Monthly Archives: April 2008

The Invisible Hand

Today’s announcement by Bank of America is the second in a series of recent rational decisions by private entities seeking to address some of the concerns that exist in the markets.

Bank of America to Modify Mortgages, Help Homeowners

Bank of America Corp., seeking approval of its Countrywide Financial Corp. takeover, said it will modify at least $40 billion in troubled mortgage loans over the next two years to keep customers in their homes. The move would help as many as 265,000 homeowners…

While clearly different in many ways than the industry-wide announcement of a privately orchestrated derivatives clearinghouse (discussed here), BofA is also pro-actively responding to the financial crisis facing millions of American homeowners that has had ripple effects across the globe.

A cynical perspective might suggest that these measures are simply an attempt to prevent direct intervention by regulators in a system in obvious need of repair, or perhaps they just want the merger to be approved.

However, if one considers that such a move is not only the right thing to do, but also economically-rational, then it appears more likely that this was purely an example of the free-market working. Private market participants are nimble and knowledgeable, and at least if we take BofA at their word, they sometimes do the right thing.

While helping 265,000 homeowners is not going to solve the foreclosure crisis we are facing, it is surely a step in the right direction. Now let’s hope they follow through.

Bad Housing But Good E-Coli

Although this is unsurprising, it is now official that the housing slump is entering into record territory nation wide.

New-Home Sales Fall to Low Last Seen in 1990s

The NYTimes today said:

Buyers vanished from the housing market in March, as sales of new homes plummeted to the lowest level since the housing recession of the 1990s, the government said on Thursday.

Builders are now faced with the biggest backlog of unsold homes in more than a quarter century, a sign that home values may continue to drop.

One thing that the article does not mention is the growing amount of foreclosures that are continuing to squeeze homeowners, reduce the demand from future buyers and create an even greater amount of excess supply.

Lets hope innovation can pull us out of this mess.

On that note, I had an interesting, but random conversation with a researcher this evening who told me about the use of genetically modified bacteria to make biofuel.

Perhaps best known for food poisoning, E-coli, have apparently been modified by scientists to make biofuel.

I never thought I would be blogging about E-coli, or that if I was it would be good news, but sometimes life surprises you in unexpected ways:

Efficient Biofuel Made From Genetically Modified E. Coli Bacteria

Here’s hoping creators keep creating.

Intelligent CDS Reform

The WSJ has a great article today suggesting the benefits of a central clearinghouse for derivatives contracts that are currently traded over the counter.

Here is the article: Street Seeks Credit-Default Safety Net: Banks, Exchanges Speed Effort to Launch Clearinghouse to Back Derivatives Swaps

For those of you who have been reading this blog for awhile or have talked to me for more than 10 minutes about the credit crisis, you probably know that my biggest fear for the markets involves a doomsday scenario where a major institution fails, leaving a variety of counterparties holding CDS contracts without anyone on the other side (earlier post: The Fan).

It seems like one step towards averting such a potential disaster is to have more transparency in this very opaque market so that people can have a better idea about what risks their counterparties are taking.

According to the article:

More than a dozen firms including investment banks, brokerage firms and futures exchanges are accelerating efforts to create a clearing entity that would function as the middleman between firms on both sides of a credit-default swap. The clearinghouse would guarantee payment on the contracts it handles, reducing the risk of a catastrophic ripple effect if one or more firms were unable to make good on their trades.

While there are issues around continued innovation (e.g. the creation of new derivatives), standardization (e.g. which contracts would be used), and internationalization (e.g. people could potentially trade elsewhere), this concept sounds promising.

It is also an excellent example of the market offering a solution to a regulatory failure. Let’s just hope that the Fed keeps their hands off or at least encourages these sophisticated players as they develop this promising market-based solution.

Former Telecom CEO And Mobile Internet

Today I had the great privilege of having lunch (along with a group of fellow students) with the former CEO of Chunghwa Telecom, Dr. C.K. Mao. He genuinely was one of the most impressive people I have met in a long time, and I don’t think I will be able to do it justice in this post.

He had a very clear and calm charisma about him, yet was able to slice through incredibly complex concepts and articulate brilliant answers in a very meaningful and precise way – all in a second language.

The key takeaway from his various years in leadership across a wide variety of sectors both in government and outside was:

Domain knowledge is not as important as having a tool kit that you can bring across various industries. His kit includes “decision making” and “change management”. You should develop your own

To communicate big ideas at the transition point in an industry (for Dr. Mao at CHT this was in the transition from landlines to broadband/DSL): get people involved in *doing*: half will get involved and feel motivated, 30 percent will follow their lead, and 20 percent will probably quit or leave the firm.

He also had some very interesting thoughts about the future of mobile and phone services generally, which he sees progressing towards mobile IP-based data-transmission.

As I can attest to by the fact that I am drafting this note on a blackberry mobile device, I strongly believe in the future of the mobile internet. I am convinced that mobile is the future in more ways than one. Our fixed screens will be cool and good for media content, but lots of content will be easily accessible and text/image based along with us all the time. We will be able to interact socially in ways that make holding the device in our hands just part of the way things are done…and you guys will stop getting annoyed at my typing away…maybe that last bit is a bit too far-fetched, but there are exciting times ahead.

Peter Lynch Visits Harvard

The Harvard Investment Club hosted Peter Lynch today to offer some basic advice on investing in public equities. Mr. Lynch is one of the most well known and likely one of the most successful investors in history judging from the track record of his Magellen Fund at Fidelity, which returned 29% compounded over the 23 years he managed the fund while growing it from $18 million to the $14 billion in assets when he retired from the fund in 1990.

He gave very commonsensical sounding yet insightful advice to future investors. The notes from the talk follow below:
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A. Know what you own.

When a stock goes down and you don’t understand what the company does, you don’t know whether to sell or buy more. Don’t buy things that are complicated. He bought stocks like Dunkin Donuts.

Keep in mind, the average stock has had a range of 100% from high to low. If you don’t know what you own, you are likely to “turf it” (sell it right before it goes up). People should employ their advantages, and buy stuff they know a lot about.

B. It is futile to predict the economy, interest rates and the stock market. (*ignore this point* ;-) )

You just don’t know what is going to happen. Predicting the future is a waste of time. If you spend 13 minutes on economics you have wasted 10 minutes. Small economics…asking questions like: how much does aluminum cost? and does a recession impact used cars or new car sales? are a good idea.


C. You have plenty of time.

When WMT went public they were a 15 year old company. 10 years later they were up 10x and after 15 more years 30x more (300x total). There are good companies, but not a lot of them. Fortunately, you don’t need to find a lot of them just a few over a career.

D. 10 most dangerous things people say about stock prices:

1. If its gone down this much already it can’t go any lower.

One of his favorite stocks went from 15 to 12.5 to 9 all the way to 3. He was still confident thinking that he was “a little early”. With a level head, he bought more and ultimately did well on the investment.

2. If it has gone this high, it can’t go higher.

This is simply not true. MCD, MSFT, GOOG are all examples.

3. Eventually they always come back.

Sometimes they don’t.

4. It is trading at $3. How much can I lose?

All of it.

5. Its always darkest before dawn.

It is darkest before complete blackout.

6. When it rebounds to $10, I’ll sell.

Numbers don’t matter. They are arbitrary.

7. What me worry? Conservative stocks don’t fluctuate much.

Things change. See the electric utility industry.

8. Look at all the money I’ve lost, I didn’t buy it.

Don’t look at the ones you miss.

9. I missed that one. I’ll catch the next one.

Maybe not.

10. The stock has gone up/down I must be right/wrong.

Don’t start buying because stocks go up. There is a 100 percent correlation between earnings and stock performance over time.

E. Avoid Long Shots.

The company says “If this works and that works it goes up 20 fold!” But now…no sales. Mr. Lynch was for 30 on these.

F. Importance of Management.

Management is important, but if you have a bad industry and terrific management, you can’t win. But simple businesses don’t need much management. Mr. Lynch wants to buy a company that any fool can run, because eventually one will.

G. Be Flexible.

Even when industries are successful, you can still lose. MCD, Outback, etc. made money in the restaurant industry even when it was growing at 2%. Even shrinking industries are OK. An industry not going anywhere but where you have a monopoly makes money. Bankruptcy is OK.

H. When to Sell.

When to sell is exactly when to buy. Always write down the reason why you made the investment decision. What is the story?
Stick by the reasons. If the story changes or you are wrong, sell…unless you can come up with a new story.

I. There is always something to worry about!

The organ in the stock market is not the brain. It is the stomach. There is way too much news now.

Key example was in 1991: Recession was imminent, 1st War in Iraq was starting (big concerns about major losses), Banking system was on the brink, etc. But…it all turned around. You can’t get too distracted by background noise.

After Caesar died, the market in Rome probably crashed. In the year 1 BC, people worried about Y0k. In 1999 it was Y2k. People overreact. There is always something to be nervous about.

The news today is the depressing channel and the super depressing channel. But look at Brazil, Philippines, Chile, Eastern Europe…there is good news out there.

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This last piece is music to my ears as I seek to ignore the horrible news coming out of the banking sector today. At least for another day or two we will stay on the bright side…but watch out for that other shoe.

Jeff Bussgang of Flybridge Capital Visits HLS

My VC seminar at HLS had a real treat Monday evening, when serial entrepreneur and venture capitalist, Jeff Bussgang (of Flybridge Capital, formerly IDG Ventures) took time out of his busy schedule to share some of his experiences and lessons learned from his time working on start ups and in the Venture Capital Industry.

Mr. Bussgang, who is an active blogger (visit his blog here) was incredibly down to earth and gave mostly common-sensical sounding but nevertheless insightful advice in plain English. He reminded me once again that speaking with clarity is a sign of true understanding.

My notes from the talk follow below. The post is long, but there are lots of good nuggets of wisdom, first on being an entrepreneur and then on being a VC:

He knew that he wanted to be an entrepreneur from the beginning. Resisted the temptation (and active recruiting) of a V.C. firm who saw value in his undergrad computer science degree and MBA.

Thoughts on Entrepreneurship:


Start-up 1: Athena

In the early 90′s (while at HBS) first start up was an app trying to replicate Lotus 1,2,3 for the emerging OS2 platform. It ultimately was not successful, primarily because they were squeezed by IBM.

Lesson 1): Technology is only as good as the platform.
Takeaway: In developing mobile apps today, we should think carefully about choosing I-phone or Android (or other) as the platform. I personally like Android, but Mr. Bussgang suggests I-phone, as the ramp up for Android will be long and unpredictable.

Lesson 2): Be careful who you are beholden to…they were squeezed by IBM because of their total dependence on 0S2.

Lesson 3): Weak team = weak outcome.
Takeaway: Find the right people for the given project.

Start-up 2: Open Market
Again pursuing his passion for entrepreneurship, Mr. Bussgang turned down another rational offer at a consulting VC firms to join a small firm called Open Market. The firm caught the wave and had a $1.2B IPO with $1.8 mm of revenues at the time. When he left in 2000, the firm was still worth $2.0B and had $100mm of revenues.

Lesson 1): Speed wins. Be First. Be Fast.

Lesson 2): Focus is important. Making the incremental improvements from 80% to 90% and on to 100% of quality is hard…but worth it.

Takeaway: Key is to get BOTH sides of the brain working. Be creative and a dreamer, but bring that down to focus and analytics. Be methodical.

Lesson 3): PR vs PE ratio. Keep the news coming.

Lesson 4: At some point the “grown ups” need to come in to run the company.

Lifetime of the company goes from: Jungle, to Dirt Road, to the Highway. And you need different skill sets (and likely different people) at each stage.

Start up 3: UPromise

In another somewhat “irrational” decision, he left a very large sum of unvested stock options on the table to join a company. It had a very attractive valuation though and had a solid team that raised money with 7 people and 20 slides.

Lesson 1: Great People + Great Idea + Great Comps = Great Valuation (comps were trading at 100x revenue at the time)

UPromise ultimately became a $100 MM revenue company. If multiples stayed as high, it would have become a $10B company. In reality, it was still a nice deal with a $300 mm exit in 2006.

Lesson 1: Save TIME not money. (However, time the market. In a down market, take your time).

Lesson 2: Brand is powerful. Difficult to differentiate between “network effects” of something like UPromise, Ebay, and others, but perhaps the early Amazon where network effects were limited shows a pure “brand” power.

Lesson 3: Build a business using “other people’s money” in the sense that unlike NetFlix, which must use its own balance sheet to promote its brand, you want to find ways to get others to promote your brand.

Lesson 4: Founder transitions are crucial to consider. Bringing in an outside CEO is sometimes necessary but may rock the boat.

General Thoughts:

Patents don’t matter. People, team, and timing trump any piece paper claiming a patent.

Being Mission Driven from the beginning to the end is crucial.

Thoughts on Venture Capital:
Two typical on-ramps to being a venture capitalist:
1) Apprenticeship Model: Join out of school. Work your way up.
2) Entrepreneurship Model: Make VC’s money by being a successful entrepreneur. Get invited to join them.

Differences between Entrepreneurs and VC’s:
Entrepreneurs are very focused. Narrow and with deep expertise.
VC’s don’t really execute. They find opportunities and match them with people. A mile wide and an inch deep.

VC industry has changed dramatically since 1999 when there was about $40B of capital available. Today that number is closer to $250-300B.

This means there are more funds, with greater capital bases, making funding small deals uneconomical.

IDG Ventures (now Flybridge) saw this as an opportunity and was launched with a smaller fund to address the needs of smaller start-ups.

The dispersion in VC is massive – even higher than in private equity or mutual funds, which makes picking a great fund even more important for institutional investors. By staying focused, Flybridge can stay in the top tier.

Flybridge is focused on being a true service provider and having a high level of customer service to entrepreneurs. From my perspective this makes a ton of sense.

The reputation market for Venture Capital is highly efficient. Reputation is everything.

In general, the Venture Capital business has had an outsized impact on the world and the economy. Approximately 1,000 partners of venture capital firms have invested in companies that employ 10 million employees and represent 18% of the GDP.

Venture Capital and Entrepreneurship are about as American as it gets. Ben Franklin was one of the first great entrepreneurs and we have not stopped since.

Struggling to Stay Optimistic

I went to a talk tonight on a talk entitled “The Subprime Crisis, Gold, Commodities and Where the Stock Market Goes From Here” given by a few investors with a collective 70 years of investing experience, and lets just say that it makes this blog sound like a cheery story.

The punch line: we narrowly avoided financial markets Armageddon last month when the Fed arranged the bail out of Bear Stearns and the risk is far from over.

The short-seller and 50 year veteran suggested a variety of things, the most tangible of which is to be long gold as a hedge against hyper inflation and further deterioration of the dollar (just his opinion, not advice). (He is also long GOOG and RIMM. Smart old dude).

That said, spending a good deal of my time on Twitter over the last few weeks has kept me in the flow of optimistic and creative ideas…allowing me to keep my head out of the murkiness caused by headlines like:

S&P may cut $57 bln subprime debt, reviewing loss:

S&P said it is reviewing loss expectation for more than 17 percent of U.S. subprime debt deals issued in the first half of 2007

and

US Foreclosure Filings Jump in March: Foreclosure Filings Against US Homeowners Soar 57 Percent in March; Bank Repossessions Surge

Instead, I am starting to focus on signs of an emerging bottom like this:

Wilbur Ross Seeks $4 Billion to Purchase U.S. Banks

Billionaire financier Wilbur Ross Jr., who made his fortune turning around distressed steel and textile companies, plans to seek about $4 billion from investors including Arab sovereign funds to buy U.S. depositary banks.

And remembering, that God Blessed Texas:
Dallas housing market: nation’s most stable

A recent PMI Group study reported that the risk of U.S. housing price declines remained low in many areas of the South, Midwest and Northwest. Among the 50 largest metropolitan statistical areas, Texas cities were the lowest and most stable in risk outlook during 2007.

The objective side of me realizes that there is much more pain to be felt before this is over. But we are still a nation of innovators and entrepreneurs. So I will keep dreaming and keeping hope alive.

Hyperbole Or Not

I was having a discussion with a friend today about a paper I am writing on the credit crisis, and he suggested that I remove some of the "hyperbole" from my analysis. He was referring to recent statements by Soros and Krugman, who have both stated that the current crisis is the "worst since the Great Depression".

That got me to thinking that in communicating extreme events or ideas in general it is difficult to avoid sounding "hyberbolic" or far fetched when describing the conclusion or the idea because it is so far removed from the status quo of the audience.

A similar phenomena occurred in a discussion with some friends last night where I was explaining the power of Twitter in the context of idea generation, dissemination and socialization. Those who are barely using Facebook thought what I was saying was extreme, while a fellow "tech-minded" person thought what I was saying was highly reasonable.

Although this problem may be limited to people like me, who tend to think at the edges of our knowledge and technology, I actually think it is more likely a general concern for communicating new ideas generally: if you are far removed from the audiences' understanding, you should build a bridge to walk them to the island of your idea, or run the risk of sounding like a fanatic or dreamer.

I guess this presupposes a desire to be heard by a wide audience. Maybe it is just better to speak and let those who can hear your voice understand and let the rest think it is all hyperbole. Perhaps one day, when the story has unfolded, they might remember some glimmer of the idea and realize it wasn't so extreme after all.

John Doerr of KPCB Visits HBS

In contrast to much of the negative news in the financial markets, there still remains a vibrant and exciting world of innovation in this country, primarily driven by the most extensive network of Venture Capitalists in the world.

One of those VC’s, Mr. John Doerr of Kleiner Perkins Caufield & Byers (KPCB) visited us at HBS yesterday.

His talk focused primarily on KPCB’s interest in “Green Tech” ventures, but he also offered general advice for entrepreneurs and future venture capitalists. Here are my notes from the talk:

The best way to predict the future is to invent it.

If you can’t invent it, fund it. But to fund the future, you first have to find it.

At KPCB, they believe “Green” technology and energy efficiency are an important part of the future.

55 percent of energy in the global economy is wasted, primarily through heat emissions.

3 primary areas of focus for KPCB: Cars, coal, and efficiency.

Cars:
Fisker Automotive: producing a hybrid electric plug in. Gets about 100 mpg. 1 of 3 car companies in the portfolio.

6 renewable fuel ventures. Amyris produces a key compound in anti-malaria drugs. This allows them to construct better fuels – molecule by molecule. Transportation fuels industry is a $1 Trillion market.

Coal:
Biggest area of opportunity with few companies succeeding to date – carbon capture and sequestration for coal power plants is a massive market. Solve this problem!

Big fan of solar. Investment in Miasole a producer of thin film solar-technology. Able to achieve 11% efficiency.

Conservation and efficiency:
RecycleBank: Uses existing technologies such as Rfid. Has been able to increase recycle rates by 50 percent. They incentivize people to participate by giving people points which they can redeem at local businesses. Huge success and growing.

Policy Matters:

Get states to change rules regulating utilities.

Interest in Green-tech is growing with $3B of VC investments in 2006 and $4B in 2007. This number is growing and will continue to grow.

However, Federal investment in green technology is less than 1 day of XOM’s revenues.

To solve this problem, we need all the people to make the right outcome the profitable outcome and therefore the probable outcome.

If we are successful, “going green” will be the largest change on planet earth in the history of humanity.

Advice to HBS students:

Hang out in engineering club at MIT. Join a KPCB, Greylock, or Sequoia portfolio company.

Think about ways to do: Green accounting, green marketing, green strategy.

Advice on becoming a great Venture Capitalist:

Most have entrepreneurial experience. V.C. is a service business, so you need to understand your partners.

You have to learn by failing…Like crashing an F16, it will cost $30 mm the first time. Get operating experience. Spend time at MIT.

Definition of entrepreneur:
Do more than anyone thinks is possible with less than anyone thinks is possible.

Restless. Never satisfied.

Difference between Mercenaries (Bad) vs Missionaries (good):

Drive vs Passion.

Pitch vs Big Idea.

Opportunistic vs Strategic.

Focused on competition vs Focused on customers.

Aristocracy vs Meritocracy.

Deferred life plan vs Whole life plan.

Money vs Meaning and Money.

Success vs Success and Significance.

Consumer change:

How will we change consumers minds to get them on board with “Green”?

Consumer change is hard. For example, we still import bottled water from Fiji.

Theory of change:

We will not have a global solution until the U.S. leads. Leadership is up for grabs. All current platforms are unacceptable. Mainstream America does not have a sense of emergency or urgency here.

Politics are non linear.

Alliance for scientific communication. WeCanSolveIt.Org.

Hewlett foundation. Design to win. The looked at 5 regions of the world that matter. Within each region and each sector and figure out what needs to happen. Figure out how to make change happen (i.e. within power industry, utility commissions have power and 20 dudes really matter). Move public opinion and change the laws.

“Brown” companies will retaliate against “Green”. Already have with things like: Coal is clean.

Coal and oil companies will do what they need to do to preserve the status quo.

We need to develop a Carbon accounting system. Carbon capture and sequestration will become standard in coal.

Future hope:
His daughter’s generation (she is 16) needs to get out of Facebook and into the face of politicians. We have numbed them into a set of career expectations.

The Energy movement is the first grassroots movement that has embraced 10 million people since Martin Luther King. He is glad Al Gore is out there and providing the leadership he is.

Future of Technology (if all his companies are successful):

Browser will be transformed by sites like: Cool Iris. We will have fully-immersive 3D technology.

We will be mobile.

A few hundred dollars will let you spit in a tube and have your DNA analyzed in hours.

We will reverse metastization of cancer.

Green fuels will be made from CO2.

General advice on balancing competing interests:

Measure how much time you spend with each priority.

For him: Family comes first.

Home by 6 p.m. 20 days a month.

Measures how much time he spends with Partners, current CEO’s, potential entrepreneurs, and community service (targets 15% of his time).

General Career Advice:

Ideas are easy. What matters in life is execution. It takes a team to win. Think and speak on your feet.

Network constantly. Network each day for 10 minutes.

Find a mentor, ask them to be a mentor. Sustain that relationship.

Take risks. To ask permission is to seek denial.

Integrity is a binary state.

Life is long – its a marathon, not a sprint.

Call your mom once a week.

Spring Is Finally Here

It is hard not to be optimistic on a day like today. 60 degrees and sunny just sets a nice tone. May help to explain the creativity and entrepreneurship of Californians.

Well, it looks like the optimism (or muted optimism) is spreading to
Wall Street with Goldman’s head honcho today staying we are in the “third quarter” of the crisis. (here is the Bloomberg Article: Goldman’s Blankfein Says Credit Crisis Close to End).

Such confidence is not only helpful to hear in terms of market sentiment, it is also a nice contrast to the more pessimistic tones reflected in the below post as well as that echoed by the IMF yesterday, which suggested that losses will rise from the current $230 billion to close to $1 trillion by the time we are all said and done.

The most pessimistic number I have heard came in my Investment Management class at HBS, where John Paulson, manager of Paulson & Co, suggested that losses will likely reach ~$1.2 Trillion before the end of the crisis. Mr. Paulson (no relation to the Treasury Secretary) made $15 Billion in profits last year for his investors (with returns approaching 700% for one of his funds) primarily by betting against Subprime ABS securities.

Here is an article discussing his success: Trader Made Billions on Subprime. His bearishness not only turned out to be correct, but it was also very profitable.

What the ultimate losses will be in this crisis will come down to a variety of factors, but I don’t think one should underestimate the importance of confidence and optimism.

So bring on the sun…or move to California.