How are people liking the Monday delivery? Should we switch back to Thursday/Friday so you have the weekend or do you prefer to get this at the beginning of the week?

There is a war, unprecedented monetary policy, multiple mass shootings, rising food and fuel costs, economic uncertainty, the Supreme Court overturning Roe v. Wade, and even Congressional hearings on UFOs. And there are still variants of COVID-19 flying around.
How in the world did the Johnny Depp and Amber Heard thing get any press?! Sometimes I’m simply astonished by how much importance our society can assign to celebrities.

By Charles Ruff, CFA

Adapting to Endure from Sequoia Capital.


Adapting to Endure from Sequoia Capital.

With speculative growth companies& venture capital taking a beating (more on that below) Sequoia Capital was circling the wagons. This deck is long but you can skim through it pretty quickly. I really think there are some terrific takeaways, not just for the current environment but for how businesses (and individuals) should approach crises.

A few highlights:

  • Slide 8 – Capital was Free. Now it’s expensive.
    • “we are just beginning to see how the increasing cost of money flows through to impact the real economy.”
  • Slide 14- Growth at all costs is no longer being rewarded.
    • The energy industry (read: US Shale) went through this same paradigm shift over the past 7-8 years. Capital got more expensive and shareholders valued cash flow and profitability over growth-at-all-costs.
    • Slide 15 shows how the unprofitable tech names have underperformed.
  • Slide 20- forecasting a long recovery and Slide 23 “Survival of the Quickest”
  • Slide 25/26- The difficulties of the current environment are an opportunity.
    • I absolutely agree with this assessment. In a bull market, everyone is a genius and there are plenty of stock-tips dispensed on barstools and golf courses. When the going gets tough, you find out who was smart and who was just lucky.

The Tide is Going Out for Speculative Growth Companies

Warren Buffett famously said, “when the tide goes out, you see who is swimming naked.” For years, 0% interest rates and bullish investors helped fuel a cycle of speculative investments in unprofitable companies with questionable business models. As rates start to rise and investor exuberance cools, we are now finding out who has a solid business model and who was swimming naked. In some cases, the sheer arrogance of these founders was just amazing. Adam Neumann of WeWork is a perfect example. Neumann was buying property personally and then leasing it back to WeWork. Then WeWork would sublease it to tenants. Softbank valued this “business” at $47 billion.

At that $47 billion valuation, WeWork controlled 16.3 million square feet. WeWork did not OWN this office space, they were a tenant.
Boston Properties (BXP) owns 53.1 million square feet of Class A office properties and is valued at $19 bil.

How did Softbank get to $47 billion?!

That brings us to Klarna. Backed by, you guessed it, the Softbank brain trust, Klarna reached a peak valuation of almost $46 billion in the summer of 2021.

Klarna is a provider of Buy-Now-Pay-Later (BNPL) financing and they are probably naked.

  • BNPL is simply short-term installment lending. It is also often offered at 0% interest which is nice for consumers. They way Klarna makes money is by negotiating a margin with the retailer. The retailer gets to book a sale and in exchange, will provide Klarna with ~3-6% of the retail price.
  • Here is the CEO discussing how he wants to disrupt banking’s “flawed business model”
  • Installment lending could make sense by helping consumers smooth out big-ticket items like a refrigerator. In fact, there are a number of companies that do this well (Aarons (AAN), Rent-a-Center (RCII), Progressive Leasing (pvt)). But instead, Klarna’s CEO wants to get into small, daily transactions.
    • Why do we need payment plans for small, daily transactions? Splitting my lunch into ‘4 easy payments’ doesn’t sound that appetizing. I think it’s easier if I just pay for my burrito now.
  • Also, haven’t we seen installment lending go badly before? Yes, in the Great Depression.
  • When buying something, even if it’s outlandishly dumb like a $250 Margaritaville blender, I can use my credit card and earn 2%, or I can use Klarna and pay in installments. Unless I’m low on cash and need the flexibility of Klarna, why would I give up the 2% I can earn from my credit card? The customers who will predominantly choose Klarna over a credit card are those customers who need the flexibility. This adverse selection will work against Klarna as they will continually get lower quality borrowers.

Margaritaville Blender

It will only take 6 weeks to pay off the Margaritaville blender. But what happens if something goes wrong? What if someone misses a payment or finds themselves unable to pay? Even though the duration is very short (just a few weeks) these loans can still go bad. This is already happening! From YE2020 through 2021, Klarna’s loan losses are outpacing loan growth (+73% versus +50%). As a percentage of loans written, about 4-6% are written off as losses. That’s a lot of people falling behind on their Margaritaville blenders. Looking ahead to 2022, I don’t expect $5 gasoline and high grocery prices to help this trend. What if people star getting laid off and unemployment rises? I think this gets worse.

Klarna was planning to go public mid-22 at about $50 billion. It’s now June and I feel very comfortable taking the under on that IPO.

Perhaps the funniest part in all of this is that the show South Park predicted this exact thing in 2009.

South Park Prediction

Doing Rubix Cubes While Juggling

Finally, check this out. Doing Rubix cubes while juggling? Insane.

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