The Intelligent VC

If you read this blog, you’re either well-versed in consumer technology, or you accidentally stumbled into it, in which case please stay. This post was spurred as I was reading a classical investing book, the very same that taught Warren Buffet how to make his $58 billion. I’m referring to The Intelligent Investor. As history has taught us, we’re not very good at remembering history. What this book does is point out, in retrospect, poor investment decisions made during the last century, and how to avoid, or at least mitigate, further bad decisions. As the title of the book suggests, it’s aimed at investors (even unintelligent ones). This post is aimed at VC’s and technology stock speculators. 

Below is a direct quote from the book (emphasis mine):

Air-transport stocks, of course, generated as much excitement in the late 1940s and early 1950s as Internet stocks did a half century later. Among the hottest mutual funds of that era were Aeronautical Securities and the Missiles-Rockets-Jets & Automation Fund. They, like the stocks they owned, turned out to be an investing disaster. It is commonly accepted today that the cumulative earnings of the airline industry over its entire history have been negative. The lesson Graham is driving at is not that you should avoid buying airline stocks, but that you should never succumb to the “certainty” that any industry will outperform all others in the future. 

The pitfalls have proved particularly dangerous in the industry we mentioned. It was, of course, easy to forecast that the volume of air traffic would grow spectacularly over the years. Because of this factor their shares became a favorite choice of the investment funds. But despite the expansion of revenues—at a pace even greater than in the computer industry—a combination of techno- logical problems and overexpansion of capacity made for fluctuating and even disastrous profit figures. In the year 1970, despite a new high in traffic figures, the airlines sustained a loss of some $200 million for their shareholders. (They had shown losses also in 1945 and 1961.) The stocks of these companies once again showed a greater decline in 1969–70 than did the general market. The record shows that even the highly paid full-time experts of the mutual funds were completely wrong about the fairly short-term future of a major and nonesoteric industry.

Growth, expansion, disruption - these are words that VC’s throw around to describe blossoming companies that will take over the world. Not now, but in the future. Google, Facebook, Twitter, and Yahoo are just some of the largest tech companies that are built upon this growth factor. They need it to thrive, since revenues are predominately built upon advertising.

Another quote, from Maciej Cegłowsk, the creator of Pinboard:

Advertising is like the flu. If it’s not constantly changing, people develop immunity.

Keep the above quotes in your head as you read the things below. 

VC’s invest in tech startups for one reason, and one reason only: to get a return on their investment. They invest a few million into a startup for a certain percentage of the company > if the company is lucky it goes public > VC firm profits and reinvests in a new startup. Rinse and repeat. Guess how most of these companies get paid? That’s right. It’s internet advertising. Sponsored search results, promoted tweets, trending topics, you’ve seen all these things before. 

Companies that are dependent on advertising make revenues and profits only if their user base grows. Their stock price is directly correlated to growth as well. Once growth levels off, reality kicks in, and Wall Street penalizes low performers. Twitter knows this problem all too well. Their growth has halted (with no doubt due to that bewilderingly mystifying homepage). And look what has happened to their stock (spoiler: you wouldn’t want to have your life savings invested in $TWTR). 

Twitter Stock Price

Google and Facebook are still managing to grow their user base, but believe me, it won’t last forever. Facebook is already trying to diversify its sources of income, first with the comically huge purchase of Whatsapp for $19 billion, and then Oculus Rift for $2 billion. Whatsapp is dependent entirely on advertising. Oculus Rift is an investment for the future, and currently unprofitable. Neither acquisition brings with it tangible resources (equipment, land, inventory, accounts receivable), only potential growth. There’s that word again, growth. 

These companies are doing the only thing that they know how to do, which is to grow their users. More eyeballs, more advertising revenue. From early in the companies life, VC’s have always pushed for growth, and then after becoming public companies, Wall Street urges for the same thing. This investment mentality won’t end well.

Growth isn’t bad, but when the business model is advertising, there is an inherent limit. It might takes years to reach, but it will be reached. VC’s should stop preaching growth and start encouraging profitability early in the startups life. Not that your startup needs a VC to begin with. There are plenty of successful startups that did it all alone without advertising, unnatural growth, and rather, just by a desirable product and hard sweaty work (for example, Basecamp).

Beats by Apple

As I'm sure you know, the last few days at the Apple rumor-mill have been quite industrious. Lots of milling work to be done, I suppose. What I'm talking about of course is the Beats acquisition by Apple. At the time of this writing, the purchase wasn't confirmed, but according to sources "in the know", the deal will happen, which is why I feel some sense of comfort writing about it before it's official. 

The Beats acquisition for $3.2 billion is a helluva huge deal - the largest in the history of Apple, which is why it's particularly interesting to pundits and analysts alike. It's worth pointing out that Apple, classically, makes smaller acquisitions, mostly because Apple has a very unique culture that large, established companies cannot easily synergize with. Now, I don't know the Beats corporate culture, organizational structure, or any of the touchy-feely environment details, which is why I will steer clear of the subject. What I do know, however, is that Apple decided that either the culture is similar to its own, similar enough not to matter, or maybe even, it's different enough to be a sub-brand. Realistically though, even Apple doesn't know the answer to that yet, and only time will tell. 

So what exactly are 3.2 Instagram's getting for Apple? 

A Hardware Business

Beats by Dre are crappy headphones, and I'm being polite here, since any audiophile will use much more indecorous language to describe them. But that doesn't matter, because they sell millions of units, much like NYC hotdogs: the terrible quality is overpowered, somehow, by a customer desire for some tubed meat. Unlike NYC hotdogs, Beats headphones actually look really good, especially when you compare them to other prosumer headphones from Sennheiser, Bose, and Sony models. Most people don't need pristine audio quality. Rather, they just care what sounds good. And by all accounts, Beats headphones sound good. They look great too. They sell millions of units. They command a coolness factor. They made two earmuffs on your head sexy to wear in public. On the business side, the Beats hardware business is very profitable, since they use cheap materials that are converted into high consumer prices. The supply chain (getting them to stores around the world) is probably the hardest problem for the business, and we know Apple under Tim Cook excels at that. In terms of Return on Investment, the Beats hardware business  pays for itself many times over.

Goodwill

Consumers love Beats. They don't love the iPod (anymore). They never loved iTunes. When most people hear iTunes, they associate it with syncing your music through a USB cord. Is that really the brand Apple wishes to cultivate for the future? It isn't. Beats is the new iTunes. I fully expect within 1 - 2 years for iTunes to go the way of the dodo, to be replaced entirely by Beats. Beats is the new music service by Apple. I suspect they will kill off the bloated confusion that goes by the name of iTunes, and release a simpler, music focused Beats app for Mac OS X, iOS, Windows, and eventually Android. It will be focused on streaming, but of course purchasing music will stay around for those who want it. 

Apple had a few options here. One, they could have created internally a brand new music brand, which is always a risky, especially with intangible services that succeed based on the consumer reaction to it. R&D would take money and time (money isn't a problem, time is), heavy advertising would cost a good chunk, and success is not guaranteed. 

Option two. Purchase a music streaming service. The most logical option would be Spotify, since they are the number one service in the business. But that wasn't an option at all. Spotify would probably cost too much (and wouldn't sell), has over a thousand employees, and is headquartered in Stockholm, Sweden. The last point is likely the largest deterrent. Apple would not purchase a company with thousands of employees that isn't based in the United States, unless it's for manufacturing reasons.

Rdio was another possibility, but that would be purely for their streaming service since it isn't a brand. Most people have never heard of Rdio. Apple could have picked it up for cheap too, since the company has been losing subscribers for the last year and is in questionable condition. At first I thought this would be a better purchase than Beats, since the Rdio design aesthetic was so similar to iOS 7 before iOS 7 was released. But after further thought it would be a pointless acquisition that Apple actually could develop internally rather quickly. 

In fact, Beats was the only brand that had everything Apple didn't. It came with a cool hardware business. It came with a streaming service. And finally, it came with connections. Jimmy Iovine is a brand on his own, as is Sir Mister Dr. Dre. If anybody can sell cool, it's these two. They can guarantee all the licensing arrangements Apple could have wished for, which was always a pain point for iTunes. Beats is what we call trifecta. 

Success Isn't Guaranteed

But it's sure as hell likely. Beats is already a well known and liked brand. The main thing for Apple now is to not diminish it. Let it thrive as its own thing. Beats is the reinvention of iTunes, and the hardware business is just added profits. Music industry connections have also been acquired, so all legal rights should be easier to negotiate. There's only one thing left, that is - Apple has to make the deal official. 

The Best Apps for an Accountant

Most accountant's aren't very technically savvy, to the detriment of our profession. That's why in class, instead of paying attention to the professor (let's hope they don't read this), I sometimes let my eyes wander to see how my classmates take notes and solve problems. As you might have guessed, they use pencil and paper. If you're not an accountant, here's something you should know. We take lots of notes, and we need lots of scatchpaper. Don't get me wrong, I love the feel of my Pilot G-2 07 Gel Pen smoothly caressing the paper, but it's far from efficient. That's why I don't use paper and pencil to takes notes and homework problems. I am entirely paperless. My devices? An iPad for taking notes, and my Mac for everything else. The only alone time I get with my pencil is during exams, and that's because I'm forced to. So here are the devices and the applications I use.

iPad 

PDF Expert

I open all the PDF slides my professors provide in PDF Expert, and sync them through Dropbox (everything I do is saved in cloud storage, but I'll leave that for another post). It's quick and easy, and let's me quickly markup documents. 

Mac

Numbers

For those unaware, Numbers is Apple's version of Excel. It's less powerful, but much cleaner and quicker than Excel for basic calculations. I do all of my homework in Numbers. It lets me play with numbers and see how various things fit together (which is precisely what accounting is). It's like a digital scratchpad that never runs out. Unlike pen and paper, I don't have to scratch out or erase my errors, I can just delete them. Is my answer off by a few cents? No problem. I can quickly adjust the numbers to see which percentage gives me the correct answer. But the best feature of a spreadsheet program like Numbers is its support for formulas. For example, I can set "Income Taxes Paid" to equal the "Tax Rate" multiplied by the "Net Income/Loss", and it computes the answer in real-time. If I decide to change the "Tax Rate", "Income Taxes Paid" changes with it. Imagine doing that on paper. I keep all of my calculations saved in a workbook, with a sheet for each chapter, so that I can refer to the examples at a later time (like when I have to take the CPA, or more likely, before an exam). Numbers is more stable and appealing to look at than Excel, and I highly recommend it for any accountant/student who uses a Mac. 

An example of my Numbers spreadsheet. If you were wondering, I was calculating the Loss Carryforward and Carryback in this problem.

Excel

Every accountant knows about Excel. It's a powerhouse application, and much more powerful than Numbers. That said, most accountants rarely, or likely never, need Excel's power-user features. I still use it for some classes, mainly when the teacher expects the homework in Excel format. It does exactly what I wrote about for Numbers, albeit in a less pretty way. The formula's are nearly identical to the ones in Numbers, so for those who are worried that everything they learned in Numbers won't translate to Excel, stay calm because it will. You'll definitely be using Excel at work, so it helps to get friendly with it.

An Excel spreadsheet with my cost accounting homework.

Soulver

Soulver is what I use when I need to do some quick, dirty calculations. Quick, what's $2,500,212 divided by $20,212? I could do that calculation in Numbers or Excel, but it's much faster to do in Soulver. You can also reverence previous lines. For example, I set "Income before taxes" to Line 1 (revenues) - Line 2 (expenses). It's fantastic for short homework problems. 

That's correct. The above calculations are my net income. 

I use many more apps, but these are the three I use most for school. It always amazes me that students still use pen and paper in 2014, when there are much better options out there. And it's great preparation for the real world, where you'll be doing all your work on the computer, not to mention that you'll be a much more productive employee out of it. If your excuse for not using technology is that exams are on paper, I say to you, sure, then you will want to do practice problems more efficiently on the computer. You can do three to four problems in Numbers in the same time as you would do one in your notebook. Make the computer work for you.

Google 2014 Q1 Results

I've been quite busy with schoolwork, "work" work, and learning to code, so forgive me for posting so sporadically. I may not be posting very often, but I've still been consuming all of the latest tech news as vigorously as ever, so all is dandy. Anyway, that's enough of my solipsism. This week we have a small treat from Google, with their 2014 Quarter 1 results. Below is a transcribed (and beautified) income statement. Percentages are mine.

Google Q1 2014 Income Statement. Q1 2013 included for comparison. 

- Items highlighted in red reduce net income. 

- Items highlighted in green increase net income.

- Items in black are totals. 

Some things of particular interest:

• Revenues grew healthily, despite what Wall Street skeptics will say. As many analysts have noted, Google revenues closely follow the amount of Google users (due to advertising). For revenues to continue growing, the user base has to expand. The U.S. is saturated already (pretty much everybody is a Google user), so revenue growth will either have to come from 1) international users, or 2) other ways of monetizing current users. It's also worth noting that international users are less profitable than U.S. ones.
• For every dollar earned, Google spends $0.14 on Research & Development. Google Glass, Google Maps, self driving cars, Android, Google TV, I can go on with other projects Google is involved in. The good part is that they are constantly innovating. The bad is that many, no - most products never leave the lab. Overall, it's great to see a large company spending so much on research and innovation. Looks like it's not stopping. Google spent 31.5% more on R&D this Q1 compared to last year. 
• Large increase in General & Administrative costs. Are they hiring up? Becoming larger and thus less efficient? Hard to say, but the increase is there and worth pointing out. 
• Net Income rose by 3.17%. Not bad, but not exactly stellar performance either. Considering revenues rose 19%, I would like to see net income follow revenue growth more closely. Trim down the fat (SG&A expenses). That said, technology companies are rarely efficient, so this is nothing to worry about, but again, worth pointing out. 

That's all for now. In the future, I would like to make some comparisons over a longer time period (10 years), but for now, this will do. As always, you can contact me here (I don't bite) or in the comment section below. 

A Smartphone in Every Pocket

"Our slogan from the very beginning was ‘A computer on every desk and in every home,'" said Bill Gates during the height of Microsoft's dominance. As many have noted, that goal has been achieved. It's been achieved years ago, in fact. Whether you were an early adopter, a late one, or even a Mac user, you've undoubtedly had to use a PC at least a few times a month, or more likely, every day. Windows has won, even Steve Jobs admitted to it. If the CEO of your key competitor says so, you know you've won. 

But now look what has happened. Windows computers are on the inevitable decline, year by year. The Surface tablet was an extremely costly public failure. To top it all off, Windows Phone never took off like it was planned to. Despite revenues still reaching record highs, it is clear that Microsoft is in an uncertain position, and management kerfuffles don't alleviate that worry. Microsoft needs the next big thing, a profit center that will lead it for the next decade. Given that smartphones have a market reach far greater than PC's, that should be Microsoft's core focus. Fortunately, they have all of the elements to succeed; it just amazes me that they don't see them.

Here's what I would do to revive the company if I were Satya Nadella.

• Make a Windows Phone. Nothing bad was ever said about the quality of the Surface. In fact, reviewers said that it had fantastic build quality. Now that Microsoft owns Nokia, who rivals Apple in hardware design, making a beautiful Windows Phone should not be a problem. 
• Bundle Free Services. Microsoft has Outlook, OneDrive, Skype, Office, a music store, a video store, and an app store. That's an ecosystem that is far more comprehensive than Apple's. Microsoft's core competition in services is actually Google. Here's how I would tackle this. Google has the reputation for being open and public, which rubs many users the wrong way. Microsoft should take the Apple approach and preach data privacy and the highest level of integrity. Moreover, make all those services free for Windows Phone users. Free calling and texting with Skype, free email with Outlook, free cloud storage with OneDrive, free Office apps. Hell, even make music streaming free for a certain number of hours per month. Right now, the main thing stopping consumers from purchasing Windows Phone devices is the lack of apps. Offering all of these services for free would compensate for that app shortage and would undoubtedly bring many new users to the platform. And developers follow the users. Note that making all of these services totally free for Windows Phone users will be an extremely expensive short term decision, but in the long term it will pay off. 
• Platform Lock In. Apps don't lock in users, but ecosystem services do. I can switch easily from an iPhone to an Android phone and back, because apps like Twitter, Facebook, and WhatsApp are platform agnostic. They offer essentially the same content on all devices. Photo storage, playlist preferences, and documents in the cloud, however, are all things that keep users locked in to your platform. Give iPhone and Android users a compelling reason to switch to Windows Phone with the bundled services above, and keep them glued to it. For example, offer a service that automatically backs up all user photo's in the cloud, give them unlimited storage (unlike Apple, which provides a limited amount for backups), and let them access those photo's online and share them with friends and family. When people are given a compelling free service, they use it. When they use it, they are locked in to the platform. Who would want to switch platforms when they have thousands of photo's saved in OneDrive? That's right...nobody. 

There's one last thing I would do as CEO, that's that marketing the Microsoft ecosystem. Show people why they should switch, and how many free services they get from doing so. Users love free stuff, and Microsoft needs users. Give them what they want, and you will receive them.