech companies that previously purchased bandwidth from telcos began pouring billions of dollars into cable systems of their own, seeking to ensure their cloud services were always available and content libraries synced. The result has been not just a boom in new cables but a change in the topology of the internet. “In the old days we connected population centers,” said Constable, the former Huawei Marine executive. “Now we connect data centers. Eighty percent of traffic crossing the Atlantic is probably machines talking to machines.”…
…In 2022, the industry organization SubOptic gathered six cable employees in their 20s and 30s for a panel on the future of the industry. Most of them had stumbled into their jobs inadvertently after college, and the consensus was that the industry needed to be much better about raising public awareness, especially among the young.
“I don’t know if anyone saw, but during the pandemic, submarine cables actually went viral on TikTok,” said one panelist, a young cable engineer from Vodafone. “People didn’t know they existed, and then suddenly, out of nowhere, they were viral. I think it’s engaging with youth and children through their own avenues — yes, you can have science museums and things like that, but they are online, they are on their iPads, they’re on their phones.”
“We’ve got some pretty senior decision-makers and influencers in the subsea cable industry here,” said one audience member. “Did any of us know that we went viral on TikTok?” he asked, to laughter.
“As this panel rightfully said upfront, it’s not that we have a brand problem,” said another audience member, “we just don’t have a brand at all.”
4. Looking for AI use-cases – Benedict Evans
I’ve been thinking about this problem a lot in the last 18 months, as I’ve experimented with ChatGPT, Gemini, Claude and all the other chatbots that have sprouted up: ‘this is amazing, but I don’t have that use-case’.
The one really big use-case that took off in 2023 was writing code, but I don’t write code. People use it for brainstorming, and making lists and sorting ideas, but again, I don’t do that. I don’t have homework anymore. I see people using it to get a generic first draft, and designers making concept roughs with MidJourney, but, again, these are not my use-cases. I have not, yet, found anything that matches with a use-case that I have. I don’t think I’m the only one, either, as is suggested by some of the survey data – a lot of people have tried this, especially since you don’t need to spend $12,000 on a new Apple II, and it’s very cool, but how much do we use it, and what for?…
…Suppose you want to analyse this month’s customer cancellations, or dispute a parking ticket, or file your taxes – you can ask an LLM, and it will work out what data you need, find the right websites, ask you the right questions, parse a photo of your mortgage statement, fill in the forms and give you the answers. We could move orders of magnitude more manual tasks into software, because you don’t need to write software to do each of those tasks one at a time. This, I think, is why Bill Gates said that this is the biggest thing since the GUI. That’s a lot more than a writing assistant.
It seems to me, though, that there are two kinds of problem with this thesis.
The narrow problem, and perhaps the ‘weak’ problem, is that these models aren’t quite good enough, yet. They will get stuck, quite a lot, in the scenarios I suggested above. Meanwhile, these are probabilistic rather than deterministic systems, so they’re much better for some kinds of task than others. They’re now very good at making things that look right, and for some use-cases this is what you want, but for others, ‘looks right’ is different to ‘right’…
…The deeper problem, I think, is that no matter how good the tech is, you have to think of the use-case. You have to see it. You have to notice something you spend a lot of time doing and realise that it could be automated with a tool like this…
…The cognitive dissonance of generative AI is that OpenAI or Anthropic say that we are very close to general-purpose autonomous agents that could handle many different complex multi-stage tasks, while at the same time there’s a ‘Cambrian Explosion’ of startups using OpenAI or Anthropic APIs to build single-purpose dedicated apps that aim at one problem and wrap it in hand-built UI, tooling and enterprise sales, much as a previous generation did with SQL. Back in 1982, my father had one (1) electric drill, but since then tool companies have turned that into a whole constellation of battery-powered electric hole-makers. One upon a time every startup had SQL inside, but that wasn’t the product, and now every startup will have LLMs inside.
I often compared the last wave of machine learning to automated interns. You want to listen to every call coming into the call centre and recognise which customers sound angry or suspicious: doing that didn’t need an expert, just a human (or indeed maybe even a dog), and now you could automate that entire class of problem. Spotting those problems and building that software takes time: machine learning’s breakthrough was over a decade ago now, and yet we are still inventing new use-cases for it – people are still creating companies based on realising that X or Y is a problem, realising that it can be turned into pattern recognition, and then going out and selling that problem.
You could propose the current wave of generative AI as giving us another set of interns, that can make things as well as recognise them, and, again, we need to work out what. Meanwhile, the AGI argument comes down to whether this could be far, far more than interns, and if we had that, then it wouldn’t be a tool anymore.
5. TIP622: Finding Certainty In An Uncertain World w/ Joseph Shaposhnik – Clay Finck and Joseph Shaposhnik
[00:29:29] Joseph Shaposhnik: I think of the credit bureaus and I think of a partner of theirs, which we’ll spend a minute talking about in a second, but. As you may know, the credit bureaus, there’s three of them in the United States. And they run an incredible oligopoly. If you want to secure a mortgage, get a car loan, rent a home, they’re involved in all of those decision making situations by the owners of those assets.
[00:29:55] Joseph Shaposhnik: As an example, if you go for a mortgage, all three credit bureaus will be pinned to get a score on you. All of them will be paid a couple of dollars for that score and all of that information that they’re pulling is contributory data. So there’s a relatively insignificant amount of incremental cost to generate that score and deliver it to the customer.
[00:30:21] Joseph Shaposhnik: You know, it’s a 95% incremental margin business. I mean, this is an incredible business. It’s basically an override on all economic activity in the United States and outside the United States where they play. And they’re just incredible businesses. But surprisingly not incredible stocks. You know, how could that be?
[00:30:40] Joseph Shaposhnik: It’s shocking to give you a sense organic growth if you look back, the last 5 years for the businesses have been approximately 7% a year. So, 3 or 4 times. Global GDP or U.S. GDP. They’ve outgrown the S&P the average S&P business over that period of time. They started with 30% EBITDA margins at the beginning of the 5 year period, so very profitable businesses.
[00:31:09] Joseph Shaposhnik: Yet over the last five years, two out of the three credit bureaus have underperformed the S&P, and over a 10 year period, they’ve been just in line performers with the S&P and so, I mean, they run an oligopoly. How could that possibly be? I used to be the credit bureau analyst at TCW, so I’m very familiar with these businesses, and they’re just incredible companies.
[00:31:33] Joseph Shaposhnik: And what happened is all three of these businesses spent more money on M&A than they generated in free cash flow over that five year period of time. They spent more money on M&A than all of the free cash flow they generated over the last five years. And they generate a lot of free cash flow. And let me say, let me just tell you, this is not on synergistic M&A.
[00:31:57] Joseph Shaposhnik: This was, I mean, they would call it synergistic, but it’s very difficult to synergize a near utility that they operate. And instead of just sticking to their knitting, they decided to acquire a lot of different data assets. that were incredibly expensive, generally from private equity, which doesn’t give assets away.
[00:32:18] Joseph Shaposhnik: And those returns are always, the returns on those businesses are always going to be lower than the returns on this incredible oligopoly that they run. And so, as interestingly as that, so of course, margins have been under pressure, returns have gone way down for these businesses because of all the acquisitions, these poor acquisitions at high multiples.
[00:32:42] Joseph Shaposhnik: And one of the most surprising things is we looked at the data on this, two out of the three businesses engaged in near zero share of purchases over that five year period of time. So you have this incredible business, you know, these three businesses that run an oligopoly, basically just an override on all economic activity.
[00:33:03] Joseph Shaposhnik: And they find all of these other businesses more attractive to allocate capital to than their own business, which is a 95% incremental margin business. Incredible. No wonder the stocks have not performed well, even though those businesses and those stocks should be like shooting fish in a barrel.
[00:33:20] Joseph Shaposhnik: So it’s incredible they bought back no, no stock, two out of the three businesses bought back no meaningful amount of stock. And not surprisingly, those businesses underperformed. In contrast to that, they have a partner, which is Fair Isaacs. And so Fair Isaacs, which is, the ticker is FICO provides the formula to the credit bureaus, which generates the score.
[00:33:44] Joseph Shaposhnik: The credit bureaus contribute the data. and the data with the formula creates a score that they can then sell to their end customers. So the bureaus pay FICO a fee for the formula, and they take the formula, and they generate a score, and they sell it to their customer. So you would think that FICO is basically in this ecosystem, has similar growth dynamics, has similar returns going into that 5 year period of time, similar EBITDA margins, tied to the same end markets, relatively similar company.
[00:34:17] Joseph Shaposhnik: Yet, over that five year period of time, FICO took all of its free cash flow, all of it, and used it to repurchase its shares. And so over the last five years, FICO has reduced share count by 20%, has engaged in no meaningful acquisitions to dilute its incredible franchise, and has generated a five bagger over the last five years.
[00:34:44] Joseph Shaposhnik: compared to the bureaus that have generated 15 to 100% return, total return over that 5 year period of time. So, a 5 bagger, which has outperformed the market by a ton, compared to an underperforming or an inline performance for the bureaus, I think just tells the tale of how important great capital allocation decision making is, how important it is to be aligned with a management team that understands how to generate value for shareholders.
[00:35:13] Joseph Shaposhnik: And I think for us and for everybody, serves as a warning when we think about investing with teams that are acquiring businesses in general and certainly acquiring businesses That are not as attractive as the core business. So capital allocation makes or breaks stories all the time, and incentives generally drive these decisions, but often times it just takes and an investor oriented CEO to see the big opportunity, which is usually in its core and not far afield.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in Alphabet (parent of Google) and Meta Platforms. Holdings are subject to change at any time.
