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Famed podcast host Bill Brewster noted on twitter that he was worried about customer concentration at a company he was researching. The company had 30% of its revenues coming from a single firm.  In many cases, a 30% customer has tremendous power over its suppliers. Let's consider some examples. Walmart v Blendco For most consumer product companies, Walmart is a major customer, often 10-20% of sales. Walmart uses this fact to its advantage, resulting in headlines like this:  This is part of Walmart's moat: their scale results in a positive feedback loop between low prices, customer traffic, and supplier negotiating power. Low prices —> High customer traffic —> Power over supplier —> Supplier cuts prices —> Lower prices To show how this works in practice, let’s war game a conversation between Walmart and a supplier of say, blenders: Walmart: We need you to lower your prices Blendco: We don’t want to Walmart: If you don’t, we will bring in another supplier of blenders Blendco: But our products are unique. People will be up in arms if you don’t carry our blenders! You will lose traffic! Our loyal customers will go online to buy our blender anyhow! Walmart: I don't think so Blendco: Eeek Walmart's success in this negotiation hinges on customers not caring much about differences in blender design. They may have a slight preference, but most wouldn’t notice if Blendco’s products disappeared from Walmart's shelves forever. In contrast, Blendco cannot recover this revenue. So most of the time, Blendco caves and offers Walmart a slightly lower price. But not all large customers have this type of power. Spotify v UMG For music labels, Spotify is an even larger customer than Walmart is in the consumer products world. For example, payments from Spotify constitute roughly 20-30% of Universal Music Group (UMG) revenue. This was the inspiration for Bill Brewster's tweet. The idea is that Spotify may be able to leverage this position and its "ownership of the customer relationship" to retain more value for themselves over time.  The "customer ownership" theory appears to rely on experience from other online media businesses, where such ownership was key to long-term success. The obvious example is Netflix, where the relationship with its ever-expanding set of consumers has created the industry's largest budget for exclusive content, improving the product dramatically relative to competitors and driving even more subscriber signups. The problem with this analogy is that Netflix has always had a differentiated product relative to peers. Much of their content is unavailable to be streamed elsewhere, and they've always had far and away the most scale. Spotify has none of these advantages. In music, it has ~zero exclusive content, and while it does have the largest subscriber base, their scale advantage is modest relative to Netflix's. We think a hypothetical negotiation between Spotify and UMG would look like this: Spotify: We need you to lower your take rate UMG: We don’t want to Spotify: If you don’t we will bring in another supplier of Drake and Taylor... ok we can’t do that. Well, we will just drop your songs from Spotify completely. Our consumers won’t care. Maybe we can lower our prices. UMG: You don’t think your customers will jump to Apple Music or YouTube Music if you don’t have Taylor Swift, Billie Ellish, Drake, The Weeknd, The Beatles, Post Malone, Lady Gaga, and Ariana Grande? Spotify: Eeek In this negotiation, the fact that Spotify provides 30% of UMG’s revenues is almost irrelevant. While Spotify appears to own the customer relationship, at the end of the day it is a music app. The music is really what owns the relationship with consumers. Yes, there may be some consumers who feel locked in to Spotify due to playlists they’ve shared or followed. But for most people, the loss of UMG artists would would far outweigh other considerations. They would simply switch apps. Daniel Ek is too smart to take that kind of risk. Musicians v UMG What then, about the stars? Can't they use their leverage to get a bigger slice of the pie? The short answer is that they will try to, and they do have some leverage. After all, these stars control important music: their yet-to-be-recorded albums, at least those that are not under existing contracts. The back catalog will be owned by UMG regardless, but many stars have woken up to the long-term value provided by streaming and want to have greater ownership over their future music. They will be tough negotiators when current contracts run out. But wasn't this dynamic true before streaming? It has always taken a lot of money to retain hit musicians with expiring contracts. Somehow this fact has not crushed the economics of labels historically and I don’t see why streaming changes the picture, other than giving both sides a larger pie to split. Stars going independent What about the artists building an audience on social media and then going completely independent? This could happen, to be sure. But the evidence shows that artists continue to value working with the major labels. And why wouldn't they? The music industry is notorious for creating one-hit wonders. The real skill is in turning one hit into two, three, and four hits. That is what makes a career in the music industry and labels still bring considerable expertise to bear on this effort. Consider Lil Nas X. He uploaded the original Old Town Road track in December 2018. Note the request in this tweet:  The song went viral on TikTok and elsewhere a few months later. He had all the attributes of an act that could've gone independent: 1) He produced his own music 2) He uploaded his songs to streaming services using an independent distribution provider 3) He gained traction on social media before signing anything All of this gave Lil Nas X leverage. Theoretically, he could have just uploaded his music to Spotify using something like CD Baby and raked in the $$$ without splitting it with a traditional label. But he didn't. He decided to sign with Columbia Records. In fact, he appears to have turned down a $1m+ offer from his original distribution platform / independent label Amuse. So far, this decision appears to be working well for him. After all, it was Columbia Records head Ron Perry that contacted Billy Ray Cyrus about appearing on a version of the song. That "remix" is now the official version, the one that broke the record for longest run at #1 on the Billboard charts. I don't think Lil Nas X is regretting his decision. While we have no doubt that some artists will go the independent route, and that social media will help them do so, we think the majority of breakout artists will want help. And that help is likely to come from the labels with the best track record of creating stars, with UMG at the top of the list. All of this being said, we continue to think that the best way to get exposure to UMG is through the extremely-discounted stock of Bollore.
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I did two podcasts over the past month talking about our Q4 letter. We discuss my background, poker, statistical value investing, current market conditions, and a few investment ideas. Enjoy!
Acquirer's Podcast w Tobias Carlisle This Week in Intelligent Investing w Elliot Turner Enjoy! It is very common for gamblers to learn lessons. It is easy to see why: there is so much data for the gambler to consider. In roulette alone there are all the numbers... are they low numbers? Red numbers? Numbers divisible by three? What color shirt is the dealer wearing? There are so many opportunities to learn lessons if you are looking for them! Almost all of these lessons are nonsense. Rational people understand this because the randomness in a casino is very explicit: an equal-weighted die, a well-spun wheel, or a shuffled deck of cards. For these games, anything except a mathematical analysis of optimal play -- based solely on the rules of the game -- is irrational. It is superstition. In the real world, the lines are more blurred between what is random and what is not. One could even argue there is no such thing as randomness at all. Was the person that took a job at a future unicorn the beneficiary of chance, or just prescient? If you were smart enough -- or perhaps had a computer in your shoe -- couldn’t you predict where the roulette ball would land? Is it lucky that the Pfizer / BioNTech vaccine works so well, or is it the result of decades of scientific research? Cleary there are opportunities in this world to sift through randomness and find truths which can be exploited. At the very least, there are opportunities to tilt the odds in our favor. The world of investing, though, is a particularly difficult place to spot such truths. Yesterday's “truth” may merely be noise. Or, if enough people are aware of it, yesterday’s truth will become today’s random walk. There is still an active debate about whether skill exists at all in investing. I do believe there is skill in investing. As a former poker player, however, I am acutely aware that small sample sizes can be misleading. This applies to investors, strategies, or simple rules of thumb like “sell in May and go away”. And learning too much from small sample sizes is particularly dangerous for bottom-up stock pickers. Some quick math will help us see why. Let’s say you are a fairly concentrated portfolio manager that typically holds 20 positions. If you turn over 5 positions per year that means over a period of 10 years you will own 70 stocks (the 20 you start with and 10 x 5 new ones). If you do a good job, maybe 10-15 of these stocks show losses over your 4-year average holding period. Perhaps 5 of them will suffer large losses of >50%. If you throw in thematic errors of omission like “missing out on the SAAS rally”, you may have ten total mistakes to analyze. Is it possible to learn anything from these ten mistakes? The answer is likely no. There is just too much randomness involved. Unless you can identify an underlying causal factor which is applicable across market cycles, taking lessons from such a small number of cases is a fool’s errand. It leads investors to double down on today’s hot strategies and divest from what is underperforming. If enough market participants invest based on these “lessons”, price movements can become self-fulfilling and move towards extremes. Below is a partial list of market “lessons” that have been learned by investors over the years: 1960s: only invest in the largest fifty companies 1970s: don’t invest in bonds 1990: don’t invest in banks 1999: buy anything tech, stay away from value 2002: don’t buy anything tech 2005: invest only in value stocks, especially banks 2007: commodities and resource stocks are an asset class 2017-today: bitcoin is an asset class 2010-today: valuation doesn’t matter, #neversell, only buy growth stocks Of course, all but the final two “lessons” have proven to be mirages. These mirages are top of mind for me when people on twitter ask what lessons we have learned from our past mistakes. Are people really learning the right lessons from their own small sample size? And further, have the past ten years really been a good teacher, or are all of these *lessons* merely a reflection of larger market trends? On the long side, the lessons being learned are obvious: Always invest in electric vehicle IPOs. Make sure not to pass on Special Purpose Acquisition Companies. You can’t lose money on SAAS stocks. 30x sales is still cheap for a “good business”. And the most frequent lesson of the past decade: never sell based on valuation.  The opposite lessons are also being learned: you can’t make money in stocks that don’t grow. There is no such thing as a mediocre company being “too cheap”. Don’t invest in banks, cyclicals, or energy, because “bad” industries should be avoided altogether. The performance of the Vanguard Energy ETF demonstrates how long investors have been trained to avoid bad industries:  As we mentioned earlier, these "lessons" can become self-fulfilling, as more and more investors "learn" them. This dynamic can cause trends to stray beyond pure randomness, and even beyond what is warranted by underlying industry dynamics. If they go far enough, they can create opportunities for investors who pay attention to valuation and are willing to look into the future rather than the past. These are the investors that buy 30 year bonds in 1982 or value stocks in 2000. Perhaps the right approach to the "lessons learned" question is to invert it: What lessons are investors learning today that aren’t based on any fundamental truth? In other words, what does the market know for sure that just ain’t so? This is where you will find the real opportunities. Given that Warner Music Group has recently had an IPO, I thought it would be interesting to compare the company to privately held UMG, which we own via Bollore. UMG and Warner, along with Sony, make up the "big three" music labels owning 80-90% of revenue-producing music.
History of Warner Music In 1957, an actor for Warner Brothers movies made a hit song for an independent record company. Sensing a missed opportunity, Warner created Warner Bros. Records in 1958. This served as a platform for numerous acquisitions, including Atlantic Records. Atlantic paved the way for WMG's success, and during the 60s and 70s became the home of hit artists such as Ray Charles, Aretha Franklin, Led Zeppelin, Bette Midler, Neil Young, and Cream. Today, WMG traces its roots back to 1811 via their Chappell and Co subsidiary, which was purchased in 1987. That firm was once called "one of the best publishers" by Beethoven himself.  Uniti Group is a weird little company that trades 9x EBITDA and arguably a ~20% free cash flow yield to the equity.
The company owns fiber optic cables and copper wires and leases them to ISPs, mobile wireless providers, and businesses. Comps Owning fiber-optic cables can be a good business. Fundamentally, they are the key asset behind a roughly $70b market in the US - fixed broadband internet (and increasingly important in mobile wireless as well). Once deployed, fiber is costly to compete with: the only real way to do so is to “overbuild” your own fiber. Estimates of the cost to run fiber to one household varies between about $700 for telcos to wire existing customers to $1250 per home for a near-nationwide build-out. Costs are even higher in some rural areas where homes are far apart. Insurance is a strange business, because unit costs are not known ahead of time and are different for every customer. Sometimes these costs are not fully known for decades, such as when asbestos claims surfaced in the 1970s and resulted in hundreds of billions of dollars in liability for manufacturers and insurance firms.
Not only are costs not known ahead of time, but they are different for each customer. In some cases the factors most heavily influencing claims are random. Who can know which coastal town in Texas is more likely to be hit by the eye of a hurricane? For car insurance, though, the customer is in much more control. While there is certainly still lots of randomness to car insurance claims, an aggressive driver has a much different risk profile than a conservative one. Since this factor -- how someone drives -- is both heavily correlated to insurance risk and knowable ahead of time, car insurance companies make a big effort to quantify it. In the early days of auto insurance, this was pretty tough. Insurance companies had to make an educated guess based on age, gender, and driving history (tickets, accidents, insurance claims). Over time, though, insurance companies have gotten more sophisticated at collecting data. Clayton Christensen is an HBS professor that coined the term "disruptive innovation".
The theory His theory states that disruption is made possible by low-end (read: cheap) or new-market footholds. Incumbents have little incentive to match prices with low-end disruptors since it would hurt their margins. This allows the disruptor to gain market share with little direct competition. Eventually, their product improves and becomes "good enough" for a large segment of the market. At this point it may be too late for incumbents to change course. Often the disruptor has developed new manufacturing or distribution methods (with the original goal of lowering costs) that make their strategy harder to imitate for the market leaders. In my view, Christensen's theory focuses too much on price. The number of investment ideas and full-fledged stock writeups in the public domain has got to be at an all-time high. Whether its on Value Investor's Club, SumZero, Seeking Alpha, or simply on twitter, there are probably multiple writeups on the vast majority of publicly traded equities.
I look at all the above. But one of the places I enjoy browsing for ideas the most is in quarterly investor letters. The folks at r/securityanalysis make this process extremely easy by collating a vast array of publicly-available letters. Here is the posting for Q3 if you want to check it out. Below are a few ideas from that post that I thought were interesting. To my wife's chagrin, I'm slightly obsessed with another woman. The other woman is smart, accomplished, and ... 76 years old.  Her name is Judy Faulkner. Here are some of her accomplishments:
Perhaps now you understand why I think she's so cool. What multiple would you pay for a business with the following EBITDA profile? To help you out a bit, allow me to include a couple more details:
 Does 10x EBITDA sound like the right number?
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