Tuesday, 9 June 2015

Zen and the art of survival. How to keep your head at Deutsche Bank when the axe falls.

How do you survive a revolution? Keep your head down and say nothing? Make yourself the center of things and be indispensable to the incoming regime? Perhaps pile in with the mob and storm the Bastille in the hope that you're going to end up on the right side of things? Essentially when the first shot gets fired, it's like Darwin's theory of evolution on speed, acid and whatever else you can loot from the pharmacy. There's only one thing for sure; Mr. Kipling said it best:

"If you can keep your head when all about you   
    Are losing theirs and blaming it on you,   
If you can trust yourself when all men doubt you,
    But make allowance for their doubting too;   
If you can wait and not be tired by waiting,
    Or being lied about, don’t deal in lies,
Or being hated, don’t give way to hating,
    And yet don’t look too good, nor talk too wise:"
                                                   (If— Rudyard Kipling)

If you woke up as a senior manager at Deutsche Bank on Monday morning, you were disconcertedly thrust into the maelstrom that was Anshu Jain and his Co-CEO J├╝rgen Fitschen's decisions to fall on their respective swords. It was like Sepp Blatter's decision to resign after carrying the vote at the FIFA AGM. Sometimes battles are won while wars are being lost. Jain and Fitschen's failure to get the full backing of the shareholders at the DB AGM was a battle won (61% to 39%) that was at the same time a war lost. So what now?

Assuming you're an MD at DB you probably spent Monday morning being bombarded by insecure underlings asking questions you can't possibly answer. I'd say a fair proportion of senior managers at DB didn't even know that incoming CEO John Cryan was already on the board, let alone that he stepped up at UBS when others were failing and brought down the axe on the notion of universal banking at the Swiss giant. I don't know Cryan personally, but I've been on the end of the phone to him a couple of times. My only memory was of someone in a hurry who expected me to have the numbers. He wasn't rude, just a bit brusque.

With all this in mind, I wanted to pen a few words on what to expect and how to possibly survive and prosper the brave new world.

1. Know everything about your business

  "Know then thyself, presume not God to scan;
The proper study of mankind is man."
                                   (An Essay on Man: Epistle II - Alexander Pope)

It may sound simplistic, but within the investment banking world you'd be surprised how some managers are in perpetual crisis mode; managing from one mandate to another. Revolutions are dangerous because the bullets start coming from all directions. You're not going to get time to solve each problem or take advantage of each opportunity individually. The only survival plan is to know your business inside out and how it fits within the bank.

Firstly you have to know about Cryan and what he'll be looking for from his team. Unfortunately, he's been on the board of DB, meaning he's all over the business. He has probably already had a plan pre-approved. That's how he got the job; it wasn't because no one else put up their hand.  The board expects the plan to go into action on day one. Therefore, time is not on your side.

a) Understand the metrics of you business.

It's more than just net profit. Do you know your cost/income ratio? Read through the recent annual reports of your bank and it's competitors. What are the hot metrics? Could you produce the numbers at a moments notice? If the bank tried to sell your business area what would it be worth?

Even if your business is underperforming a fresh look at the numbers might throw up obvious opportunities. Too many managers just go for the straight 10% cut in headcount and hope the consultants will see them as constructive and proactive. Think more radically and be prepared to shrink your business to grow. Ask yourself what would your business looks like with 50% less headcount and capacity cuts across the board. Would you prefer to run a business with $500m in revenue and a RoE of 4% or one that brings in $200m with a 20% return? Either way you need to know the numbers to be able to come up with an achievable set of goals when examined.

b) Chose your team wisely and early.

A plan is only so good as the execution. The team needs to be small and focused. The bigger you make the core, the harder it will be to make the changes needed to survive and hopefully prosper. The underachievers need to go. Just because X or Y has attached themselves to a huge line of revenue does not mean that they are untouchable. I once heard a broker tell the head of sales at a bank that he knew the client didn't want to do the deal because he was the fund manager's child's godfather. That is not a reason in investment banking. In fact, that's a reason for summary execution, as it shows that the member of staff in question would be forever unable to find out the real reason for the failure to close.

Draw up a plan and have specific tasks allocated to each headcount. Do not be afraid to be the most radical person in the room. Take to your client or product lists with a guillotine. The only thing you have to watch is where your team is acting in support of another. For example, the biggest fixed income client for the bank may be proportionally one of the least profitable from an equities point of view. In that case, you have to see if you can improve your returns on this revenue without increasing costs or have the existing costs you incur "up streamed" to the business head unit. This is hard to do and will mark you as being a non-team player. The way around this is to make the numbers very clear and allocate either lower cost resources to the client or have someone higher up take it out of your hands. The cheaper up and coming AD might be a better solution rather than sticking with a more senior headcount. Be prepared to defend your analysis and plan every step of the way.

c) Attend every meeting no matter when, where or whatever time.

Absence is an excuse for others to fill in the blanks. If you've followed my advice and knew your business inside and out you don't want others speaking for you. Any shifts regarding the requirements of the CEO and his chosen team will not be sent around in emails for all and sundry to leak and eviscerate. There are going to be times when a nuanced nod or turn of phrase will be better than hours spent going over plans with the inevitable McKinsey type strapped to your shoulder. At these times, you'll also get the chance to change the debate or do some land grabbing. The constructive use of such gems as "why don't we just cover that product with the London/NY/Tokyo team, instead of duplicating the headcount" can often be the start of something more positive. The defender of the status quo better know what they're saying because ipso facto that approach probably hasn't worked up until now.

2. The Big Picture

Do not go gentle into that good night,
Old age should burn and rave at close of day;
Rage, rage against the dying of the light.
                                             (Do Not Go Gentle Into That Good Night - Dylan Thomas)

It's not all doom and gloom. The bank doesn't want to close down; it just wants better returns. No institution with the revenues of a Deutsche Bank is going to go down without a fight. The new CEO has certain levers to pull, and you need to know the order of action.

a) Keep your friends close and your enemies closer.

Read everything you can on the CEO and his team. In Mr. Cryan's case, you'll want to know how he succeeded in turning UBS around. Your first hint is that he was the CFO. That means he wasn't dealing with soft issues, such as culture, marketing or work-life balance. He was dealing with the tangible numbers that impact the business such as capitalization and risk. Everything you do and say has to have cold hard numbers at the forefront.

b) Valuation, valuation, valuation . . . know the focus.

"The economy, stupid." 
                               (James Carville to Bill Clinton)

Currently, DB trades at roughly half of its net asset value. This is a joke and an indictment of the outgoing management. This one metric says that the shareholders don't trust management to realize the value the bank has assigned to assets. There's going to be assets or businesses divested or written down in value. This is without a doubt the biggest opportunity in the restructure. Know what is on the block and contribute accordingly. When others shy, away from the toxic be prepared to take on the impossible. The only caution to this is to have an unambiguous mandate to take action. Remember that the mere fact that some of these assets are trading at a steep discount probably means the odds are on your side that you can turn things around and release value. This might be a one-off situation, but every time you report a revaluation you'll be thanked and set yourself up for success in the future.

c) Risk and the art of survival

"Risk comes from not knowing what you're doing."
                                                                                                          (Warren Buffett)

I'm almost never surprised by bankers who don't understand the way risk capital is allocated. DB and its peers spend lots of time and money producing exquisite risk reports. These reports are available to one and all online . . . gratis.

Ever seen this?
It's your fault if you haven't read them.

A broker tried to tell me over a coffee last week that the equity derivatives market in Australia was being dominated by UBS because they were warehousing the risk. When I challenged him as to where he got this fact, he came back with the usual "gossipy" hearsay quotes. When I pointed to the VaR numbers that the bank published he admitted he'd never seen them. I didn't stomp on him too hard, but if you're at DB and you start making these type of statements to the new management team you'll be in trouble. Here's what to do:

i) Go through the VaR numbers and note the changes over time
ii) Understand the capital allocation process required to support those numbers
iii) Read the Basel committee reports regarding risk as it pertains to DB and the other global banks
iv) What is your current capital adequacy position

Once you have these facts, you can participate in high-level meetings with something more than generalisations.

3. Plan B

It's very likely that things will move quicker than you expected, and you need to know when to stand your ground or retreat.

"It's a very sobering feeling to be up in space and realize that one's safety factor was determined by the lowest bidder on a government contract."
                                                                                                                                         (Alan Shepard, Astronaut)

Around the time of the GFC, a friend of mine was headhunted to Barclays. Happy days, big salary package, a department to run on his terms. Sweet. The bar was low because the Barclays business had been underperforming in his sector. Unfortunately, his feet hardly had a chance to touch the ground. First of all his bank got into a dispute with a headhunter who said he'd facilitated the deal. His salary details got leaked as the dispute escalated. Next Barclays bought a chunk of the old Lehman Bros. business and with it a whole team of managers looking to stamp their authority on the business. No one at Lehman's ever lacked hubris and humility even in the face of total abject defeat was in short supply. Given my friend was probably earning more than his new ex-Lehman's boss he didn't stand a chance. He was a big target, and the Lehman gang didn't like outsiders. He got metaphorically shot.

All this leads me to the sobering fact that you need a "Plan B". It might not be an outsider who causes your demise, but it could be anyone. Even the best brokers, traders or corporate financiers will not be indispensable in a revolution. Look for opportunities to exit with "an edge." A good example might be with an underperforming asset or business. If you can see the sinking ship to port (or in this case asset), it might just be possible to salvage something tangible.  Always consider jumping for longevity. Take a smaller pay packet and survive in a sector you know and enjoy rather than being set adrift at the last moment into the unknown.


The main thing is to remain positive. Constant gloom will kill your profile and your plans in the eyes of the new management. Don't be afraid to engage. Being a small target might seem like the best tactic, but insignificance is a sure way to oblivion.


Tuesday, 19 May 2015

A month of disruptive tech companies . . . Disruptive Lunches, TURF Sports Entrepreneur Night, Maru-D and follow-ups

This edition of the blog has been a long time coming. As an apology I've summarised all the tech orientated events I've been to over the last month.

14 May:

I got an invite to the TURF sports entrepreneur meeting held in Sydney's hipster ground zero Surry Hills.

Disrupt Surfing is likeable but not disruptive to my mind in the purest sense. Essentially they're doing the bespoke design thing on sports equipment. Gary Elphick (CEO) was presenting the business on the night. Their primary product is surfboards though they will offer snowboards and eventually move into equipment categories. It's one of those ideas that will have good appeal to Gen Y / Millenial market where everyone wants to be an individual, even if they all seem to have the same dodgy tattoos and fashion sense (apologies, that's the cranky old man in me coming out).

Disrupt is also part of Telstra Corp's Muru-D accelerator (see below). So I'd already seen the presentation at the demonstration night earlier in the month. I liked the fact that they were very honest about mistakes they'd made in getting their product(s) into production. I'm not sure where this one will go, but I got the feeling that the guys need someone to take them in and shake it up a bit.

The presentation of the Rip Curl Wave watch development process was fantastic for the sports science geek in me. Excellent. We got taken through the development from the start when it was just a waterproof bag of sensors carried down the back of a wetsuit, right through to the social media data sharing website.

At first I though it was just a waterproof Garmin GPS watch, but with the addition of accelerometers it suddenly transformed itself. Think about it this way. A site like Strava cross relies on the cross-checking of GPS with known earth mapping. That is why when you're on abike or a run the meters climbed or ran changes when you get home and upload into your computer. For surfing the problem is that waves are somewhat random, so a standard GPS data dump can't tell you how big or frequent waves were. Add the accelerometer and that changes. The size and frequency of waves can be measured. Now think about the big data aspect and sharing this information correlated with weather conditions and I bet that all sorts of useful information becomes available. The team said they're already observing some unknown surfing spots. The only possible blockage is the secretive culture that surrounds surfers favourite spots. Get them to share as a community and things start to happen.

I don't surf anymore, but would love one of these watches. Surely they can rev it up and make it a triathlon device as well. I'll bet Rip Curl doesn't leverage this. If I were Strava, I'd hire the developers and put them to work. If I were an investor, I'd follow these guys.

12 May:

A two company presentation at a Disruptive Lunch. I went into this without much enthusiasm as prima facie the companies presenting had a bit of a "been there seen that flavour to them". In reality though this was a lot more interesting and once again proves the point that you have to see these companies in the flesh before making a judgment.

More Peer to Peer lending . . . Rate Setter.

Daniel Foggo is the CEO of Rate Setter Australia; he is ex-Barclays Capital. Like many investment bankers, Daniel saw a business he liked and took the leap of faith to establish it in Australia. Rate Setter is the third peer to peer lender we've had present at a Disruptive Lunch, so the audience is familiar with the basic business case.

I would argue that the only differences between the three P2P businesses we've seen is their approach to risk management. Rate Setter is the only one that has introduced a Provision  Fund. The idea is that the borrowers place funds into the fund that can offset default list. Instinctively if you are a lender, that sounds good, but as a banker I don't get it in terms of having a transparent market. Furthermore, I don't understand how it will operate, mainly because we haven't been in a credit environment of escalating defaults. Foggo refers to Rate Setter Europe as his guide statistically but acknowledges that the Australian experience, being devoid of a recent serious recession is skewed away from Europe or the US's experience.

So far, the company only has AUD 3m of loans outstanding. Market leader Society One has just north of 20m according to reports.

I asked a number of questions regarding margin, and while Foggo didn't go into hard numbers he suggested that the margin wasn't a flat line, but rather varied according to credit quality. This suggests yet another level of sophistication in the modelling of the loan book and a nod to the fact that as interest rates have fallen the absolute margin has to have some "curve".

It's still relatively early in the life of the P2P sector to formulate a hard judgement. Readers know I liked the Society One "dashboard" app for lenders. I'll add to this now Foggo's "second level" of risk management implementation. Investors may be best advised to think about a portfolio approach to this sector rather than putting it all on "Red".

Bullet Proof - Cloud Computing (ASX Code: BPF). Great name.

Amongst my generation cloud computing still invokes a certain trepedation. Millenials are less inhibited when it comes to storing data or relying on the "technical hand of god." Either way software and associated data is becoming more cloud-based and for businesses there's certainly value and flexibility in shifting from hard data and application ownership to the cloud.

I'm always skeptical when it comes to companies that are listed on the stock exchange via a backdoor. In the case of Bulletproof, the management used the shell of Spencer Resources. I'll leave that cynicism to one side for the purposes of this blog. The positive side to this is that if you want to look at the hard numbers a quick search of any of the financial specialist websites will get you what you need.

I want to go on record as being a little confused about Bulletproof as a company. Reading back over my notes I thought that the CEO Anthony Woodward was going to hand me the game plan from Louis Gerstner, the brain behind the radical overhaul of IBM that changed it from a hardware company to a fully-fledged consultancy. Maybe that's where bulletproof wants to go, but for the moment Woodward was at pains to emphasise that they're currently 85% a "managed services" group.

So what does Bulletproof do exactly? They provide you with technical assistance for deploying and migrating your environment to the cloud. In short they want all your staff and customers the access, flexibility and speed of interacting through the scalable cloud. Assume you're a company that has lots of variable traffic across your business. Convention says you plan for the peaks because if you fail when business is running hot, you're failing at a time of maximum visibility. To avoid this, you deploy capital inefficiently into racks of servers and capacity that idles for much of its life. With the cloud, you can turn on a tap without the physical restrictions of running a server farm.

Bulletproof doesn't do the hardware side itself. Instead, it relies on Amazon Web Services (http://aws.amazon.com) for this and takes a cost +30% approach to billing. The results are clear for all to see with revenues for FY 14 up 29% to 18.3m and are already running at 11.9m for 1H15. I worry though that the barriers to entry might not be high enough. How hard would be for a dozen middle-level staff (of the current 110) to walk out and replicate what Bulletproof is doing. I don't have an answer to that, but I'd suggest that the management would like to go down the consultancy road, which given revenue growth is not out of the question.

Investors might want to follow Bulletproof as a proxy for business management trends in Australia or better still just as a growth business offering exposure not often found on the boards of the ASX.

 7 May:

Muru- D demonstration night at Telstra Sydney. 4 hours, multiple businesses.

Muru-d is Telstra Corp's accelerator for tech. Start-ups that jump through the various hoops get six-month intensive support, including a workspace. Telstra gives these young companies 40k for 6% of their company in a filtered shotgun-style approach to finding unicorns. It's a great idea for a once monopoly telco to inject some new avenues for revenue into their business.

I got to wander the auditorium and speak to eight of the companies that appealed to me most. I gravitated towards the infrastructure and education offerings and left the social media hipsters to do their own thing. It was an impressive evening. My pick on the night was Freight Exchange led by CEO Cate Hull.


Freight Exchange is one of those ideas that truly could be disruptive. I was telling Cate about the time the hedge fund I was working for in Singapore found out that Komatsu had installed black boxes in their heavy equipment than did more than track GPS. The "brain" could tell Komatsu engineers everything from engine run time to workload. In many ways, it was the first big data I'd seen applied in the real world. I'm not sure Komatsu used it as I would have to bet on economic activity (currencies and bonds), but they could definitely make production line changes to reflect demands in the supply chain.

Hull's idea was to avail fleet owners (at the moment is mostly ground transport orientated) with the ability to source contracts outside of their normal footprint. If 20% of the fleet is idle (or in transit without a load), there's certainly a gap to be filled. The Clever algorithmic analysis we are seeing more of is starting to gain traction in logistics, but there's still a gap. Hull told me at a follow-up meeting that the inefficiencies are especially prevalent in China where the market is highly fractured and in need of a central clearing house function. Normally I try and advise start-ups away from diving into China because of the problems with the intellectual property and cash flows. In Freight Expresses case I'm sure trying the Singapore / Malaysia road transport axis would be successful. Having said that who am I to hold back truly ambitious companies?

6 May:

Investor presentation Moko Social Media (ASX code: MKB)

Moko Social Media on both NASDAQ and the ASX. To be frank, I wonder why they don't axe the ASX listing as it would probably save some money and allow management to skip the flight from the Washington  DC area back to Australia. Just to be clear, yes I know their investor base is dominated by Australians, but as this is the twenty-first century I'm sure they'd cope with a single listing in exchange for saving a nice chunk of change. Enough said.

The revenues of Moko business can be divided into three units. Of the three I thought the most interesting was the REC*IT offering. REC*IT is a facilitator of intramural sports and offers a schedule / social app for college and high school students in the US. Essentially they go to schools and offer the app for free and in exchange get an audience to tap for various streams of revenues.

Moko claim to have access to 900 colleges and through a recent deal into 4,000 high schools. That's significant firepower. They currently have had over 200k app launches, and the users are all in that 18 - 22 group. Though as the high school side gets traction the age average will come down. This part of the business is currently dominated by males, but overall across all of their platforms they skew more to women.

The companion app (for want of a better phrase) to REC*IT is "Speakiesy." This is designed as a kind of antidote to Facebook as it excludes non-students from signing up. They're rolling it out in 120 selected schools this year and aiming for 200k users. This one is not sports orientated, so should have a more immediately better male to female balance.

Other than the school orientated apps they have:
  • Blue Nation Review - a left-leaning politics focused social site
  • Tagroom - which to me looks like a mommy-blogger hybrid (sorry but I couldn't think of a better description)
  • Run Haven - Strava / Garmin Connect with a social side that skews female
Overall they have 5 million actively monthly users comprised of 3.5m for BNR, 1.1m Tagroom, 450k RunHaven and 150k REC*IT. In 2015, they target to double that. Last year revenue declined, but they say this should stabilise and reverse this year on the back of the schools segment.

What do I make of Moko? I like the schools segment for the same reason that the management is investing so much time and energy. I know BNR has their highest "touch", which makes me wonder why they don't launch Red Nation Review and gobble up some conservatives as well. Then again why would I get active on BNR rather than the Huffington Post? RunHaven aside from the strong female skew is in a crowded segment, and yes I'm a Strava bull. Moreover, I haven't had a good look at Tagroom.

The more I look through the Moko presentation, the more I wish they'd just choose one space and focus. This obviously has potential, but I'm not quite there yet.

27 April

A Disruptive Lunch headlined by Black Pearl, an email enhancement app and Aussie commerce, a conglomerate e-business group.

Black Pearl - email how it should have always been

Black Pearl is about email branding. In its simplest form, you have to think about email presented on a professional letterhead with interactive elements. I can't describe it another way.

Pricing starts at US$14.99 per month for first 1-15 users, then US$0.99 per each additional user. You can upload unlimited signature designs, and there is no cap on total users and subgroups. If you're the IT manager you can utilise their Central Management Console and follow, track and trace (analytics) how email is being used. Black Pearl has exactly what I want in any business and I can understand the price.

Nick Lissette is the highly caffeinated CEO, who's already managed to get Black Pearl mail into companies from advertising agencies to banks. The only thing stopping Lissette will be other tech groups adding this feature. I suspect that Black Pearl might get swallowed up sooner rather than later.

Aussie Commerce - Revenge of the bankers

No group at a Disruptive lunch has caused me to procrastinate so much over my blog than Aussie Commerce. If I were to write merely about the 15 e-commerce portals that comprise Aussie Commerce's offering readers would be hitting the "quit" button on their browsers within the opening sentence.

Aussie Commerce is not as much about the business they run as it is about how they acquire them.  There's an adage that says you make most of your money in business when you buy a company, not when you sell it. In other words, if you buy an asset cheaply enough you don't have to worry too much about the rest. That's called value investing and without saying it Adam Schwab and Josh Borenstein were leaving it out there for the audience to connect the dots.

The Aussie Commerce team has built a business with 9.4m members, 3.7m of which are active. Their crown jewel is their Luxury Escape portal that partners with providers to offer vacations to members. Gross turnover per buyer is $344 at the moment, and 84% of buyers are repeat purchasers. Their offerings are desktop-centric at the moment, but they'll have apps by the end of the year.

I wrote in my notes: "these guys are traders". I meant that as a compliment. They say they're not afraid to pay a reasonable price for a business. I'm guessing the management team worked out what they'll pay per user and what synergies they can derive from bringing a business on board. This is far more sophisticated than what I've seen from a couple of Australian based groups recently. They always seem to fall in love with the business rather than the metrics. It surprises me that how few businesses I've seen have been able to value customers in this way. I remember in London, in 2000 at the height of the dotcom/telco bubble attending some of the bankers briefings on Vodafone's acquisition of Mannesmann in Germany. The dominant driver in many of the valuation models was the cost per user. I was always a bit skeptical, but it does make sense. Just consider marketing spend per 100k users versus just buying a customer base.

If you are an investor, who likes trading you could do worse than follow Aussie Commerce. This team at the very least could be a decent guide on valuing a business. Sometimes it's better to be smart than creative.


Many thanks to all those people who invited me to events this month. Apologies again its taken so long to get a post out. I look forward to following-up with as many groups as possible and as always I can be contacted through the IBCyclist Consulting website.


Monday, 20 April 2015

Five things I've been looking at since the last blog

1. Hedge Funds

I've been doing some work on some new hedge funds in the last two weeks. I usually like to concentrate on volatility or "quant" style funds because these seem to be the most under-represented here in Australia. Having said that I was contacted last week by a Japanese long/short fund based in Singapore. Normally I wouldn't have spent much time on them, but a couple of things caught my eye:
  • They have a track record going back to March 2006. This means they've come through the GFC and survived. That's good, and it also gives me enough data to look safely at their correlation to various indices and events. 
  • The returns are good and show positive asymmetry. Their worst month was down just under 6% while their best month was up over 20%. A US investor once said to me: "Mike, I prefer not to invest in people who eat like birds and shit like elephants."
  • The team has been stable. That means no major blow-ups and no significant style drift. I hate it when a fund reinvents itself and doesn't make it clear on their track record.

Elsewhere I'm still trying to help a volatility fund and a start-up fund of ethical investments.

2. Start-ups and Investing in Businesses

Last week I met up with what I'm calling a modified incubator. Essentially they take large equity stakes in businesses or ideas very early in the process. Their main hook is the management wrapper. I'm not sure what to make of it though I'll give them A+ for openness. They invited me to spend some time working out of their office so I could get a feel for the place.

This week I have a BBY Disruptive Lunch and a slightly off-piste function looking at the sporting goods space.

3. Cycling

The battle continues to stay fit. When you're not a 65kg jockey sized cycling god, you're going to be putting a lot of stress on your equipment. Lots of high-end stuff comes with a rider plus bike weight limit. I heard of a chap much larger than me who suffered a carbon wheel brake failure and got busted up quite badly last week. If you and your bike weigh more than 110kgs, you need to check your equipment limits.

My equipment is starting to see signs of needing replacement. I've rebuilt the front wheel of my Fulcrum Racing Zero wheels due to the brake track getting worn down. The original rebuild didn't last long, and I swapped wheel builders to get a different result.

My Mavic Cosmic Carbone SLR's have also seen better days. Followers of the blog know I rebuilt the freehub because of the wear I'd exerted on the main wheel hub over the last three years. The "exalith" brake track is also wearing down and rather than flirt with death I'll be replacing the wheels in the coming weeks with the new Mavic Cosmic Carbone 40's.

If all that wasn't bad enough I suffered my first flat on by Campagnolo Bora tubulars since leaving Switzerland. I rode these quite a bit over the summer when I was rebuilding my green Cannondale and was riding the Pinarello Dogma 60.1.

I knew they were going, and usually I'm good at having new tyres glued on before incurring the wrath of the cycling gods. All I can say is that Vittoria Pitstop "latex goop" and a CO2 cartridge got me home without the indignity of having to ask for a lift. 

4. Rugby

People close to me know that for many years I was a rugby tragic. I lost touch with the sport after returning from the UK and moved to Singapore in 2006. Somehow watching rugby in a tropical environment didn't feel right. Also, a health scare got me into the gym and for many years I avoided any events that required sitting, eating and drinking alcohol for hours at a time. Just lately, I've gone to a couple of Super XV games here in Sydney thanks to some tickets from a friend.

I have this feeling that the game has lost its way though I'm not sure if that's because the local team seem somewhat unlovable, or whether the atmosphere their half full stadium is somewhat lifeless. I used to hate being an Aussie at Twickenham, but the crowd at least had some spirit in them.

5. Europe

Readers know that I've lately been advising a higher weight in Southern European investments. My thesis has been simple. Low growth and budget balancing would see interest rates lower for longer in the region. As the over-hand of real estate looks to sort itself out, I'd expect better returns in the region. The more I look at things, the more it reminds me of Japan post the real estate crash in the early 90's. It took forever for the banks to work themselves out of their property portfolios, and Europe is following a similar trajectory. Investors should never underestimate the value of Chapter 11 bankruptcy in the US. The ability to go through a cleansing process in an orderly fashion is good for investors and debtors. Take for example GE.

Last week GE announced that they were going to exit the last of their finance businesses. Remember this business began when Jack Welch and the team started financing capital equipment leases. First it was aircraft engines and later it was MBS's. I don't blame GE; the returns were sensational, and the regulatory requirement was minimal. The trouble is when you wake up one day, and you're the seventh largest bank in America someone is going to notice. It also helps if the market doesn't collapse. Well, soon they'll be back to being a capital goods company. If you're lucky enough not to be a bank saddled with the title of "too big to fail", it's more than likely that you'll be able to buy a piece of  what GE is selling, apply less equity to it and immediately show an accretion in both your EBIT and your RoE. Happy days are here again.


Tuesday, 7 April 2015

Nexus Notes, Free is Better and Money Place: BBY's Disruptive Lunch series continues.

At Sydney University, the first course in the Faculty of Law that I was  required to complete was entitled "Legal Institutions". It was a bit of misnomer because it was a combination of Constitutional Law, legal philosophy, and Australian court structures. It was an absolute pig of a course.  To get through it, you needed a map, a compass, and a sherpa guide. The few who had a lawyer in the family might have been lucky enough to get some help that shed light onto its sprawling curriculum. If you didn't, it took every ounce of student diligence and cunning you could muster to get through to year two.

At last Wednesday's BBY Disruptive Lunch, one company gave hope to students everywhere.

Nexus Notes allows the confused, the time poor, or (yes) the plain lazy the chance to acquire the course notes of top quartile students for  a mere $US35. For that, you get anything from a complete years worth of notes to a pre-exam outline. If nothing else you get the chance to see what's required to get through what at times might seem impossible. You can browse the available library and get a free 10% sample of each of the available offerings before you buy.

Some of the notes I've looked at are amazing. If I knew a 2015 freshman, I'd give them a set of notes from a successful student to show them just what it takes to get those elusive "A's". For example, if someone had given me "masonzhang1221's" Administrative Law notes I'm pretty sure that the second year of law would not have been such a grind.

The 1000 page case book, the lethargically paced textbook; the memories are still with me. I passed this course, so I know what I'm talking about when looking at these notes.

So what does the author get? 50% of all the fees that they generate. It's that simple. Maybe they get the altruistic sense of helping others? I doubt that's why students and graduates put their notes up for sale. No, it's 99% about the money. Their top author is up about $3000 so far.

Co-Founder's Hugh Minson (CEO) and Richard Hordern-Gibbings (COO) presented as upbeat, energetic and relentlessly logical. Their Advisory Board has plenty of familiar names and reeks with success.

I got a quick five minutes with the guys before the presentations started, and they immediately batted back my questions on plagiarism, etc. They rightly pointed out that students can't plagiarise notes because universities don't mark notes. In fact, universities are supporting Nexus Notes. The team has been smart enough to hire "promoters' or "brand managers" at a number of universities to get the word out.

Nexus Notes are already getting some love internationally. They have a foothold in New Zealand and are starting to roll-out their offerings at The University of Texas (Austin).  It makes sense, as the university experience is almost universal.

It would be easy to get too far ahead of yourself on this one because the model does have some problems, the most glaring of which is scalability. At present, the approval process is 90%+ manual. You sign up and submit your course notes for approval. You can choose to submit your academic record with your notes. They say:

"The file you attach is hidden from the public but your notes will become verified - represented by a visible blue shield. A digital version, scanned copy, or screenshot of your academic transcript will do."

Then the team goes through the approval process manually. I should have asked more about this because I assume Nexus isn't checking the notes for the content, but rather is looking at the format.  It sounds somewhat laborious and will need work.  Imagine if this takes off at the University Texas with its 17 colleges and schools, and more than 50,000 students? The guys hinted at some automation based not only on academic transcripts but also social media type algorithms, but that is still to come. I'm positive this could be a great add-on to a social media site. Remember Facebook started as an attempt to link students at Harvard. It's not hard but will cost money and time.

As I've been a portfolio manager, I'm used to ranking companies. Tech start-ups are no different. It's a numbers game as much as anything else. The more you see, the more you can pick the quality ideas or people from the fakers. Education is a key theme in the "disruptive" world at the moment. Nexus Notes has a solid chance to be a winner in a growing segment. Investors could do worse than spend some time tracking this company's progress.

If $35 seemed like a bargain for quality course notes, then Free is Better has even greater resonance. Take some marketing and advertising energy and stick it onto a basic product like a bottle of water. Give it away for nothing. "Thirsty? Want a free bottle of water? Did you know about the new Mini Cooper S?"

Free is Better is the brainchild of Melbourne based marketing tyro Alex Chen. The idea is that you connect your product to consumers by linking your marketing campaign with free water. They don't just hire a team of kids and drop them off anywhere to hand out the bottles; instead they target districts, and precincts they determine have a high concentration of demographically compatible consumers.

Why water? Chen rightly suggests that the bottled water market is only differentiated by fashion. It could be the colour or shape of the bottle, or it might be the name itself. The Free is Better bottle goes for that clean "google-like" look. The austerity neutralises any social cache down to the statement itself. That makes it firstly inoffensive and secondly a statement that you're smarter than someone paying $2 for something that you can get for free at a public water fountain. There's smugness factor at work here. The price you pay is that on the other side of the label you have some advertising.

The company has gone through a two year gestation period. Now they aim at running limited edition campaigns of one month duration. Each effort sees 20,000 bottle of water handed out and so far they've had mini cars and Levis jeans amongst their product placements. The cost is about $1 per bottle delivered to distribution points, and they essentially charge another dollar for the distribution and marketing know-how to their clients.

Free is Better is only in Melbourne currently. The key is the product placement, and we didn't get a good look at the modelling process behind identifying geographies. I hope it's more scientific then just saying this space looks hot right now. In fact, that's a bit disingenuous because the team hinted at social media analysis as being core to this process. Obviously to roll this out elsewhere and make it worthwhile to investors you'll need to make sure that the underlying processes are robust, quantifiable and somewhat proprietary. If the science isn't right, I can't see the investment case for the product. The wall around the business just won't be high enough.

The team has plans to roll-out vending machines that can be unlocked from a smartphone app. While I'm not sure that this adds to or subtracts from the "fashion factor", it at least shows that Chen and the crew are looking for more data on who is getting the bottles. That is key for them selling the idea to clients.

As an investor, I'm somewhat unsure whether this has legs. The business model seems niche and undefendable without some "secret sauce". At this stage, I think I'd be more an observer than equity buyer. I like the enrgy and thought involved, I just need to see the engine in action.

The last business to cover from the lunch is another peer to peer lender: Money Place. I think Stuart Stoyan (CEO) got unnerved by the presence in the room of some of his competitors. That gave me the feeling he shut up shop in regard to presenting what differentiated his business model from others. Instead, we got the usual arguments as to why peer to peer lending was going to be big in Australia. We didn't get why Money Place was likely to be one of the winners.

I'm fast becoming a peer to peer sceptic. Readers of the blog know that I liked the offering of Society One when it was first presented because of the well thought out smartphone portfolio monitoring tool for lenders. That to me differentiated the business. Others agreed because they've been the market darling, raising capital from the big players in town. Having said that my sources indicate that even with the support that they've garnered the growth of the loan book has been disappointing. That also suggests to me that the marketing campaign needed for the industry to take off may cost more and require a greater gestation period than originally suggested.

How does Money Place compete? Well, the answer is we don't know from this presentation. Given Society One's loan book is still less than $30m, after the support they've had, then Money Place will need to have something special up its collective sleeves.

Stoyan was asked about peer to peer competing with banks in the long run. If you look around the room and make a statement that Australia hasn't seen a downturn for a long time, and "I doubt anyone here has seen one" you want to stop and look at your audience a little more closely. I know I looked around and saw quite a few people who'd had to put up with double digit mortgage rates, bankruptcies and a finance minister who said we (Australia) were in danger of becoming a banana republic. The super liquid monetary conditions we've had recently are not the norm in economic history, so you better have a better set of answers or thoughts when challenged about the industry's sensitivity to interest rates.

When Society One presented at BBY last year, they suggested that average rates of return to lenders was in double figures. Money Place is now saying it's closer to 8%. What happened? Well, the chase for yield in smaller packages is part of the answer. To me, 8% is closer to investing in a second mortgage, not in a fully unsecured personal loan. The problem, of course, is that second mortgages require more funds and longer duration thinking. But this is unsecured and unlike Society One we got no behind the scenes look at recovery processes.

So as an investor what would I do in peer to peer lending in Australia? I want to say that Society One is going to be the big winner, but remain somewhat concerned at their loan book growth. Money Place and others in the field are being given an opportunity to bridge the gap. If it were me, I'd try and get a one on one with Stoyan to see what he and the team have to offer. On the evidence of this presentation, the jury is out and needs to ask the judge for further directions


Thursday, 26 March 2015

Of entrepreneurs and capital raising . . . free advice from the IBCyclist

I don't care what type of entrepreneur you are, whether it's tech, mining, pharmaceutical, mechanical or financial I just need you to answer some very straight forward questions in our first meeting.

1. Opportunity: What market are you attempting to satisfy? 

It's an easy question, but you'd be surprised how many fledgling companies don't state it right up front. I've seen some great presentations, and they usually start with a clear value proposition:

Did you know that the average amount spent on a taxi fare in New York is X? Total income for the industry, last year was X.

Did you know that the average automobile has X meters of copper wire in it? And if every third Chinese or Indian household owned a car we'd require X amount of new copper production . . .

Obesity is the single biggest killer of adults under the age of retirement. Spending on related solutions is likely to grow at X% over the coming decade?

2. Concept: What are you offering that satisfies the opportunity you identified? 

Show me your solution. Don't use words when pictures, maps and numbers will best highlight things.

Our app is a unique solution that enables the user to connect with the nearest taxi directly and offers passengers a rebate for frequent use.

The "Big Deposit" copper mine can be operating within 18 months and produce ore at a rate of . . . 

"Nofatsilose" is currently in stage 2 of clinical trials and we hope to confirm that it reduces cholesterol by X% in the first year of use.

3. Demonstrate: Walk me through the process.

How do we get the solution working. Give me a timeline and state various hurdles, be they regulatory, physical construction or software testing.

Here's a mock-up version of our app. It's taken 12 months to get to the beta phase and $100k. As you can see the user's location is automatically identified, and all they need to do is select a destination either from their address book or by inputting it in the address bar like this . . . 

This map shows the mine location. You'll notice the proximity to transport, both road and rail. The pit depth for stage one needs to be . . . 

If we pass stage 2 the drug goes to final FDA approval which should take 12 - 18 months. In that time, we'll need to conduct some additional studies . . .

4. Funding: How much do you already have? How much do you need? How much cash are you burning per month?

Entrepreneurs need to demonstrate they have a grasp on their business costs. Don't ask me for a million dollars today if you need to come back in 3 months for more because you didn't understand the risks of cost blow-out, etc.

The app needs 300k users to breakeven. We estimate total operational costs (developers, testing, etc.) in the first 18 months to be $850k. In addition using recent data from X, Y or Z, we're estimating those first 300k users to cost us $4.50 each. That will be attributable to marketing and database maintenance. All in we're raising $1.5m, allowing us a contingency . . . 

The basic mine infrastructure is likely to cost $40m, but that excludes a rail track extension for the last 9km. That costs $3m, but the weather means we need to double that contingency if the rains fall early. We have $10m in cash, which will last us nine months . . . 

We have $30m in cash on hand. The final trials will cost $38m, but if the regulator needs extra evidence we don't want to be coming back to the market in the middle of the process. We think it makes sense to raise an additional . . . 

5. What's in it for the investor?

What is the current capital structure (who owns the business)? How long before you breakeven? What is the dilution effect of the capital raising you're conducting? If you have to raise money again do I get first right of refusal on new shares?

Post breakeven we estimate that each new users will generate around $2.50 of income. Of that roughly 30% will be needed for operational costs and 20% for ongoing marketing. In terms of valuation comparables . . . 

Total cost per ton of Ore will be XXX. That means we'll be the lowest cost producer in the market. Stage 1 is likely to be exhausted in 3 years at which time we will have shipped XXX . . . .

Once FDA approval is granted, we estimate marketing costs (via conferences, literature, etc.) to be approximately $26m when implying the same model Fizer used for it's inferior product that launched in 2008. That means that once we're on the approved list we'd expected take-up in the EU and the US of around 50m patients at a cost of . . . 


Obviously the more facts and figures you have, the better it is and the better your credibility. Some entrepreneurs have an advantage in that they come from a very numeric background. If you're more about style, then you need to have a good CFO that you can toss to in case deep divers (like myself) start throwing out detailed questions. It's not the end of the world if you can't answer the questions, but you do need to show that you understand what's being asked.

Finally some words on your presentation.

If you're a hedge fund and I'm an institutional investor I don't want to come to your office and see six traders dressed in shorts playing air hockey because nothing is happening in the market today.

If you're a miner and you've just entered the car park in a $300k Ferrari I'm going to wonder why you need my money.

If you're tech looking for $1.5m it's probably best if you're not wearing a $75k Patek Philippe and $1500 John Lobbs, Christian Louboutin's or Jimmy Choo's. I'm going to ask why you're not funding this yourself.

If you're a pharmaceutical . . . . don't get me started.


Tuesday, 24 March 2015

BBY Disruptive Lunch: CBA's Kelly Bayer Rosmarin

It's sometimes easier to write about the "less" polished presentations we get at the BBY Disruptive Lunches then those that are focused and tested. Commonwealth Bank's (CBA) Kelly Bayer Rosmarin presented a cogent and polished summary of that institution's approach to disruptive technology generally and specifically to the digital client interface.

Bayer Rosmarin's engineering background was to the fore as she set limits on the subjects she was going to discuss and stuck to those parameters. Part of the charm of these lunches is the way that some of the start-ups meander through their business cases almost rethinking what they're saying as they go. I don't expect young companies to have laser sharp focus. When they do, as was the case with someone like Catapult Sports it can be riveting, but it's not always necessary. Take Pocket Book's (19  Feb 15) offering last month, that to me was notable because I got the sense the team was still discovering their capabilities and a best avenue of action.

Bayer Rosmarin sought to deal with disruptive technology and CBA through the lens of three distinct examples: Crypto Currencies, Cognitive Computing and Cyber Crime.

1. Crypto Currencies

Would crypto currencies exist without the 2008 financial crisis? Security, trust, convenience and efficiency, all areas severely tested by the crisis. The collapse of major banks severely tested the faith of people during the GFC. Historic examples from past economic adventures (think Weimar Germany, South American banana republics, African hyperinflation) provided fertile ground for Bitcoin (and other crypto currencies) in recent years.

Bayer Rosmarin's Bitcoin case study was a gentle debunking of the currency.

Firstly, coming from the angle of a large bank the security aspect of Bitcoin seemed to CBA somewhat counter-intuitive. Approximately 10% of Bitcoins would never be used because the security system functioned on the basis of a one-time passcode. Lose that, and you lose your ability to redeem your "money". Imagine (she suggested) if CBA froze your account permanently if you lose a passcode. The bank would likely to suffer an outflow of customers. How then could Bitcoin pass a convenience test?

Secondly there are a limited number of Bitcoins. I was somewhat confused by the CBA argument here because as we know Bitcoins can be split into fractions down to (I believe) nine decimal places. Additionally the raison d'etre for most Bitcoin believers is that the cap on the eventual size of the Bitcoin pool serves as a hedge against their concerns about central bank incompetency and associated currency debasement.

Thirdly, and more convincingly Bayer Rosmarin pointed to concerns as to the security of Bitcoin exchanges given various scandals that have erupted in the last two years. It's hard even for ardent Bitcoin enthusiasts to rebut this because the evidence is strong that this has been the weakest facet of the currency.

Lastly, Bitcoin according to CBA lacks differentiation. In fact, anyone can start a crypto currency. I think the suggest here was that these currencies might sink or swim as a group. If one currency was exposed as having certain vulnerabilities, then the group was likely to suffer because the flight to safety element of say out of Euro and into Swiss Francs wasn't available.

Not everything about crypto currencies is negative. Various protocols for payments were worth exploring. CBA have recently paid $A40 million for South African-based Take Your Money Everywhere. "TYME" is one of those bridging technologies that gives lower end or under-serviced users access to regulated bank accounts. The protocols and tech derived from this business is likely to add growth for CBA across not only Africa, but also in Asia. Bayer Rosmarin's analysis is clearly concluding that crypto-currencies are likely to stay as niche speculative ventures if banks can link their services in a way to make their day to day use unnecessary.

2. Cognitive Computing

The roots of today's Cognitive Computing can be traced back to the work done by IBM's lab in the mid 90's. That research culminated in the famous series of chess matches between supercomputer Deep Blue and Garry Kasparov.

Fast forward to today and think self-driving cars and algorithmic securities trading. The key to each step in these developments was the ability to handle ever-increasing amounts of data. "Big Data" as readers will know is an ever present theme at these lunches. For institutions such as a big bank, the question becomes one of sourcing and distributing access to that data, and what to charge or pay.

If you're a CBA SME customer, you can access some of that data through their Daily IQ application.

As a further add-on, CBA offers an open interface called Pi. The front-end of Pi is "Albert" and that gives you the opportunity to develop your own ways of interacting with clients.

Interestingly I allowed my mind to stray to some of the many presentations we saw last year which purported to provide just this type of add-on to users. As a friend of mine who runs a restaurant said when I showed him Posse (https://posse.com): "Why should I pay for that? I think my bank already offers the same thing?" What it says to me as an investor is that many of the businesses I look at are predicated on a single business plan. Attract a buyer such as CBA before they put their mind to developing their offering in your chosen sector. I know that sounds obvious. I've lost count of the number of times I've walked out of presentations thinking I've just seen the next unicorn only to change my mind after a cooling off period.

3. Cyber Crime

Readers will know I'm a long time fan of predictive algorithmics. We saw these methods first adopted by the Israelis in order to be able to deploy their limited security forces to the maximum effect. Financial institutions are already using these same techniques to track fraud and security infractions within their businesses. Cybercrime remains a huge challenge. Biometrics is often put forward as a solution, but Bayer Rosmarin doesn't see this as a standalone answer to tech-crime.

If you can find a business with a unique slant on cyber crime, I'd grip on tight. The very fact that there is no current industry standard solution suggests to me that this is an area that investors have a chance to make serious returns. Maybe part "Local Measure", part biometrics is what I'm looking for to fill the gap?


I view Kelly Bayer Rosmarin's presentation as a nice counterpoint to much of what we've been privileged to see and hear over the last year of BBY Disruptive Lunches. Call it the "Empire Strikes Back" if you will. It was at its core a well reasoned and somewhat sobering reminder that big institutions are well able to fill niches that smaller more nimble entrepreneurs are claiming as their own. One question during the Q&A best summed this up. Bayer Rosmarin was asked about the challenge being made to CBA's business by peer to peer lenders. While not dismissing the sector out of hand, she did suggest that operators (e.g. Society One) might find their businesses struggling if interest rates started rising. If you think about it, that makes sense. P2P's model is based on occupying the spread between lenders and borrowers. As rates rise that spread is likely to narrow and with it squeeze P2P business. Ultimately I got the sense that Bayer Rosmarin modus operandi is not to jump at shadows. Like all good engineers, it would seem she prefers to analyze first and act after carefully weighing up the possible responses and solutions.


Monday, 9 March 2015

CAIA / Deutsche Bank Volatility Breakfast. Check your ego, you're a passenger on this bus.

The hardest thing you can do as a professional in finance is to listen to others who are experts in your chosen field. It requires a certain modesty and the ability to close your mouth. For me, it was very strange to be sitting in the CAIA / DB Volatility breakfast listening to a panel discussion with David Dredge (Fortress Convex Strategies Group), Jerry Howarth (36 South), Michael Armitage (Milliman Financial Risk Management) and Michael Winchester (State Super, Australia). The panel was moderated by David Walter (PAAMCO).

For starters I worked briefly with Dredge at Artradis, in fact; he interviewed me, and I really enjoyed the process for once. Dredge (ex-BT) was on the team that developed the NDF (non-deliverable forward) market for currencies in Asia during the early 90's. That was a seminal product for emerging markets, and he told me some great stories about the early days of that market. The good thing about David is that he's willing to look at a lot of left field ideas. I remember getting a good hearing on some research I had done in the Australian mortgage insurance market that was initially dismissed by the team, but got some encouragement from David that was appreciated.

I wrote briefly about Jerry Howarth in my last blog, and so had a good idea of what he was likely to say. Michael Armitage  is new to me, and to be frank it took me a while to understand where he was coming from as I hadn't researched the firm before the event.

Michael Winchester was meant to represent the ideal investor for these funds. My guess is that he may or may not be invested in any or all them. It at least seems that he has done his due diligence on each of the funds. If I missed a disclaimer about this, I apologize, but I'd respectively suggest some disclosure. So be it.

Moderator David Walter (PAAMCO) is an investor with whom I'm familiar. I had the discomfort of once having to front him in his offices in Singapore to explain some returns that were somewhat unexpected. At the time, he was with ABN Asset Management, and they were being sold to PAAMCO. I only saw him one time after that during a Goldman Sachs conference in Tokyo, where he was kind enough to not dwell on the past too much.

Given that the breakfast theme was volatility and tail risk hedging, it was unsurprising that two of the three represented funds (Fortress and 36 South) focused on producing best cheapest convexity. Milliman as an offering was a different beast. Milliman state that they aim "to stabilize the volatility of an investment portfolio". In the context of this panel that effectively means, give us your portfolio, and we'll try and provide cheap hedges that will help protect or enhance your returns.

The discussion followed the usual path of each fund stating their raison d'etre. Dredge's opening statement was very familiar to me. Fortress Convex are going to go out into the market and try and buy the cheapest convexity. That means that you'll never know whether the hedge has a direct correlation to your portfolio as the purpose is to provide exceptional returns in extreme circumstances (3 standard deviation movements). If you're a long-only equity portfolio, you should get negatively correlated returns during "crash type" events. Fortress choose the best bets, whether that is (say) KRW/Euro or Canadian interest rates, and then that's what they'll own. So long as its positive convexity. The difference between Fortress and 36 South is that Fortress look for catalysts as part of their analysis. Howarth and 36 South are not concerned with specific events; rather they're looking at situations where volatility is cheap versus historical norms. It's a subtle difference, and I'm not sure the audience picked up on the fact. Both want to deliver a product that offers cheap convexity, but Fortress partly produce their "cheapness" by mitigating the cost through scenario analysis. 36 South do the same thing by a relative "cheapness"; the expectation being that the position itself has an innate value likely to offset some of the theta costs of holding the derivative position.

Milliman's direct hedge model is difficult for an independent consultant like me to assess. So much of what they do seems to rely on getting under the hood of a particular fund. How can I go to an investor and say that this company is likely to be successful in dampening the volatility in your portfolio and ipso facto improving your Sharpe Ratio if I can't do the math independently?

David Walter I felt hard a hard job getting Michael Winchester involved.  It seemed to me that the panel was leaning heavily in the direction of a consensus that volatility as a whole was cheap, and the dangers in markets were growing. Consensus is never as interesting as conflict and I would have liked Winchester to reflect on what his preferences were rather than to be in sync with the panel. He did allude to the difficulties he as a strategist confronted when trying to hedge volatility in a portfolio so concentrated on its exposure to the Australian banks. His conclusion seemed to be that historically as correlation went to one in disasters, then the basis risk was acceptable.

One other thing struck me as missing, and that was some discussion on the costs of the three offerings. I know 36 South is a conventional "2 & 20" fund, and I guess Fortress is similar. I have no idea what Milliman charges. Let's assume from the literature that the theta costs of 36 South and Fortress are in the region of 50bps per month. That means that if nothing happened in a year the likelihood is that you'd be down 8% (12 x 0.5% + 2%). That means that either you, as a fund manager have to produce enough excess alpha to pay for this, or you have to rely on the convexity provider to reduce this cost through clever positioning. I know with 36 South I get a reasonably long track record, and thus can weigh the propensity of the managers to achieve this. In the case of Fortress, the track record is shorter, and I'd have to add on to it David Dredge's previous track record to illicit the same conclusion.

After the breakfast, I was asked by an old associate what I thought. He liked 36 South and knowing him to be reasonably quantitative in his approach I could see the attraction. I'm somewhat conflicted on the argument that 36 South's model of outright cheap volatility is better than the Fortress catalyst enhanced model. If I'm 36 South, do I take profits too quickly if I didn't factor in a particular scenario? If I'm Fortress do I overplay my hand and get too stubborn regarding a situation not playing out, always increasing my bet in the hope it triggers?

Milliman is a different animal entirely. It seems I'm being asked to time the market more. Why would I take on their overlay if that's what the offering is if I'm bullish on the market? How much better is their offering than buying zero cost collars in index options? If a client asked me to investigate Milliman with them, I'd be very interested. It's hard not have an open mind about a company that has been around so long and is thriving.

After the main panel discussion had concluded, we got 30 minutes from DB derivatives strategist Alex Staab. A quick look at four  particular trades and an overview of what DB thinks is likely in the volatility markets. I thought it was particularly interesting that Staab pointed out the unusual correlation between the advancing Nikkei, QE and an upturn in volatility. The assumption in the "Anglo" markets has been that low rates, QE, and a rising market has dampened volatility. DB is suggesting that the Japanese pattern is repeating itself in Europe. I wonder if that means that Europe will have the same economic growth patterns as Japan had after its real estate market crashed in the early nineties. Let's hope not. Having said that It is true that Japanese volatility was extreme especially during the recapitalisation of the banking sector around the turn of the century.

Staab didn't get me with every point he made. I have to say a wry smile came to my face as he explained the positive return drift in daily v. weekly variance swaps. The trouble with that trade has been always to find someone to take the other side at near the theoretical value. I know at UBS we did our first trades in this in 1999 for the Japan book. What Staab didn't point out was that the seller over the swap makes a chunk of their margin in the hedge by trying to beat the end of day or week marks. On top of that there's a compliance problem because the bigger you are, the more likely it is that you can influence the close of the futures market. Regulators don't like that as it looks like market manipulation. This means that after a while compliance probably taps you on the shoulder and puts volume limits on trading around the close so as to avoid influencing things. My bet is that if I went to DB and said sell me the swap I'd pay a bigger premium than I wanted and be restricted in size. I'm fine with that, but others in the room who were more actuarial and less market experienced might be disappointed.

Overall I enjoyed the morning and will do some follow-up in the coming weeks. If you're interested in my conclusions and wish to discuss please contact me through the website at www.ibcyclist.com.


Thursday, 5 March 2015

Five things I've been doing this week

1. Hedge fund due diligence

I was lucky enough to get a lunch meeting with UK based volatility fund 36 South Capital Advisors on Tuesday. Fund CIO Jerry Howarth was in town and gave me 90mins or so over lunch at Tattersalls Club in Sydney. I have to be honest and say that 36 South was not on my radar until a client of IBCyclist Consulting mentioned them to me. It's strange given Jerry's history in the volatility space in New Zealand and Australia that we never crossed in the early 90's when I was a market maker on the floor of the Australian options market (92 - 97). Perhaps he was on the other side of some of the positions I had in New Zealand conglomerate Flecther Challenge when it demerged into smaller units at that time? That was a lot of fun and I have a great story about one particular fund manager who thought he was a genius and instead got that one very wrong.

36 South are presenting at the Volatility and Tail Risk Hedging Educational Breakfast being held at Deutsche Bank's HQ in Sydney on Friday. It should be interesting given the difficult environment that the last few years have been for long biased volatility players. There seems to be a bit of light at the end of the tunnel, and I'd expect tail risk and volatility, in general, to throw up some interesting opportunities this year. Chief catalysts for volatility events that I see are:

  • The US Federal Reserve Bank returning to a more normal monetary policy in Q3 - 4
  • The Eurozone reaching a long-term resolution of the Greek crisis, good or bad (end of summer)
  • A solution in respect of the current Ukrainian problems

I expect most of these topics to be covered at the breakfast along with various strategies aimed at either protecting or enhancing portfolio performance.

My write up of 36 South will be available to clients next Wednesday. Prima facie it looked to me that they passed the eye test of delivering what they say they will. If any investors would like me to provide a complete DDQ, please contact me directly to discuss the format and terms. Obviously I always suggest an onsite visit before investing in any hedge fund.

2. Bike Wheels

Believe it or not it is possible to wear out the rims on your bike's wheels. My Fulcrum Racing Zeroes have seen their fair share of kilometers over the last two and half years, and the brake track on the front rim was "cactus". The result was reduced stopping power and a nasty squealing noise when under medium braking conditions.

The answer is either new wheels or a new rim. Luckily for me Fulcrum does offer replacement rims. My local bike shop cheeky monkey is unfortunately at the end of the usual anti-Aussie supply chain economics. That means I had to go to eBay or wait for the Aussie distributor to come up with the goods.

What happened to the spokes?
Seven days later I had the rim from a US bike shop and had delivered it to Cheeky for change over. I pick up the wheel tomorrow. Total cost about AUD400. A new set would have been AUD1100 locally. I think that's a good deal given the hubs (both front and back) are still buttery smooth.

3. Leaky central banks 

The Reserve Bank of Australia is asking local regulator ASIC to look into irregularities in the currency and rates markets ahead of recent policy decisions.

Leaky ship or central bank?
Most of the questions being asked are in respect of the way the AUD traded in its various pairs this week when the RBA chose to keep rates on hold. That is only the tip of the iceberg. Last month the RBA chose to alter a well-inked policy of steady policy and lower rates. At the time, there were concerns that insiders were leaking the change ahead to experienced local commentator Terry McCrann. I don't know the truth of it, just that for years my favourite brokers in Sydney, when asked about policy at the RBA, used to say (I kid you not), just read Terry McCrann's column. Whatever the truth I'd say good luck to ASIC in trying to piece together the why's and why nots of what happened. The winners will be at the bar sipping Krug, and the losers will be whining to whoever will listen.

4. Residential property

Do people who invest in residential property really know what they're doing? Honestly, when was the last time you sat down at a dinner party and heard someone who's just bought an investment property tell you how great the rent yield was? In Sydney, I'd say 65% of them don't even know that they have to pay annual state property tax. So what? Well, if you've ever had to analyze property companies or REITs you'd know that the serious end of town takes cap rate calculations very seriously. A tiny move in gross rent or maintenance costs can put companies in play.

That's why when I met Josh Masters of Sydney based buying agent Buy/Side that I realised I'd finally meet someone who was trying to put investment banking type models into the hands of retail investors. Buy/Side's Suburb Investor app will be available soon in the iTunes and Android shops, and I bet when the dinner party Donald Trump's get a look they might go a little quiet.

5. You know you're a cycling nerd when . . . 

I was accused of being a nerd for tweeting out my latest bike maintenance achievement. For my birthday, I was given the uber-expense Campagnolo chain tool.

That gave me the ability to change my bike chain as per this video:

What a nerd. Guilty. Just to add to this level of nerdiness I've also become a black-belt in headset maintenance. None of this is rocket-science, and my go-to bike mechanic, Mark at Cheeky Monkey, admits there's a lot of trials, errors and broken parts in reaching my level of "nerdiness".

It makes me happy to strip down and rebuild parts of my bikes. Clients of IBCyclist should know I feel the same way about producing appropriate spreadsheet models. When you get the right tools and have clear instructions and some quiet time anything is possible. 


Thursday, 19 February 2015

Under promise and over deliver. #BBYltd Disruptive Tech Lunch: PocketBook & Singtel Innov8

There wasn't much hype surrounding the first BBY Disruptive Technology Lunch of 2015. I took along the CEO of a real estate buying agency as he's about to launch an app aimed at residential buyers. I thought it might give him an idea of some of the tweaks other innovators had taken with their tech offerings. These lunches also toss-up a nice cross section of investor questions that entrepreneurs are going to face as they get their message out to the capital markets. Forewarned is forearmed.

Long time readers of this blog will know that normally I like to come to these lunches with at least a modicum of background on the businesses presenting. On this occasion, I hadn't adhered to my routine. I had no idea what PocketBook was, save for the function implied by the name. Co-Founder Bosco Tan immediately came off as self-effacing by apologising for not wearing a suit. Nice touch from a man who's parlayed his position as a security engineer at BAE Systems Australia into a highly touted financial organiser app with 130,000 downloads.

So what is PocketBook? Pocketbook automatically organises your spending into categories like clothes, groceries and fuel, based on your transaction history.

It does this by you taking the "leap of faith" and linking it to your bank account. The algorithms go to work looking for patterns in your history. The result is that it quickly enables you to see incoming and outgoing cash, enabling you to take appropriate action. In addition, you'll get messages through various portals (email, pop-ups, etc.) prompting you of the fact. I think my guest had downloaded it before Bosco got to mid-presentation. Personally I'm a little slower at doing anything that entails me giving my bank account information to a smart app, but that's just me. Bosco himself said that the security aspect of the business is a game of trust. When they first launched, the active user numbers were closer to 30% than the 60% they have today. That's the trust capital being built up, but it also shows how important it is for this business to stay focused on security. One slip-up and users would just shut down their participation, and with it any potential revenue stream.

This blog is a fan of big data, and PocketBook is a great entree into that sphere. As part of their algorithmic scrapings, PocketBook has been doing case studies on various businesses and events in Australia. Bosco presented 4 of these, just to give us an idea of what's possible:

1. Uber

A fairly obvious study into the growth of Uber's market share in Australia. I say obvious because Uber users are smart device-centric and, therefore, the cash flow from electronic transactions is a very accurate measure of Uber's market penetration.

2. Sephora

Geographically based study of the impact of cosmetics retailer Sephora's impact on the main retail shopping strip when it opened pre-Christmas last year. The presentation showed the impact versus a number of retail categories, including the big department stores and smaller discounters of cosmetic products.

3. Apple sales cycle

This case study confirmed what we all know, that the hardware cycle drives Apples Australian earnings and significantly impacts non-Apple sellers in the smart device space. Apple doesn't split out it's Australian earnings for the group, but this presentation study showed what was possible with PocketBook's data scraping.

4. Netflix

If you're an Aussie "tech-head", you've been playing with VPN's and geographical masking for years in order to get the latest media. The time lag between US or European release of a book, movie or TV show and it's Australian release used to be infuriating. One media mogul used to buy up all the best police themed shows in the 60's and 70's and lock them down for years, only broadcasting them when reruns of previous shows had exhausted themselves. That's, not the case now thanks to tech. Netflix is an obvious example. PocketBook was able to extract the actual spend on Netflix and interpolate it to a number that that showed just how big the business was without a "real" offering in the country. The reaction to the recently announced roll-out of Netflix in Australia and the PocketBook study has seen multiple new offerings in the download space spring up virtually overnight. The panic is palpable.

So what do these studies tell us about PocketBook? Well, primarily PocketBook may be a chameleon. On one hand, it's a nifty tool for the budget concerned though it's unclear how that translates to revenue from this presentation. On the other hand the business, as it exists, might change radically in line with its use of data scraping. Additionally I wonder if ultimately the data side might create so much value that PocketBook should pay users to take the app? Whatever the long term eventuality PocketBook's future looks assured in some form and investors looking for multi-faceted opportunity could do worse than read through the current offering documents if they're lucky enough to be invited to participate. Of course, if you're concerned with privacy you might be more likely to get upset than to invest.

Singtel is the owner of local telco number two Optus. As part of this they've rolled out some capacity of their VC fund Innov8 (not a spelling error or typo). Alfred Lo is the "Lead Principal" here in Australia responsible for implementing the broader strategy that comes out of Singapore, San Francisco and Tel Aviv. The usual themes in terms of investment targets were all there:

Innov8 partners with the Fishburners project, I detailed at the end of last year. They also have spaces at Inspire9 in Melbourne. I got the sense that Innov8 was focusing on the rapid growth of connected devices beyond the usual smartphone / tablet sector. A good example of this is smart home controller Ninjablocks.

If I understand it correctly, Ninjablocks  is a communications facilitator that allows developers to connect devices within home or work environment without having to worry about embedded programming, electronics, & networking protocols. I love this type of thing in the same way I've always gravitated to the picks and shovels suppliers in every boom. Levi Strauss might not have discovered gold in California, but he did clothe generations in his denim trousers.

On wider business themes, Alfred offered some pithy insights into the current state of the VC space in Australia. I wasn't surprised when he said that Australia in general was underweight. It seems onshore investment in the local tech is about 38%, compared with 64% in Berlin and 59% in London. That's a none too subtle plea to the government to support the sector. This blog is never a big fan of tax-incentivised industries. Solar cells, wind turbines and alike are all very well when they meet real ongoing demand. Where's the value in providing tax breaks to offshore companies unless you get something more than a couple of thousand installation and maintenance jobs?.  If you disagree, I've got a friend who can sell you a solar farm in Spain or better still a bond that enhances its coupon through stripped German solar tax credits.

Finally for readers wondering why VC funds have doubled since 2009 just think about this: There are 80 pre-IPO billion dollar companies just waiting to come to market. Entrepreneurs no longer look to exit publically in the short term; rather they're content to feed out small amounts of equity to diligent investors. If that's you please contact me through my web page IBCyclist Consulting.