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Valuing the bleeding edge

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With all this talk of disruptors, it’s hard to figure out what any of them are actually worth. Less, is the prevailing wisdom. You won’t find many investors in the market today who believe that Tesla has that special something that established auto manufacturers don’t (unless it’s a maverick, spacefaring CEO).

The question is, how much less? Or the inverse, saved for those genuinely special cases – how much more? The answer depends on how long the company is going to be around, and whether it can be disrupted too.

“Trends start and people get excited about them, but you want to wait some time before you get some conviction that there’s something to it. Persistence of a trend is something that we think about when we analyse any emerging trend,” Dennis Lynch, head of Counterpoint Global at Morgan Stanley Investment Management, told the Morningstar Investment Conference on Thursday (September 23) “And while it’s good to talk about themes and tailwinds, if there’s not a company that’s going to be able to take advantage of them then it’s not worth exploring.”

“We’re constantly looking at what comes next, and cases where people might be thinking that the runaway is clean, the outlook is great, and that everything is going to flow from there. But there’s always someone better than you in life and you have to be almost paranoid in your approach in looking for new alternatives.”

One of the main beneficiaries of Covid-19, Zoom, has generally been viewed as disruptive, thrashing Skype due to its ease of use despite the latter having a decade-long lead. So does it have staying power? It was leading the pack in early 2020, but there’s now plenty of competition in the form of Google Meet or Microsoft Teams, and it’s not uncommon to use multiple platforms across a single day.

“There was so much capital going into trying to dominate video conferencing, we weren’t comfortable underwriting the idea that ten years from now Zoom would be a clear market leader,”
Bill Nygren, portfolio manager at Oakmark Funds. “That’s the reason we opt out of a lot of these investments; we fail to justify the current price. You need to have an opinion about market leadership position past the time frame we’d be comfortable making our estimates for.”

On the flipside, Lynch believes that Zoom’s primacy in the consumer market and its “hyper-focus” on video conferencing – which sits alongside a slew of other products in its competitors – means it has staying power that the others lack. Counterpoint invested in Zoom at the IPO and has, according to Lynch, maintained a “disciplined” position sizing.

“Every time I have to use Google Meet or Microsoft Teams, I want to shoot myself, because it’s actually very clunky. It’s a case where the product is superior, the adoption is superior, and that creates a very large endgame potential,” Lynch said. “… And there are a lot of things that can go right.”

Any conversation about disruptors inevitably turns to Bitcoin. Its proponents argue that Bitcoin is disrupting fiat currency itself; but Bitcoin’s main use, before the speculative boom, was as a vehicle for laundering fiat currency on dark web drug marketplaces. It’s now worth around $50,000 (on a good day) for reasons that nobody can quite agree on. But that doesn’t mean it can be ignored.

“There’s some interesting qualities to it that I think can add to a portfolio. You don’t get in trouble making investments if you size them properly,” Lynch said. “If I bet one penny on the stupidest idea in the world, and I lost it out of a hundred dollars, it can only hurt me so much. So I like the idea here that you can bet small and win big.”

“Bitcoin’s kind of like Kenny from South Park; he dies every episode and then he’s back again. Since 2008 you’ve seen the media say “Bitcoin is dead, it’s over this time” – and it just continues to persist… It’s almost like Bitcoin is a virus and we’re all a little bit infected.”

And then there’s the “super-crazy”: Tesla, which in late 2020 had a market cap greater than the top nine auto-makers combined.

“There’s a lot of money going into electric vehicle R&D at Audi, Porsche, BMW, not to mention General Motors – it’s hard to believe that R&D isn’t equally valuable to the R&D that’s being spent by the companies that are new in the electric vehicle space,” Nygren said. “I think oftentimes, when there’s massive change going on, people are too quick to be dismissive of the efforts of the existing leaders.”

Counterpoint owned a small, “speculative-sized” position back when the first consumer reports were released on Tesla and the company was just starting to have a real revenue stream, which it held onto for three years – but repeated trips to capital markets became “problematic”.

“You can see the capital intensity and the constant need for the company to come back and get capital, and that isn’t necessarily bad, but it does put you in a position of relying on, during times of uncertainty, the kindness of strangers to continue the business model,” Lynch said.

“Obviously Elon Musk is controversial, but he’s done a lot of amazing things and should get credit for them, Having said that, when you’re relying on capital markets and you’re dreaming big, there’s a fine line between inspiring and making promises you can’t keep, and that can go badly from the perspective of having capital to sustain what Tesla’s doing.”




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