One Step Up #33
This week, we look at Hyperleveraged companies, Robinhood, human psychology a la Morgan Housel, GOAT talk - Jeff Bezoz & Bernard Arnault of LVMH + why it's a young persons market
Hands up if you’re still reeling from the week that was. 🙌
From the WallStreetBets saga, to Robinhood freezing trading in mem stocks, to Bezoz deciding to give up active management at Amazon at the end of the year, tech companies continuing to crush earnings expectations - it was WILD.
Hyperleveraged Companies
Over the last decade or so, there have been several examples of companies that had an outsized impact with relatively small teams i.e. companies with hyperleverage (not in the traditional financial sense of debt/equity).
When Instagram was acquired by Facebook in 2012 for $1B, it had a total of 13 employees, including the two founders. At ~30M users at the time and a value of $1B, that’s roughly 2.5M users per employee and $75M EV/employees
When WhatsApp was acquired by Facebook in 20 for $19B, it had a total of 55 employees. The 55 employees supported ~400M monthly active users, over 7M users per employee. And the $19B in value represents roughly ~$350M in enterprise value per employee.
The Swedish firm Mojang developed the game Minecraft which had over 100M users and brought in more than $100M in profit each year. It was acquired by Microsoft for $2.5B when it had ~40 employees. That’s 2.5M users per employee and $62.5M in enterprise value per employee.
Craigslist makes over $1B in revenue each year and has ~100M users globally. It operates with just 50 employees. That’s 20M in revenue per year per employee, and 2M users served per employee.
The goal for employees is to maximize leverage i.e., maximize the impact they have for a given amount of effort, rather than efficiency, i.e., minimizing effort for a given amount of impact
If the existing employees failed to create enough leverage to grow the company themselves, then the company needs additional help, and so hires additional people.
Robinhood Robinhooded Robinhood
Enough has already been written about the Robinhood saga, but Packy really delves into why this was inevitable.
One word: incentives.
As the old saying goes: bite only what you can chew.
Why It’s Usually Crazier Than You Expect
Say an elephant is being hunted for its tusk. The rate of hunting often massively speeds up over time, cascading into a frenzy that pushes a mildly at-risk species into quick extinction.
It’s simple: As the number of elephants declines, tusks become rare. Rarity pushes prices up. High prices make hunters excited about how much money they can make if they find an elephant. So they work overtime. Then fewer elephants remain, tusk prices rise even more, more hunters catch on, they work triple-time, on and on until the number of hunters explodes as everyone chases the last herd of elephants whose super-rare tusks are suddenly worth a fortune.
Forecasting models that don’t appreciate how frantic the last-minute hunt can become “give a false sense of security when managing large harvested populations,” the researchers wrote. A species’ endangerment starts slow, then picks up, gets a little faster, then boom … spirals into a disaster seemingly overnight. Supply and demand are intuitive; realizing how quickly supply and demand can go from linear to exponential is not.
Feedback loops – where one event fuels the next – often lead to that kind of bewilderment.
GameStop – whose stock is up 100-fold in the last year as a reddit message board coordinates a buying spree to hurt short sellers – is experiencing a similar thing.
The reddit campaign to push its stock up started two months ago. At first shares rose a little. That caught people’s attention, those people bought, which pushed prices up more, which caught more people’s attention – on and on – until this week when virtually every investor in America is paying attention to GameStop because it’s risen so high, and it’s rising high because every investor in America is paying attention to it. I have three friends who bought a few shares of GameStop this week “to see what happens.” They’re only doing that because the price went up. And they’re making the price go up.
What is somewhat ironic, though, is that while the Internet is unquestionably a critical component of what makes Amazon Amazon, what makes the company so valuable and seemingly impregnable is the way it has integrated backwards into the world of atoms. Real moats are built with real dollars, and Bezos has been relentless in pushing the company to continually invest in solving problems with real world costs, from delivery trucks to data centers and everything in-between. This application of tech economics to the real world is what sets Bezos apart.
This is how Bezoz ended his letter to announce he’s relinquishing his CEO position later in the year to employees:
Keep inventing, and don't despair when at first the idea looks crazy. Remember to wander. Let curiosity be your compass. It remains Day 1.
The Perfect Paradox of Star Brands: An Interview with Bernard Arnault of LVMH
What a fascinating interview, covering many aspects. The bit I loved the most:
I don’t have alarm bells when it comes to creativity. If you think and act like a typical manager around creative people—with rules, policies, data on customer preferences, and so forth—you will quickly kill their talent. Our whole business is based on giving our artists and designers complete freedom to invent without limits.
Not long ago, I said to one of our designers, “Why don’t you take a trip to Japan and see what the teenage girls are wearing on the streets at night?” These girls are very leading edge in fashion; they create trends years before they hit the mainstream, like with those very high shoes, and it makes very good sense to watch them. I did not say to the designer, “Go and see what kinds of shoes they are wearing and copy them,” although I was hoping he would notice their shoes. I just suggested, “Go look.” And in fact, he came home very inspired. That’s all a manager can hope to do, or should do, in my opinion.
A lot of companies talk about quality, but if you want your brand to be timeless, you have to be a fanatic about it. Before we launch a Louis Vuitton suitcase, for example, we put it in a torture machine, where it is opened and closed five times per minute for three weeks. And that is not all—it is thrown, and shaken, and crushed. You would laugh if you saw what we do, but that is how you build something that becomes an heirloom. By the way, we put some of our competitors’ products through the same tests, and they come out like bouillie—the mush babies eat.
Fashion, of course, comes from innovation—the creativity of the designers. That is sometimes harder to guarantee than quality, which you can actually build in to a product, but just as important. The hard truth is, you must be old and new at once. In a star brand you honor your past and invent your future at the same time. It is a subtle balance.
For Better of For Worse, This is a Young Person’s Market Right Now
Till next time.
Always remember:
Comparison is the thief of joy. - Theodore Roosevelt
