Here’s a problem: Your business assigns contractors to fulfill contracts. You look through your rosters and decide which contractors are available for a one month engagement and you look through your available contracts to see which of them are for one month long tasks. Given that you know how effectively each contractor can fulfill each contract, how do you assign contractors to maximize the overall effectiveness for that month?
Creating software does not end with writing good code. It gets completed when the software is deployed and able to handle the requests properly and when we can scale without hindering the performance and the cost of running it.
You’re probably thinking about how you have cloud computing to take care of all these things. “So what is this new serverless thing, Vignes?”
Cryptocurrency Market Size and Technology
- The market cap of Bitcoin exceeded $70 billion, with peak trading volumes around $3 billion per day.
- Technology consulting firm CB Insights has identified 27 ways blockchain can fundamentally change processes as diverse as banking, cybersecurity, voting, and academics.
- The World Economic Forum estimates that by 2027, 10% of global GDP will be stored on blockchain technology.
- Most mining pools are located in China, comprising more than 70% of total Bitcoin mining. China manufactures most cryptocurrency mining equipment and leverages the country’s cheap electricity prices.
Types of Cryptocurrencies
- There are over 1,000 cryptocurrencies in existence right now (called “altcoins”); over 600 have market capitalizations of over $100,000.
- Bitcoin’s market share has fallen from 81% in June 2016 to 41% one year later, in June 2017. However, Bitcoin’s price has continued to soar.
- In August 2017, Ether’s market capitalization was around $28 billion. At one point, commentatorsanticipated that Ether’s market capitalization would surpass that of Bitcoin (the “flippening“). However, issues with Ethereum technology have since caused its value to decline.
Investing in Cryptocurrencies
- Supply and demand matters. The rate of increase of the supply of Bitcoin will decrease until the number of Bitcoin reaches 21 million, which is expected to take place in the year 2140. Similarly, the supply of Litecoin will be capped at 84 million units.
- Initial coin offerings are trending right now. This year, former Mozilla CEO Brendan Eich raised $35 million from an ICO in less than 30 seconds, and Bancor Protocol raised $153 million in under three hours.
- Blockchain-related projects have raised more than $1.6 billion via ICOs to date, while venture capitalists have provided only $550 million for cryptocurrency companies.
- Accounting. While the US has been cracking down on unregulated activities, in countries such as Germany and the UK, cryptocurrencies are treated like “private money” and are not subject to tax outside of commercial use.
- Regulation. New York State created the BitLicense system, mandates for companies before conducting business with New York residents. As of mid-2017, only three BitLicenses have been issued, and a far greater number withdrawn or denied. In 2015, the cost of obtaining a license was estimated to be as much as $100,000.
- Security. The FTC recorded an increase in identity fraud complaints of more than 100% between 2013 and 2016, and Coinbase, the largest US-based exchange, saw account hacking double just between November and December 2016.
EBITDA’s use as a measure of “clean” operating performance is questionable
- For capital intensive industries, where capex is a fundamental part of standard operating performance, excluding depreciation and amortization does not provide a “cleaner” picture of operating performance. Sprint’s financial results, for instance, swing from $7.4 billion of EBITDA in 2016 to essentially zero EBIT once D&A is taken into account.
- Similarly, if necessary capex is financed via debt and other financing arrangements, the same can be said about excluding interest expense. Charter Communications, for instance, which financed much of its capex via necessary debt issuance, with one bad year in 2008 where the business didn’t operate efficiently, had to file for bankruptcy despite maintaining positive EBITDA.
- Finally, excluding tax expense for certain industries where geographical location and/or capital structure are not easily changed (e.g., the defense industry), again distorts, rather than clarifies, the assessment of operating performance.
EBITDA is often a bad proxy for cash flows
- Comparing EBITDA and operating cash flows for Apple and Exxon, one can see a huge gap between the EBITDA of these companies ($56 billion vs. $95 billion) but not the cash flow from operations ($52 billion vs. $55 billion), which were almost equal in June 2012.
- Taking the case of La-Z-Boy, the eponymous recliner company, in 2017, the company was able to convert over 90% of its EBITDA into operating cash flows, but in 2015 and 2016 the opposite was true.
EBITDA is sometimes a dubious valuation metric
- Seth Klarman believes that EBITDA might have been used as a valuation tool because no other valuation method could have justified the high takeover prices prevalent at the time (1980s). According to him, EBITDA overstates cash flow as it does not take into account all the non-cash gains and expenses along with working capital changes.
- A research paper on valuation analysis at the University of Oxford looks at how Twitter valued itself using adjusted EBITDA, the definition of which excluded depreciation and amortization, interest, and taxes but also stock-based compensation. In fact, Twitter incurred more than $600 million in stock-based compensation expenses in 2014, which was more than 40% of its 2014 revenues.
- Investor overconfidence can lead to excessive or active trading, which can cause underperformance. In a 1999 study, the least active traders had annual portfolio return of 18.5%, versus the 11.4% return that the most active traders experienced.
- Fear of loss. When asked to choose between receiving $900 or taking a 90% chance of winning $1000, most people avoid the risk and take the $900. This is despite the fact that the expected outcome is the same in both cases. However, if choosing between losing $900 and take a 90% chance of losing $1000, most people would prefer the second option (with the 90% chance of losing $1000).
- The “disposition effect” is the tendency of investors to sell winning positions and hold onto losing positions. This effect directly contradicts the famous investing rule, “Cut your losses short and let your winners run.”
Misuse of Information
- Gambler’s Fallacy. When asked to choose which is more likely to occur when a coin is tossed—HHHTTT or HTHTTH—most people erroneously believe that the second sequence is more likely. The human mind seeks patterns and is quick to perceive causality in events.
- Attention Bias. A 2006 study posits that individual investors are more likely to buy rather than sell those stocks that catch their attention. For example, when Maria Bartiromo mentions a stock during the Midday Call on CNBC, volume in the stock increases nearly fivefold minutes after the mention.
Cultural Differences in Investing
- International differences in loss aversion. After controlling for factors such as national wealth and growth, a study found that Anglo-Saxon countries are the most tolerant of loss, while investors in eastern Europe have the greatest loss aversion.
- International differences in investor patience. The same study found that investors from Germanic/Nordic countries (85%), Anglo/American countries, Asia (66-68%), and Middle East cultures are more willing to wait.
“The investor’s chief problem—and even his worst enemy—is likely to be himself.”
– Benjamin Graham
- After dropping out of Stanford in 1995, Musk started Zip2 with his brother Kimbal using $28,000 borrowed from their father. In 1999 it sold to Compaq for $307 million, with Musk earning $22 million.
- Musk invested $10 million of his Zip2 proceeds into founding X.com, one of the first attempts at online banking. It later merged with Peter Thiel’s Confinity and became PayPal in 2000. After IPOing in 2002 it was sold to eBay the same year, Musk made $180 million from the sale.
- Post-PayPal, Musk invested all of his proceeds into his new projects: SpaceX ($100 million), Tesla ($70 million) and SolarCity ($10 million). By 2008, he was almost penniless and living on $200 thousand monthly loans from his friends after a $20 million divorce.
- By 2017, his fortunes had changed and his net worth had risen to $16 billion; just six years earlier, it was only $68 million.
Goes All-In with His Businesses
- After being outmaneuvered in the boardroom at Zip2 and PayPal, Musk began to take more of an iron grip with managing his companies. At Tesla in 2007, he converted $8 million of preference stock to weaker common stock just to oust its CEO.
- Aside from small angel investments, he avoided cashing out of his businesses at opportunistic or exit stage moments and maintained large ownership percentages. His proceeds from Tesla’s IPO were only $15 million.
- Musk has personally borrowed over $620 million that he has used to purchase more stock in his companies. In 2013, he drew down a personal loan to buy stock and help Tesla pay off one of its own loans.
Creates Ecosystems around Himself
- Investing within his network has provided Musk with a successful angel investing record. He made a $90 million return from DeepMind and only one of his investments has been a total loss: Halcyon Molecular in 2012.
- Over his career, he has been involved in four businesses with his brother Kimbal and two with his cousin, Lyndon Rive.
- His businesses regularly cross paths and transact with each other. SpaceX has purchased over $250 million of SolarCity’s bonds and Musk has personally bought $65 million. These kinds of links were a worry for investors during the Tesla and SolarCity merger.
Creative Financing Methods
- By 2015, Musk’s businesses and their customers had benefited from $4.9 billion in savings from government subsidies. The benefit split between the two was 70% and 30% respectively.
- Within the aforementioned benefits were $517 million in Zero Emission Vehicle credit allowances that Tesla sold to rival automotive producers. This allowed Tesla to boost revenue at opportune times.
- A $1.6 billion contract from NASA in 2008 helped stave off bankruptcy at SpaceX.
- Musk’s hands-on and all-encompassing roles have led to cries of poor corporate governance within his businesses. This issue was raised by a group of Tesla shareholders in a 2017 letter to him.
- Capitol Hill lawmakers have also raised concerns about federal money paid to SpaceX being used to inadvertently prop up SolarCity.
- He will only float SpaceX once regular travel to Mars has commenced (its first trip is planned for 2020). He has discovered that the public markets carry more pressure and scrutiny.
Artificial Intelligence (AI) Is Exploding
- The widespread adoption of AI across industries is predicted to drive global revenues of $12.5 billion in 2017 and $47 billion in 2020 with a CAGR of 55.1% from 2016 to 2020.
- The industries that will invest the most in these technologies are banking and retail, followed by healthcare and manufacturing.
- Economists designate general purpose technologies (GPT) as those important enough to spur protracted economic growth and societal advancements. For example, electricity is a GPT. A recent Harvard Business Review article designates AI as the most important GPT of our era.
- PayPal has been able to boost security by leveraging deep learning technology. PayPal’s fraud is relatively low at 0.32% of revenue, a figure far better than the 1.32% average that merchants see.
- While a linear model can consume 20-30 variables, deep-learning technology can command thousands of data points.
- For years, investment management companies have relied on computers to make trades. Around 9% of all funds, managing $197 billion, rely on large statistical models built by data scientists.
- However, these models are often static, require human intervention, and don’t perform as well when the market changes. Therefore, funds are increasingly migrating towards true artificial intelligence models that analyze large volumes of data and continue to improve themselves.
- In 2000, Goldman Sachs’ US cash equities trading desk in its New York headquarters employed600 traders. Today, it has two equity traders, with machines doing the rest.
- For investors, robo-advice can offer up to 70% in cost savings in certain services.
- Some established investment firms are buying existing robo-advisors, such as Invesco’s acquisition of Jemstep and Blackrock’s purchase of FutureAdvisor. Others are even creating their own robo-advisors, such as FidelityGo and Schwab’s Intelligent Advisory.
- 77% of wealth management clients trust their financial advisors and 81% indicate that face-to-face interaction is important.
Insurance Underwriting and Claims
- A PWC report predicts that AI will have automated a considerable amount of underwriting by 2020, especially in mature markets where data is available.
- In a 2013 Oxford study analyzing over 700 professions to determine which were most susceptible to computerization, insurance underwriters were included in the top five most susceptible.
- Underwriting may leverage not only machine learning but also wearable technology and deep learning facial analysis technology.