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 ( "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


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.