What We’re Reading (Week Ending 24 July 2022) - 24 Jul 2022
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 24 July 2022):
1. CRISPR, 10 Years On: Learning to Rewrite the Code of Life – Carl Zimmer
In just a decade, CRISPR has become one of the most celebrated inventions in modern biology. It is swiftly changing how medical researchers study diseases: Cancer biologists are using the method to discover hidden vulnerabilities of tumor cells. Doctors are using CRISPR to edit genes that cause hereditary diseases.
“The era of human gene editing isn’t coming,” said David Liu, a biologist at Harvard University. “It’s here.”
But CRISPR’s influence extends far beyond medicine. Evolutionary biologists are using the technology to study Neanderthal brains and to investigate how our ape ancestors lost their tails. Plant biologists have edited seeds to produce crops with new vitamins or with the ability to withstand diseases. Some of them may reach supermarket shelves in the next few years…
…Will the coming wave of CRISPR-altered crops feed the world and help poor farmers or only enrich agribusiness giants that invest in the technology? Will CRISPR-based medicine improve health for vulnerable people across the world, or come with a million-dollar price tag?
The most profound ethical question about CRISPR is how future generations might use the technology to alter human embryos. This notion was simply a thought experiment until 2018, when He Jiankui, a biophysicist in China, edited a gene in human embryos to confer resistance to H.I.V. Three of the modified embryos were implanted in women in the Chinese city of Shenzhen.
In 2019, a court sentenced Dr. He to prison for “illegal medical practices.” MIT Technology Review reported in April that he had recently been released. Little is known about the health of the three children, who are now toddlers.
Scientists don’t know of anyone else who has followed Dr. He’s example — yet. But as CRISPR continues to improve, editing human embryos may eventually become a safe and effective treatment for a variety of diseases.
Will it then become acceptable, or even routine, to repair disease-causing genes in an embryo in the lab? What if parents wanted to insert traits that they found more desirable — like those related to height, eye color or intelligence?
Françoise Baylis, a bioethicist at Dalhousie University in Nova Scotia, worries that the public is still not ready to grapple with such questions…
…In the 1980s, microbiologists discovered puzzling stretches of DNA in bacteria, later called Clustered Regularly Interspaced Short Palindromic Repeats. Further research revealed that bacteria used these CRISPR sequences as weapons against invading viruses.
The bacteria turned these sequences into genetic material, called RNA, that could stick precisely to a short stretch of an invading virus’s genes. These RNA molecules carry proteins with them that act like molecular scissors, slicing the viral genes and halting the infection.
As Dr. Doudna and Dr. Charpentier investigated CRISPR, they realized that the system might allow them to cut a sequence of DNA of their own choosing. All they needed to do was make a matching piece of RNA.
To test this revolutionary idea, they created a batch of identical pieces of DNA. They then crafted another batch of RNA molecules, programming all of them to home in on the same spot on the DNA. Finally, they mixed the DNA, the RNA and molecular scissors together in test tubes. They discovered that many of the DNA molecules had been cut at precisely the right spot.
For months Dr. Doudna oversaw a series of round-the-clock experiments to see if CRISPR might work not only in a test tube, but also in living cells. She pushed her team hard, suspecting that many other scientists were also on the chase. That hunch soon proved correct.
In January 2013, five teams of scientists published studies in which they successfully used CRISPR in living animal or human cells. Dr. Doudna did not win that race; the first two published papers came from two labs in Cambridge, Mass. — one at the Broad Institute of M.I.T. and Harvard, and the other at Harvard.
2. A Revolution Sweeping Railroads Upends How America Moves Its Stuff – Paul Ziobro
Freight railroads generally have operated the same way for more than a century: They wait for cargo and leave when customers are ready. Now railroads want to run more like commercial airlines, where departure times are set. Factories, farms, mines or mills need to be ready or miss their trips.
Called “precision-scheduled railroading,” or PSR, this new concept is cascading through the industry. Under pressure from Wall Street to improve performance, Norfolk Southern and other large U.S. freight carriers, including Union Pacific Corp. and Kansas City Southern, are trying to revamp their networks to use fewer trains and hold them to tighter schedules. The moves have sparked a stock rally that has added tens of billions of dollars to railroad values in the past six months as investors anticipate lower costs and higher profits.
The new approach was pioneered by the late railroad executive Hunter Harrison, who engineered turnarounds at two major Canadian railroads and Jacksonville, Fla.-based CSX Corp. by radically revamping their logistics.
His template won over Wall Street by boosting profits and stock prices, but it generated chaos on the tracks. The 2017 revamp at CSX caused crippling congestion east of the Mississippi River, jeopardizing operations at plants that made Pringles potato snacks, threatening deliveries of McDonald’s french fries and idling Cargill Inc. soybean-processing plants because of lack of railcars…
…“The board does not want to see any carrier implement so-called PSR the way CSX did,” said Ann Begeman, chairman of the Surface Transportation Board, the federal agency that oversees freight railroads. “It had unacceptable impacts on so many of its shippers and, frankly, other carriers.”
CSX spokesman Bryan Tucker said the company could have done better communicating the changes to customers, but he defended the actions by pointing to its financial results. He said CSX trains are running faster and with less downtime, and the railroad is hauling more cargo with fewer locomotives, railcars and employees.
Norfolk Southern estimates that its own plan will similarly allow its system to operate faster and more efficiently, while cutting about 3,000 employees from its current workforce of about 26,000 and shedding 500 locomotives from its fleet of about 4,100.
Ideally, the end result would be a more fluid railroad network that operates much like a moving conveyor belt, with fewer jams. It would allow shippers and customers to ship finished goods on a just-in-time basis, reducing carrying costs across the board.
Norfolk Southern is starting its overhaul with a process it calls “clean sheeting,” which involves dismantling and reassembling schedules and processes—one yard at a time…
…BNSF Railway Co., which operates alongside Union Pacific in the Western U.S., has resisted the industrywide push to cut capital spending and drastically change service plans. Executive Chairman Matthew Rose, who is scheduled to retire this month, said railroads that cut back on service risk pushback from regulators. Mr. Rose said BNSF, owned by Warren Buffett’s Berkshire Hathaway Inc., is focused on carrying more loads. “More volume leads to more investment,” he said.
Norfolk Southern, Kansas City Southern and Union Pacific all had service issues last year that they said exposed the perils of maintaining the status quo. When, in some cases, they responded by adding cars to handle the extra volume, congestion in some corridors got worse.
As Union Pacific tried to clear gridlock, it experimented with some strategies modeled after Mr. Harrison’s, which it then decided to adopt more broadly.
“We came to the realization that experimenting with pieces of precision-scheduled railroading was less effective on our network than going the whole way,” said Chief Executive Lance Fritz. The catalyst, he said, “was nothing more complex than our growing frustration and our customers’ growing frustration with the service product at that time.”
Norfolk’s Mr. Farrell, a 53-year-old former All American wrestler at Oklahoma State University, previously worked at both Canadian railroads where Mr. Harrison’s plan went into effect—Canadian National Railway Co. and Canadian Pacific Railway Ltd. At Norfolk Southern, he spent more than a year crisscrossing the network as a consultant to identify problem spots, a process he jokingly called the longest-ever episode of “Undercover Boss.”
After he formally joined the company in November, he ramped up clean-sheeting sessions. As of mid-February, the railroad says, trains were running 13% faster and dwelling 20% less in yards compared with last year.
3. Little Ways The World Works – Morgan Housel
If you find something that is true in more than one field, you’ve probably uncovered something particularly important. The more fields it shows up in, the more likely it is to be a fundamental and recurring driver of how the world works…
…Part of the second law of thermodynamics is that you get the most efficiency out of a system when the hottest heat source meets the coldest sink – that’s when an engine will waste the least amount of heat, converting as much energy into power as it can.
And isn’t it the same in business and careers?
A genius entering a crowded and competitive field may find a little success, but put her in a “cold” industry full of idiots and she’ll create a monopoly, destroying competitors. Jeff Bezos famously said “your margin is my opportunity,” which is the same concept. The biggest opportunities happen when a hot talent meets a cold industry. Thermodynamics has proven this since the beginning of the universe – no one should doubt how true and powerful it is…
…Muller’s ratchet (evolution): Dangerous mutations tend to pile up when there’s no genetic recombination, ultimately leading to extinction. It’s is why so few species reproduce asexually. In the absence of variety, bad ideas tend to stick around, which is also exactly what happens in closed societies and large corporations…
…Cope’s Rule (evolutionary biology): Species evolve to get bigger bodies over time, because there are competitive advantages to being big. But big has its own drawbacks, and can often be the cause of extinction. So the same force that pushes you to become big can also cause you to go extinct. It describes the lifecycle not only of species, but most companies and industries.
Emergence (complexity): When two plus two equals ten. A little cool air from the north is no big deal. A little warm breeze from the south is pleasant. But when they mix together over Missouri you get a tornado. The same thing happens in careers, when someone with a few mediocre skills mixed together at the right time becomes multiple times more successful than someone who’s an expert in one thing…
…Tocqueville Paradox (sociology): People’s expectations rise faster than living standards, so a society that becomes exponentially wealthier can see a decline in net happiness and satisfaction. There is virtually nothing people can’t get accustomed to, which also helps explain why there is so much desire for innovation and improvement.
Cromwell’s rule (statistics): Never say something cannot occur, or will definitely occur, unless it is logically true (1+1=1). If something has a one-in-a-billion chance of being true, and you interact with billions of things during your lifetime, you are nearly assured to experience some astounding surprises, and should always leave open the possibility of the unthinkable coming true.
Liebig’s law of the minimum (agriculture): A plant’s growth is limited by the single scarcest nutrient, not total nutrients – if you have everything except nitrogen, a plant goes nowhere. Liebig wrote, “The availability of the most abundant nutrient in the soil is only as good as the availability of the least abundant nutrient in the soil.” Most complex systems are the same, which makes them more fragile than we assume. One bad bank, one stuck container ship, or one broken supply line can ruin an entire system’s trajectory.
4. Munger on Airlines, Cereal Makers, and Bottlers – The Investments Blog
From this 1994 USC speech by Charlie Munger:
“Here’s a model that we’ve had trouble with. Maybe you’ll be able to figure it out better. Many markets get down to two or three big competitors—or five or six. And in some of those markets, nobody makes any money to speak of. But in others, everybody does very well.
Over the years, we’ve tried to figure out why the competition in some markets gets sort of rational from the investor’s point of view so that the shareholders do well, and in other markets, there’s destructive competition that destroys shareholder wealth.
If it’s a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the world—safe travel, greater experience, time with your loved ones, you name it. Yet, the net amount of money that’s been made by the shareholders of airlines since Kitty Hawk, is now a negative figure—a substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business.
Yet, in other fields—like cereals, for example—almost all the big boys make out. If you’re some kind of a medium grade cereal maker, you might make 15% on your capital. And if you’re really good, you might make 40%. But why are cereals so profitable—despite the fact that it looks to me like they’re competing like crazy with promotions, coupons and everything else? I don’t fully understand it.
Obviously, there’s a brand identity factor in cereals that doesn’t exist in airlines. That must be the main factor that accounts for it.
And maybe the cereal makers by and large have learned to be less crazy about fighting for market share—because if you get even one person who’s hell-bent on gaining market share…. For example, if I were Kellogg and I decided that I had to have 60% of the market, I think I could take most of the profit out of cereals. I’d ruin Kellogg in the process. But I think I could do it.
In some businesses, the participants behave like a demented Kellogg. In other businesses, they don’t. Unfortunately, I do not have a perfect model for predicting how that’s going to happen.
For example, if you look around at bottler markets, you’ll find many markets where bottlers of Pepsi and Coke both make a lot of money and many others where they destroy most of the profitability of the two franchises. That must get down to the peculiarities of individual adjustment to market capitalism. I think you’d have to know the people involved to fully understand what was happening.”
5. The Dark Side of Solar Power – Atalay Atasu, Serasu Duran, and Luk N. Van Wassenhove
Solar’s pandemic-proof performance is due in large part to the Solar Investment Tax Credit, which defrays 26% of solar-related expenses for all residential and commercial customers (just down from 30% during 2006–2019). After 2023, the tax credit will step down to a permanent 10% for commercial installers and will disappear entirely for home buyers. Therefore, sales of solar will probably burn even hotter in the coming months, as buyers race to cash in while they still can.
Tax subsidies are not the only reason for the solar explosion. The conversion efficiency of panels has improved by as much as 0.5% each year for the last 10 years, even as production costs (and thus prices) have sharply declined, thanks to several waves of manufacturing innovation mostly driven by industry-dominant Chinese panel producers. For the end consumer, this amounts to far lower up-front costs per kilowatt of energy generated.
This is all great news, not just for the industry but also for anyone who acknowledges the need to transition from fossil fuels to renewable energy for the sake of our planet’s future. But there’s a massive caveat that very few are talking about.
Economic incentives are rapidly aligning to encourage customers to trade their existing panels for newer, cheaper, more efficient models. In an industry where circularity solutions such as recycling remain woefully inadequate, the sheer volume of discarded panels will soon pose a risk of existentially damaging proportions.
To be sure, this is not the story one gets from official industry and government sources. The International Renewable Energy Agency (IRENA)’s official projections assert that “large amounts of annual waste are anticipated by the early 2030s” and could total 78 million tonnes by the year 2050. That’s a staggering amount, undoubtedly. But with so many years to prepare, it describes a billion-dollar opportunity for recapture of valuable materials rather than a dire threat. The threat is hidden by the fact that IRENA’s predictions are premised upon customers keeping their panels in place for the entirety of their 30-year life cycle. They do not account for the possibility of widespread early replacement.
Our research does. Using real U.S. data, we modeled the incentives affecting consumers’ decisions whether to replace under various scenarios. We surmised that three variables were particularly salient in determining replacement decisions: installation price, compensation rate (i.e., the going rate for solar energy sold to the grid), and module efficiency. If the cost of trading up is low enough, and the efficiency and compensation rate are high enough, we posit that rational consumers will make the switch, regardless of whether their existing panels have lived out a full 30 years…
…If early replacements occur as predicted by our statistical model, they can produce 50 times more waste in just four years than IRENA anticipates. That figure translates to around 315,000 metric tonnes of waste, based on an estimate of 90 tonnes per MW weight-to-power ratio.
Alarming as they are, these stats may not do full justice to the crisis, as our analysis is restricted to residential installations. With commercial and industrial panels added to the picture, the scale of replacements could be much, much larger.
The industry’s current circular capacity is woefully unprepared for the deluge of waste that is likely to come. The financial incentive to invest in recycling has never been very strong in solar. While panels contain small amounts of valuable materials such as silver, they are mostly made of glass, an extremely low-value material. The long life span of solar panels also serves to disincentivize innovation in this area.
As a result, solar’s production boom has left its recycling infrastructure in the dust. To give you some indication, First Solar is the sole U.S. panel manufacturer we know of with an up-and-running recycling initiative, which only applies to the company’s own products at a global capacity of two million panels per year. With the current capacity, it costs an estimated $20–$30 to recycle one panel. Sending that same panel to a landfill would cost a mere $1–$2.
The direct cost of recycling is only part of the end-of-life burden, however. Panels are delicate, bulky pieces of equipment usually installed on rooftops in the residential context. Specialized labor is required to detach and remove them, lest they shatter to smithereens before they make it onto the truck. In addition, some governments may classify solar panels as hazardous waste, due to the small amounts of heavy metals (cadmium, lead, etc.) they contain. This classification carries with it a string of expensive restrictions — hazardous waste can only be transported at designated times and via select routes, etc.
The totality of these unforeseen costs could crush industry competitiveness. If we plot future installations according to a logistic growth curve capped at 700 GW by 2050 (NREL’s estimated ceiling for the U.S. residential market) alongside the early-replacement curve, we see the volume of waste surpassing that of new installations by the year 2031. By 2035, discarded panels would outweigh new units sold by 2.56 times. In turn, this would catapult the LCOE (levelized cost of energy, a measure of the overall cost of an energy-producing asset over its lifetime) to four times the current projection. The economics of solar — so bright-seeming from the vantage point of 2021 — would darken quickly as the industry sinks under the weight of its own trash.
6. Why America Will Lose Semiconductors – Dylan Patel
The US has always been the world leader in semiconductors: design, manufacturing, and the tools to produce them. Semiconductors are the base of all technological innovation in computing and information technology. Without them, companies such as Amazon, Google, Microsoft, Meta, Apple, and Tesla would not exist. The US has slowly been losing its dominance over the semiconductor industry over the last couple of decades. In recent years, the rate of loss has been accelerating. If it is lost, then the foundational building block of modern technology is lost, and the US will cede its overarching technology advantage. In this article we will discuss the major causes of this problem and offer solutions which should be bipartisan in nature.
Before we get into the problem, let’s talk about the current state of the US’s semiconductor dominance. Most of the largest semiconductor equipment, design, and software companies are based in the US or have critical engineering in the US. In the equipment space, Lam Research, Applied Materials, and KLA are based out of the US. ASML, the widely known leader in lithography, does much of their critical engineering for the EUV Source and EUV Collector out of San Diego. These technology assets and teams come from the acquisition of San Diego based Cymer. ASML pays royalties to the EUV-LLC whose membership includes multiple US national labs. Without these tools, it is impossible to manufacture chips.
The critical software needed to be used to design chips is called EDA and it all comes from the US. Cadence, Synopsys, and Mentor Graphics (now owned by Siemens) are located in the US. Without this software, it is impossible to design modern chips.
American companies like Texas Instruments and Intel hold leading market shares in their respective fields while manufacturing their own chips. The 4 largest companies that design chips for external sale and use contract manufacturers are also American. They are Qualcomm, Broadcom, Nvidia, and AMD.
But that dominance is shifting away to countries that pose as geopolitical risks. US share of chip manufacturing is at an all-time low. The US will lose the semiconductor industry unless immediate action is taken. This is a national security crisis.
The US has been the hallmark of innovation through entrepreneurship, education, and making large investments. All three of these tenets are eroding, partially due to the private market’s attitude and partially because the government’s policies incentivize certain behaviors. The shift is occurring in favor of countries that have favorable government policies, regulatory support, focus on STEM higher education, and a general cultural recognition of the importance of semiconductor manufacturing…
…The US private market of venture capital and angel investing is completely off its rockers investing in software platform based “tech” companies. While this type of investing is fine, these same venture capital and angel investors have completely ignored the semiconductor and hardware space. We here at SemiAnalysis have seen it firsthand as we have helped a few firms in the semiconductor industry raise money. It’s extremely difficult to convince venture capitalists to invest in startups, even if they have promising technology and exceptional track records.
The private market has a strong prejudice against hardware startups. Semiconductors in general have higher startup costs, and the market potential is limited in comparison to a platform-based tech company. US based venture and angel investors that require them tend to think in terms of tens or hundreds of billions of dollars addressable markets. They want software platforms that can have a few dozen employees with the potential to scale to billions in revenue. There can only be so many Instagram’s, Uber’s, Shopify’s and Airbnb’s though. Hardware entrepreneurship is needed even if it doesn’t meet the wild dreams that US based venture and angel investors have. A friend of SemiAnalysis, Jay Goldberg has written about this phenomenon on his newsletter in posts titled Hard or Soft, and Hard or Soft with Math…
… Even if the startups and production facilities were in the US, there is now a severe shortage of skilled workers in the field. By 2025, this shortage is projected to be as high as 300,000 workers. Educated and skilled personnel is a cornerstone of innovation, and without them, the job cannot be done.
Most Americans who pursue a higher education do so in a non-STEM field. While not a negative in and of itself, this is a huge concern when viewed in light of the expected growing shortage of skilled workers in the semiconductor industry. Over 5 million people were granted degrees/certificates at postsecondary institutions in the US, yet not even 1/5th were in STEM according to the chart below from Statista.
2/3 of STEM PHD students in the US are foreigners. They were able to get student visas for their education, yet many of them have a very difficult time immigrating after their education despite hoping to do so. China has nearly 5 million people graduating with STEM degrees annually, population size differences make the gap between China and the US impossible to fill with domestic population alone.
The US must make it easier for educated people around the world to immigrate. It was much easier at other points in US history, which was part of the recipe for the US outpacing the rest of the world in innovation. The concept of brain drain is very real, and the best and most qualified in the world must be allowed to move to the US.
7. Twitter thread on Three Arrows Capital’s bankruptcy – Jack Niewold
Three Arrows Capital was one of the biggest crypto hedge funds, at one point managing over $10 billion in capital— Until the founders dropped off the map. A 1000-page legal document came out today, bringing clarity to the case. I went through it. This is what I found:
To get you up to speed: After making a series of large directional trades (GBTC, LUNA, stETH) and borrowing from 20+ large institutions, Three Arrows Capital (3ac) went bust. Then the founders ran, and the loan defaults have lead to mass contagion in crypto.
As founders Su Zhu and Kyle Davies are nowhere to be seen, legal proceedings move forwards. Today, a court document was leaked, one which asks the Singapore Government (where 3AC is based) to recognize liquidation proceedings and cooperate with liquidators…
…1. CREDITORS
• 3AC owes over $3b
• The biggest creditor is Genesis, with $2.3b loaned
• Default on debts contributed to insolvency of Celsius and Voyager Digital…
…3. Reasonably Sized Yachts/Houses/Crimes
Between Sep 20 and June 22, Zhu bought two Singapore ‘Good Class Bungalows’ and a yacht that has yet to be delivered. It’s likely that borrowed money was used to fund it; the yacht was shown to lenders as proof of 3AC’s creditworthiness.
It looks like there was some really suspicious movement of ETH and stablecoins just before 3AC was widely known as insolvent. At one point, they made a down payment for the yacht while ignoring an outstanding loan payment.
Other potential crimes:
• Lying about extent of losses to lenders
• Lying about leverage and directional market exposure
• Movement of funds
• Not disclosing their liquidation to shareholders/creditors
4. The Business Structure.
Some reporting has recently been done around TPS/Tai Ping Shan LTD, which is a legal entity related to 3AC and owned by Su Zhu and Kyle Davies’ partner, Kelly Chen. It was recently transferred $31m in stablecoins by a 3AC account.
As for Su Zhu and Kyle Davies (well, his wife), they’re actually creditors in the suit against 3AC, claiming that 3AC owes them money. That’s not part of these documents, but it’s wild enough to include…
…6. What’s left?
Equity and token agreements in 3ACs illiquid investments, some of which have surely been sold off. JPEGs, including ‘Crypto Dickbutt #1462’…
…7. How did this happen?
Well, it looks like these lenders just didn’t do their homework. Take Blockchain.com as an example:
• 3AC was asked to to ‘keep them informed’ if their leverage went above 1.5x
• Davies signed the below letter confirming over $2.3b in TAM
And when can you pay back the loan, by the way…?
“Yo
uh
hmm”
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 ASML and Shopify. Holdings are subject to change at any time.
