Sonntag, 24. April 2016

US-EU Trade Slowdown?

In December 2015, oil tankers made u-turns while crossing the Atlantic [ZHOIL]. In March 2016 the mayor German rail carrier announced a 8-10% percent drop in fright shipments for 2015 [RG]. In April 2016 its cheaper to rent a dry bulk tanker than a Ferrari F40 [ZHTANKER].

European capital markets started weak this year, recovered to their highs again while the US dollar weakened during Q1 2016. Are US and Europe's economies are healthy?

(Side note: As TTIP is coming back onto the agendas of the media, political parties, NGOs, investors and companies. Why should a rigid trade deal be made, when the benefits are small but the risks of loosing national sovereignty is high while the future economic situation is very uncertain? Maybe some oligarchs try to secure their power before historic changes are happening?)

US-EU Trade
The first industry which feels a slow down in the (world) economy is the logistic  sector. This early indicator worked like charm the last 2 crisis. Now its crashing and the media seems not to notice. If the US economy slows the first countries which feels it is Germany and China.

US slows scenario? 
The trillion dollar fracking industry slowed in 2014 after the easy QE money was gone. As debt refinancing got harder they were forced to pump for their lives, taking down natural gas prices and than oil prices. As Saudi Arabia did not play the marginal producer anymore the oil prices collapsed in 2015. Yet the US middle class did not recover from the housing bust in 2007 and piled up lots of student and car debt, so demand is still weak (look at total Christmas retail sales). The rate hike in December killed the last offspring’s the US economy had.

As oil prices are down and the rate increased in December 2015, fracker refinancing got even harder and they had to lay-off people. Also the bank balance sheets might be full of deteriorating fracker debt. Lay-offs further weakens the US consumer demand which weakens China's producers, their CapEx and machinery manufactures like Germany. These demand fewer raw products causing commodities to crash and require less transport services [ZHCHINA].
Now the Fed rate hikes seems on halt and reverse becomes more likely. The oil price is going up from the lows and may revive the fracking industry again. The upward oil price move looks for some like a oil short squeeze, others think its a trend reversal and I believe its a retreat strategy as crushing the Russian oil exporters was not successful, hurting the debt-laden oil producers of the west and their allies more than initially planed.

All that happens at a time when global financial flows are changing direction. The the petro dollar is reversing, the Asia merchandise dollar is very week and the liquidation of assets of sovereign wealth funds [ZHNOR] requires to re-allocate assets.

With this much turmoil cooking just below the surface, the release of the Panama Papers smells like an intelligence operation. East? West? Who benefits? Its not clear yet. But a freighting message is launched to all oligarchs of the world: "We know where your money is and we can take you down at will.".

Nobody knows what will happen next. Yet you can position yourself to loose less or even benefit from any events unfolding. We are in front of a historic rift where fortunes are made and lost!

History does not repeat but it does rhyme and a word of caution!
In 2008, banks did not trust each other, causing the global financial flows to stopped, which caused a nearly complete halt of the global trade / transport. At that time ships were waiting in ports to get the money for their fuel.

In 2016 the freeze of global trade comes from the other side of the equation. The trade collapses because nobody can consume all the produced goods. This causes a slowdown in the real economy infecting the financial economy. The huge problem is that real economy is sick of overcapacity caused by debt. As debt is future cash flow moved to today, the debt (and its overcapacity) has to written off. This will cause a lot of rich people to loose money and poor people to loose jobs. In the past this dynamic lead to revolutions and wars.

Note: Macro influence on value investing
As value investor I base my investment decisions on bottom up analysis! Talking about macro is like talking about the healing abilities of traditional Asian medicine or yoga in front of hospital medical staff. It's awkward for all. 

Bottom up approach is like the doctors and nurses in front of their patient. They have to make decisions based on data of the patient in front of them. Top down is more like traditional Asian medicine. It is focused on a general healthy life style.

How to prevent heart attack? Follow traditional Asian medicine. Who do you call when having a heart attack? The hospital. It's kind of a barbell strategy for all Nassim Taleb fan boys and girls among us: Live healthy for almost all time, but sometimes when your are ill take drugs at (advised) high doses.*
*: Bonus question for Taleb fan boys and girls: How would a Gaussian bell strategy look like? A Gaussian bell strategy is to live less healthy because you live healthy but you take toxic drugs at low doses all the time, even if you are not ill.

[RG] (Comment: the train driver strike was just a few days, but indicated that they strike 1+ month. The strike alone does not explain the whole drop.)

Freitag, 1. April 2016

Value of written goals

Here and there I heard about a Harvard study about having goals drives success. I thought "Sounds reasonable, no need to think about it deeply." Today I heard a talk of Gerald Hörhan and he mentioned the example, again. So my many-smart-people-talked-about-it threshold was crossed and I did a short research to find that study. I hoped to get an interesting topic I can use as material for talks.

And I found an urban myth [DOMINICAN]. But is there any truth to it? The Dominican University (?researcher Gail Matthews and Sarah Gardner?) did a study, because they saw a research opportunity. I found just a summary (see [SUMMARY]) and no original source to the study. But, well, once you kill a cow, you gotta make a burger.

Goal Study
The study split the participants into 5 groups and compared what goals they achieved 4 weeks later [SUMMARY, FORBES]:
  • Group 1 - deeply analyzed their goals and the resources they had to accomplish them.  
  • Group 2 – wrote down their goals after the deep analysis.
  • Group 3 – set action commitments after writing down their goals.
  • Group 4 – did all of the above and shared them with a friend.
  • Group 5 – did all of the above and sent a weekly progress report to their friend.
Goal Achievement [SUMMARY]
The study concludes [SUMMARY]:
The positive effect of accountability was supported: those who sent weekly [short] progress reports to their friend accomplished significantly more than those who had unwritten goals, wrote their goals, formulated action commitments or sent
those action commitments to a friend.

There was support for the role of public commitment: those who sent their commitments to a friend accomplished significantly more than those who wrote action commitments or did not write their
The positive effect of written goals was supported: Those who wrote their goals accomplished significantly more than those who did not write their goals.
I think the result is astonishing and seems to increase the success rate by 80%. Write down your goals (+40%), commit to the goals in front of a friend (+8%) and send weekly reports to a friend (+28%). Writing actions seems to have a negative impact (-23%).

The ONE Thing
Related to achieving goals, Gary Keller [KELLER] proposes to organize goals in time windows (every Saturday 2 to 3 pm; every morning) to work on just your one thing. No interruptions, turn of the smart phone, just work on the one thing! The one thing might be several (work, life, sport, financial independence, hobbies) - key is not to mix them up. Work only on one and only one goal at a time. Work on another goal in another time window.

He breaks down the goals into long-term, 5-year, 1 year, month, week and now. Another trick is to organize goals that the achievement of one makes achieving the other goals easier (related to compound interest of achieving goals).

Using the study results and techniques written by Gary Keller, allows us to organize and achieve goals more effectively. I will give it a try and then report.

[KELLER] The ONE Thing, Gary Keller

Sonntag, 13. März 2016

2015 Portfolio review

2015 was dismissal! I increased my portfolio just by 3.53%.

2015 Buy Price Buy Date Price Date Perf.abs BEGIN END

Nestle 67.89 € 2015-02-09 69.66 € 2015-12-30 2.61% 10.00% 10.26%
Barrick Gold 10.99 € 2015-02-09 6.98 € 2015-12-30 -36.49% 20.00% 12.70%
Oracle 37.79 € 2015-02-09 33.96 € 2015-12-30 -10.13% 10.00% 8.99%
Reply 67.69 € 2015-02-09 127.90 € 2015-12-30 88.95% 10.00% 18.89%
SMT Scharf 14.67 € 2015-02-09 10.00 € 2015-12-30 -31.83% 15.00% 10.22%


Mircosoft 22.30 € 2013-04-18 38.94 € 2015-09-19 74.62% 10.00% 17.46%


25.00% 25.00%


100.00% 103.53%

This year I failed to achieve my target RoIC of 26% p. a. by a whopping 22.5%. The suckers were Barrick Gold and SMT Scharf which I overweighted.

SMT Scharf
The coal decline was somewhat foreseeable - surely not to its extend.* The years before 2015 coal mines produced more than the world demanded, thereby anticipating growth mainly in China. Right now China seems to grow slowly. Looking at electricity consumption growth of 1.3% from January to June 2015 [ZHELEC], I cannot believe in an economic growth in China of 6.9% in 2015.

My investment thesis was, that SMT Scharfs earnings and multiples will normalize after the CEO has been exchanged. Well this did not happen. The coal price took a dive and so did SMT Scharfs stock price.

Deep dive in my error
The high coal price suggested growth in China, assuring mines to extend production and produce on inventory. This lead to increased capex spending and an increased demand for SMT Scharf's products. The moment the China growth story proven wrong, the coal bubble collapsed - way before the media caught the story. Right now, coal mines around the world having a hard time. They reduce capex to have more money to pay back their debt. The EU sanctions against Russia hurt, too. All that giving SMT Scharf a hard time. Fast forward the stock price recovered a bit to 11.65 € until now (March 2016).

Coal Price versus Production Overlap
Seeing the multi-year overproduction above, should have been a big red flag. SMT Scharf numbers were inflated because the cyclical coal industry were thriving in a high tide / favourable environment. As Warren calls it, the low tide came and now we see a lot of companies naked. 

The next investment I do, I have to understand the economics of the underlying customer relationship.

Checklist: Does the company thrive, because its customers having a high tide?

Barrick Gold
Barrick Gold was the biggest sucker in my portfolio, but my thesis did not change. My thesis is a hedge against monetary and financial policy failure. If policy fails, the Gold price explodes and Barricks stock price will increase even more. If policy is right, my other portfolio positions will thrive. Only if the Gold price did not increase to at least $1.200 until 2019 than Barrick can go bankrupt. 

Barrick sold mines and ownership rights of mines of it in 2015 to serve its debt. It sold a part of a mine to a Chinese state company at a "fair" price - not unfair cheap, but in my opinion too cheap.

Life lesson: Do not get in debt! If you are in debt, than you can be force to sell your stuff at a price your buyer dictates! This is true for individuals, companies and states (look at Greek!)). 

The interesting part is that China is one of the world largest gold producers but it is importing gold, too. So some of the gold will be used in industry but the rest kind of disappears within China. The Chinese central bank updated their gold numbers, but it was way fewer than the "disappeared" gold.

Since end of 2015 Barrick jumped nearly 100%. As of now (March 2016) the price of Barrick Gold increased to 12.55 €, which is a little over my initial buy price of 10.99 €.

I bought MS because it was valued at a PE of 10 and I sold it after it revered to a PE of 16. I wanted to use some of my 2015 tax benefits. As of now Microsoft increased further to 47.50 € and I left >40% of performance on the table within the last 6 month.

Microsoft is a great company. Its core business model did not changed and it has some bets outstanding (cloud, mobile, games, IoT). Its core business prints money (OS, office) and it has a wide and deep moat around it. The management and CEO is great. I have deep insights into the company and I have seen the immense cultural shift from a Software behemoth to a agile internet-focused software company! From business perspective, I know they will do well. I just have to get in cheaply - and I did get in cheaply!

I regret, I should not have sold!

Checklist: Does the company have sustainable competitive advantages? If yes, let the winner run (Warren: holding period forever) and sell only if the price is really wealthy.

Checklist: Are the tax benefits substantial so that my compounding benefits in the long run? If not do not use the tax benefits.   

*: I will write a post about commodity markets, micro economics and market structure in future. It is a very interesting topic. Just one question. It is more likely that the oil price is expensive (>100) or cheap (<35) than that it is in between - why?

Montag, 7. März 2016

Silverlake Axis Ltd

Silverlake Axis is a banking software company. It operates in south East Asia and is one of a few player in the banking software oligopoly. Prior to August 2015 Sliverlake Axis was a star. Than the bombshell dropped, as razor99 accused Mr. Goh (60% shareholder and CEO of Silverlake) that he and Silverlake did dubious deals in related party transactions at the expense of minority shareholder [RAZOR99]. The stock got slaughtered - from 1.20 to 0.55 SGD. In January 2016 Deloitte cleared Silverlake of these accusation [DELOITTE]. Is Silverlake a value buy now?

Can I trust the numbers?

Deloitte Singapore was ordered by Silverlake to investigate razor99 accusations [RAZOR99, DELOITTE]. Deloitte found that for the 3 acquisition in question, the prices 2 had fair prices where 1 was in the higher range of fair. ROI is for the 2 fair acquisitions 10 to 12% whereas the other is about 3%. Today the 3 acquired businesses make up to 85% of revenue. Silverlake today is Silverlake because of the 3 acquisitions. In my opinion razor99 accusations are unfounded and I adopt Deloittes perspective. BUT I will keep my eyes wide open and be cautious. razor99 argumentation is tempting and a good filter on my checklist. [SAIM2016]

On the contrary accusations of anonymous short sellers, like these of razor99, spiked in the advent of August 2015 flash crash and the growing unbalance of indices (a few large caps are up whereas the rest is down; look for FANG stocks versus S&P). These short sellers might provide interesting investments in future after the stock got hammered.

Business Model

Bank software is driven by regulation, customer integration and less technology.

Bank software has to respect the regulation of the legislation of its country its operating in. This leads to a couple of conclusion.

First this causes market segmentation by legislation within South East Asia. Because these markets were this small, larger players (Oracle, FIS, ...) have neglected these markets earlier and local players could establish market dominance.

Second the markets are separated by different regulation which requires constant adoption to regulation changes causing constant supply of adoption, maintenance and extension projects.

Third the sales process is driven by the network of the executives to customers which share cultural similarity and similar former positions. Goh Peng Ooi (CEO; Top 10 of the richest Malaysian) and Lin See-Yan (former Malaysian central banker) seem to have a strong network within the banks of the region to which they sold Silverlake’s core banking solution.

The technology side of banking is quite unimportant. It is technological simple to make bank transfers, support and implement business processes or extract insights out of banking data.

Bank transfer technology is simple but meeting the formal requirements is hard. (Who wants to invest the money to meet the requirements to do what already been done?) I was told that the core of bank transfer technology is 20 years old - never change a running system. The regulative changes require constant adoption of business processes. This requires a project but not R&D. Last but not least I am skeptical that banks will make use of their data wisely (Look for big data in banks - except fraud detection). These require R&D but corporate politics and regulation will prevent creating creative / innovative business processes to make really use of the data.

Once I interviewed a big data researcher (of an university) which told me the following story. He did a research project together with a bank and extracted interesting and counter-intuitive insights out of their banking data. The result was not only ignored by the bank's management but the management even fired the employee responsible for this project. I would have fired the employee, too. I would show my employees what happens if one breaches the one rule of banking: never risk to loose the trust of your customers! But hell, if the damage is already done, why should I not use the insights?

Depth of Moat: Switching Cost of Core Banking IT

Exchanging (parts of) a banks IT system will cause lots of expensive bad surprises - like data loss. Also lots of employees have to be trained on the new software and many business processes have to be changed. Lots of development and project cost are caused by switching parts or the whole core banking system. Any kind of data loss or incompetent looking employees have to be prevented so that no (trusted) customer relationship is at risk. This fear of loosing the customers trust causes the switching cost even more explode. That’s why Silverlake Axis realizes return on sales of >40%. [BARRONS, FOOL, VALUEPOD].

Wideness of Moat: Long Lifetime of Core Banking IT

I estimate the replacement cycle of core bank IT between 10 and 30 years [COMPWEEK, SAOCBC]. Planning and implementation can take up to 10 years, whereas the productive use is a multiple of that [BBG]. Because of these long time frames (for IT standards), a bank will bet on established players, like Silverlake Axis. This will keep non-established competitors out of the market and away from Silverlake’s cash-rich castle.

Marc Faber assesses the economic progress of the world mostly done in South East Asia, primarily in Vietnam, Malaysia, Indonesia, Philippines and Thailand. In all of these markets Silverlake is a dominant player. All these economies are heavily impacted on the slowdown growth of China, but on long-term he is still optimistic. [MFABER]
Over the long-term Pat Dorsey expects that the increasing economic growth in South East Asia, will lead to over-propositional growth of the financial sector [BARRONS]. I agree with his assessment, as the economy grows, the population accumulates money and needs to store it in financial institutions. These use the money to invest it in the country. On the other hand as the bureaucracy matures (legal certainty) in developing countries, these economies attract outside capital which need a financial sector so that the money can be allocated efficiently.

As a side note Silverlake acquired SunGard Ambit Retail Banking which is active in Europe, on the Indian subcontinent and the Middle East, too. For Indian subcontinent and Middle East I expect long-term growth to close the gap to the West. I see the possibility of war in that region which will hurt its growth. Silverlake is mostly active in the growing Eastern Europe. I do not see major risks there. If there is a major war in that region, than NATO and Russia are likely to be pulled in, in which case I do not worry about my Silverlake investment anymore. I see the acquisition as an option of having the foot in the door to sell other Silverlake software to former SunGard customers. [SUNGARDAMBIT]

Looking at the latest deal, Silverlake paid 17m SGD for SunGard Ambit Retail Banking which SunGard paid in 2006 120m SGD for [SUNGARDAMBIT]. In my opinion Silverlake unlikely did overpay but got a lot of optionality to expend in other geographical markets which otherwise would have cost a lot more. Vice versa, I guess the Ambit product maybe at the end of its life cycle so it might not create lots of future cash flow any more (this is a speculative thought). I believe it’s a lottery ticket for international expansion at a cheap price.

As shown below, Silverlake has (at least) an oligopoly in South East Asia core banking applications. (I will try to get market share information.)

Silverlake Competitors by Country in 2016 [SA2016Q2]
The main competitor are FIS and Oracle. FIS acquired SunGard in 2015. Interesting is the Silverlake acquisition of SunGard Ambit Retail Banking, which might have been done with FIS support. If that is the case than FIS decision not to compete with Silverlake underpins its moat in that region [SUNGARDAMBIT]. On the other hand software companies have a coopetion (cooperation-competition) love-hate relationship with each other. Basically cooperate in one market and fight to death in another market.

Competition through Fin-Techs?
Another source of competition are today's Fin-techs. In my opinion most of them are not innovative. They basically clone already known ideas of each other. For example direct sales of finance and insurance products eliminating bank "consultant" intermediaries is nothing new - just look at decade old direct banking. Banks try the direct way of sales because they have to make their cost structure lean because of 0 or negative interest rates. And now Fintech think they can capture the revenue of banks which are them self-struggling. It’s like selling to homeless people - even if they like the product they cannot pay much. And of course block chain based stuff. Cloning bit coins block chain for asset transfers or cloning bit coin directly to replace it as digital currency by larger players like Goldman Sachs. In my opinion a very crowded space which does not leave lots of space to grow a company. In my assessment core banking IT is unaffected by fin-techs [COMPWEEK].

Most of fin-tech ideas are straight forward, their future market is crowded and therefore low ROI should be expected. I would bet on really strange fin-tech ideas if I have to bet. In general I have the feeling that most of the fin-techs only exist because investor’s money was easy to get. But I keep my eyes wide open - ignorance is deadly in technology business.

Currency Risk

Silverlake Axis uses in Malaysian Ringgit but books 80% of its profits in Singapore Dollar. Long-term the Singapore Dollar strengthen against the Euro (more) and US Dollar (less). I believe that over the long-term the SGD will keep its value against Euro and US Dollar. Also I like to keep some of my assets geographically diversified.

Silverlake is worth about 2.02 to 2.22 MYR (current price: 1.82 MYR; SG$ 0.75) at lower bound, with upside potential through faster than expected growth. I like these kind of lottery tickets which pay them self.

Here is my valuation on Google drive:

The Otte valuation method uses return on sales (very stable metric), and simple growth and discount rate assumptions to estimate the value of the earnings of a company. I named to the guy who made me a value investor. Prof. Dr. Max Otte is one of the few professional value investors in Germany. The whole idea of Otte valuation is getting the first question out of the way, is that company cheap and worth diving deeper? According to this valuation the intrinsic value is about 2.22 MYR (SG$ 0.75).

My discount rate is 15% because it is my hurdle rate. The idea is, if an investment earns 15%, is safe and no better alternative is likely to be available, I make an investment. According to DCF risk should determine the discount rate. But this idea is flawed in my opinion because it assumes a thin tailed distribution of risk (so that the average of all risks converges to the median of the risks), but in real world risk is accelerating and skewed towards one direction (average and mean do not converge) [FATTAILS]. In my opinion its better to put risk into the cash flows and keep the discount rate constant across the investments. For me it is just a discount factor of my personal time value.

I assume growth at 10%. Some of this nominal growth is caused by inflation 3-5% and real company growth 5-7% (see above growth discussion). Estimating long term inflation at 3-5% at nearly deflationary levels at the moment is a gamble on my side. in As I mentioned earlier, I can expect that the currency to my local currency exchange rate should be stable or even yielding in my favour so that I do not take that into account here (and I diversify my assets around the globe).

I do not do a complicated DCF model with future projections of cash flows because they are projections, which look precise but are fantasy. More important is to see that the process of how the company makes money is stable and having a lower bound / conservative estimation of its worth.

Owner Earnings
Similar to Otte but using Buffett’s Owner Earnings valuation method. Owner Earnings = Net Income + non-cash flow influencing charges - CapEx - M&A. I get an enterprise value per share at 2.04 MYR. The difference is caused by the M&A charges.

I added M&A as kind of capex cost because software companies can acquire proprietary technology through M&A - similar to mine companies which buy machinery. I used 2 years average to smoothen these M&A cost, but partly these M&A increasing the company size so they should not be included fully. I want to be conservative, so I subtract nearly all M&A costs like it is capex (150M MYR of 170M MYR of M&A).

The SunGard Ambit deal increased top line by 40-50M MYR this Q2 of FY2016. I think I should not treat the 50M MYR of acquisition cost as kind of R&D expenses. But estimating the proportion I should charge is hard. I will charge nearly all this year so that I know I error more on the conservative side.

Hurdle Rate
The idea is to check for sanity in my valuations above. I want to have 15% return, where does it come from? 6% net income related to current stock price + 3-5% inflation + 5-7% growth. As Silverlake is operating in emerging markets the economy is likely growing >3% per year long term (catching up to developed word) and the financialization is likely to grow faster than that [BARRONS].

The main risks in my opinion are Chinas economic slowdown will slow down south east Asians economies, slowing the financial sector growth or even shrinking it for some time giving Silverlake’s Customers a hard time. US, Europe or a Global slowdown will effect Asia for sure in similar ways and cause similar problems for Silverlake.

A second financial crisis like 2008 which leads to a Global financial meltdown, stop of international trade and the collapse of banks around the world and bankruptcy of some of Silverlake’s customers.

Razor99 allegations are true and Deloitte did a miserable job.

Competitors may start cut throat completion making selling of new software solutions hard and only at price discounts. Most of Silverlake’s revenues are maintenance / extension projects of products with decade long life cycles so that competition needs many years of completion to real steal market share from Silverlake’s core market, but market share in their "marginal" markets will be hurt and would make Silverlake’s expansion costly.
John’s cake is awesome.
Legal environment might get uncertain through internal political instability or protectionism of Asian countries.

War in the south china sea, dragging major regional powers and major nuclear powers into.

A conflict between countries politics and the management of Silverlake.

The loss of Mr. Goh as leader of Silverlake.

Investment Thesis
I expect that Silverlake will grow fast the next years but paid "only" for 5-7% growth. Even if Silverlake does not grow, it pays a good dividend which makes waiting pleasant.

Most growth comes from marginal markets, which drives down Silverlake’s gross margin but increases revenue (see SunGard Ambit acquisition). This leads to an overall increase in owner earnings. Early indicator of growth is the sale of software licenses which causes a series of future maintenance and extension projects. The project revenue is recurring and predictable.

M&A on a regular basis are expected and should be made at reasonable prices, like in the past.

The banking IT market is conservative and even disruptive technology will need a long time to disrupt Silverlake’s core market. I have to keep my eyes open! If that hypothesis breaks, Silverlake is in danger of being disrupted away.

In the short term I expect that software licenses revenue increase / normalize as razor99 allegations are proven unfounded and banks award contracts again to Silverlake.

This post represents an opinion and does not imply any investment advice. The author may own stock in this company.

[VALUEPOD] Pat Dorsey mentions Silverlake Axis at the end of the Podcast.

Donnerstag, 31. Dezember 2015

Understanding Energy Sector: The history of oil and fracking

2015 is over and my challenge of 2015 was to acquire knowledge outside the software industry. In my opinion the energy sector is the most important sector of all, so I want to understand more of it. Without oil, no warm houses, no fertilizer (= less food), no transport, no travel (beyond a couple of miles). I felt like Alice in Wonderland going deep the rabbit hole and I want to share some of my insights.

Grand Canyon
First I studied oil history, than fracking oil industry, than the coal industry. Fracking is a very interesting topic by itself. 10 years ago nobody though the US will ever produce > 10M barrels a day - now it does. This is a huge game changer economically and geopolitically. The political debate in Europe to allow fracking made me very interested. Is there an hidden opportunity? Therefore I wanted to understand this (1) fracking revolution as well as (2) its impact on doing business. After the crash of the oil price in August I did research into the market structure of oil.

After oil the second most important fuel is coal. Its used primarily for electricity and steel production. As developing and emerging economies industrialize, they need more electricity and steel to build up infrastructure. Betting on coal is a bet on developing countries.

Here comes the first part of the series.

History of Oil and Seven Sisters

The oil access was and is controlled by a few. After WW2 the oil access was controlled by the Seven Sisters. The Seven Sisters are the successors oil companies of the WW2, the successors of today's Chevron, Exxon Mobile, BP, Shell and Total. (The east was communist and did not have oil companies.)

Controlling the oil was a major cause for WW2. Before Japan attacked Pearl Harbour, the US sanctioned Japan by prohibiting oil exports to Japan. Therefore Japan's empire had to expand into oil / resource rich region like Dutch East Indies just to keep its empire running. Dutch East Indies lies on today's Indonesia. This move would have caused one way or another to a war with the USA, so Japan did the first strike. Dutch East Indies oil exploitation was operated by the successor of Royal Dutch Shell.

On the other side of the globe Hitler's main reason of invasion of Soviet Russia was to get access to oil rich Caucasus - and therefore energy independence from the Communists. Caucasus is a land piece between today's Ukrain-Russia and Russia-Georgia border on Russian territory. Hitler's attempt was not successful.

Its no coincidence that Germany and Japan do not have their own "Sister" big oil company. After loosing WW2 the allies prevented them to secure their access to oil, so that any potential military threat can be countered by cutting their oil supply lines. Without oil no tank drives - no fighter plane flies.

In reverse, the major strategy of global powers is to secure oil access, so that they can use it as a weapon in economic and military conflicts as well as establishing economically and political independence.

History does not repeat, but it does rime

Looking at today's conflicts, we see the US-China Conflict in the South China Sea (neighbours former Dutch East Indies) and growing tensions between Sunni extremists and secular Indonesian government.

Today's conflicts in the Caucasus region on Russian territory is between Russia-Georgia (2008) and Chechen Wars (Islamists-Russia) (1999, 2009) might have the same underlying reason of securing oil access. Also the Russia-Ukraine conflict (2014) neighbours the Caucasus.

After WW2

As western oil resources depleted their traditional oil fields while large oil reserves were discovered in the middle east, the Seven Sisters moved out, supported by their governments, to secure the oil access. Billions upon billions are earned with oil. Oil is extremely important for economic development and military reasons. In my opinion the trouble in the middle east is caused by the oil. Everyone wants to secure their fair and not-so-fair share of the oil pie.

With the emergence of developing nations, new members of the Seven Sisters occurred and other lost their importance. Saudi Aramco (Saudi Arabian-American Oil Company), China National Petroleum Corporation, Gazprom (Russian), National Iranian Oil Company (Former Iranian parts of BP) to name the most important.

Oil shale, shale oil and fracking

Basically all oil was bounded in oil shale. Oil shale is a rock, which contains organic material. These rock formations can be pushed down nearer to earth's hot core.

In the case of conventional oil and gas exploitation as these oil shale formations get cooked by the cores heat and cracked by pressure the hydrocarbons (oil and gas) is released. Through rifts hydrocarbons can escape upwards and flow into sand stone (basically a sponge) which is surrounded by non-permeable stone in bell-like form. If someone drills a whole in the top of the bell, hydrocarbons can escape the bell. As a lot of hydrocarbons can be stored in sandstone a traditional oil and gas well produces as long as the sponge is filled. Think of the Grand Canyon Sandstone stuffed with oil, multiple size the Grand Canyon. The problem is that this special bell formation filled with hydrocarbons is seldom.

The earth has excessive amounts of oil shale but the bounded oil is hard to extract. Fracking is a technology to crack and extract oil and gas from oil shale directly. This oil is called tight oil or shale oil. Fracking uses water, pressure and chemicals to crack and extract the hydrocarbons. It is able to extract hydrocarbons nearby the drilled whole. Everytime this whole is depleted a new whole has to be drilled and fracked. Over 50% of hydrocarbons is extracted within the first year of production, than flow of hydrocarbons decreases rapidly. The big problem of fracking is that fracking requires constant drilling.

Comparing conventional extraction with fracking is a huge mistake. The conventional cost structure is drill a whole and operate the whole over 40 year. While fracking drills constantly new wholes just to substitute depleting wells. Fracking is CapEx expensive and the cost grow exponentially the deeper the whole gets. As long as CapEx can be financed cheaply, through low interest rates and easy credit as well as high oil price, fracking is economical.

In Europe few oil shale formations lie in economically exploitable depth, where as Ukraine has the largest economically exploitable oil shale formations.


Oil and gas investing:

Freitag, 25. Dezember 2015

Startup Investing: Throw a snowball

This article is how I came up with a medtech startup idea, which is based on my previous article about filtering ideas Startup Investing: How to build a snowball.

How I got an idea

Half a year ago I read the high interesting book "Risk Savvy" by Gigerenzer. The book is about decision making under uncertainty and risk. A couple of chapters are about medical decision making for doctors and patients. Basically Gigerenzer promotes the idea of using natural frequencies and fact boxes to communicate risks of a therapy, drugs and illnesses.

Natural Frequencies describe probabilities as absolute numbers. Saying "5 out of 100 people get ill" is better than saying "5% of people get ill". The main advantage of saying "5 out of 100" is, that its easier to visualize. A second advantage is that it explicitly says on what the probability refers to and prohibits evil relative probability.

Relative probability is mathematically correct, but really evil, if not communicated correctly. 'Newer pills [...] double the chances of blood clots' is evil usage of relative probabilities. The same relative probability ('double the chances') expressed as natural frequencies is the following. First generation (contraception) pills cause blood clots in 12 out of 10,000* women. Second generation of (contraception) pills cause blood clots in 22 out of 10,000* women. The probability of having blood clots is 0.12%* (1st gen) to 0.22%* (2nd gen) or an absolute increase of 0.1%* or in relative probabilities 83%*. You see, just saying 'double the chances of blood clots' misrepresents the real information! That is why relative probabilities are evil or at least have to be used very, very cautiously.

On the sad side, most journalist are not cautious and misrepresent this life-depending fact wrong! Because of this article above (and similar others), many women did not use the pill any more. Thereby getting pregnant and causing more(!) abortions. As abortions are way more life threatening than using the 2nd gen pill, it is fact that many more women suffered physically and psychologically or even died because of this misrepresentation of facts. A chill went up my spine: because information about 'chances of blood clots' got misrepresented, many women suffered and some even died! Got anyone arrested because of not doing their journalism job? NO!

Fact boxes are a way to represent (medical) information in a transparent and compact way [1]. The following fact box represents the pill case* above:

                                    1st gen pill       2nd gen pill
Women treated               10,000              10,000
Blood clots occured              12                     22

The comparison between 1st and 2nd generation pill represented as fact box is obvious and easily understood. Lets make a Keynes twist to the fact box ("It is better to be roughly right than precisely wrong."), because 10,000 is a large, hardly countable and imaginable number:

                                  1st gen pill       2nd gen pill
Women treated              1,000                   1,000
Blood clots occured             1                          2

Now its obvious that the risk increase of taking the 2nd gen pill is there but in absolute terms small. In other words 'double the chances of blood clots' was transformed into 'an increase from 1 to 2 cases of blood clots per 1,000 women treated'. I do not think masses of women will stop taking their pill, risking an abortion, based on this representation of facts.

MedTech Startup

The idea of using fact boxes to represent medical information is in my opinion a very valuable service provided to society. Right now I am in the third step in my process and I have to do small capital investments (server) and large time investments (website). Here is my first website in German:

My primary competitor is informulary., which already provides fact boxes to the American market (FDA). Its founded by the inventors of the fact box. My target market is Europe. In Europe the drug admission, languages and health care systems is quite different, so that American and European markets are quiet distinct from each other. I do not think head-to-head competition is likely in short- and mid-term even if the product is exactly the same.

At the moment the business model is quiet straight forward. Create a fact box once and sell the fact box multiple times. The cost structure of creating the fact box is primarily manual labour (time-depended) of a specialized pharma-graduate. The online selling per unit has near 0-costs. The drug admission documents are free of cost, while access to medical journal publications have to be paid for (in some European Countries medical publications are open and free of charge).

The customers might be patients and health-insurer (consumer) or doctors, hospitals and health-insurer (professional). Maybe some subscription model is more favourable than pay per download? Maybe some customization and reselling model is also more interesting to my customers? Maybe some kind of reviewer & education services can be provided to consumers and professionals? The acceptance of the user interface and service has to be verified, so that it is easily accepted by my customers. All these questions have to be tested in step 3 and is yet to be done.

The primary market barrier is a trusted customer relationships. After a trusted and proven relationship is established, the switch barrier is relatively high, as the cost on my customers P&L statement is relativity small compared to other cost positions and the use and feel of my service should create some switching cost which have to be overcome by my competitor. In my opinion there are only a few paying customers: doctors & doctor's office, hospitals and health insurers. In my opinion going after the health insurer first should be most promising.

Sources & Comments
[1] Schwartz, Lisa M., Steven Woloshin, and H. Gilbert Welch. "Using a drug facts box to communicate drug benefits and harms: two randomized trials." Annals of Internal Medicine 150.8 (2009): 516-527

* Estimated numbers based on:

Freitag, 23. Oktober 2015

Startup Investing: How to build a snowball

Alice Schroeder named her Buffett biography "Snowball". What a wonderful analogy for compounding! In this article I describe how I build my snowballs aka. startups.
A wonderful snowball (flickr) 

The maths of rolling a snowball

Imagine a snowball on top of a hill. The ball is sunk into the snow coverage. Without a force pushing the ball to one side, it will not move. As we push the ball to one side, the ball moves and collects snow. As more and more snow is collected the ball grows bigger. This growing process absorbs some if not all of the pushing force.

So, if the ball is too small, too slow or the hill not steep, the ball has not enough energy to support the growing process. Than the ball will just stop rolling. If the ball has more energy than the growth process requires, the ball will further accelerate thereby increasing its kinetic energy. As the ball has more kinetic energy it can accelerate the growth process.    

The growth process creates friction consuming energy. Similar to growing company using capex and other expenses capital is costumed.

Building a snowball

The first step is to build a snowball / startup. As I am young I have not much capital to build a startup (using much snow) but I have some time, much creativity and being a digital native. This leads to the problem that my snowballs are small. I have to push them around in smart ways to add snow.

I have already build one startup which is currently incubating into a self sustaining business. As I love the process of getting deep insights into the problem's of my customers. I want to describe my process here.

My process

The first step is to walk around in life with wide open eyes looking for other businesses and pains customer have. As I am a digital native I have good insights what technology can and cannot do.

The second step is to filter out business  ideas fast. The earlier an idea is out the more time and money you save. Ideal I cannot come up with a technology solution for a pain in a fast way it's filtered out. I do not try to jump over 6 foot hurdles, I jump over 1 footer. The next thing is to understand what players (customer, supplier, regulator) are involved.  A good solution is not complex and fits on a napkin. In my case only one idea in 2 years is good enough to go to the third step.

One thought on technology. In most cases technology does not do something new but better or at less cost. For example Uber is not new in the sense that you can call cabs since 1906 by phone. As Rory Sutherland pointed out, it just makes the waiting experience much better. Another widely known ability of tech is to cut out intermediary from the supply chain and  saving expensive manual labor.

Step three is to do small customer tests. Build your idea in power point and let customers click / play through it. Keep time and money investment's low. Normally customers come up with good ideas how to improve the process. Key here is to find out if they would pay for it. If they do not, filter the idea out.

Step four is to build the real thing as well as a marketing and sales. Here investment's are high but you could decrease the risks by rigorous filtering.

After step four there should be some revenues. If revenues are high enough to cover your expenses you have a  rolling snowball. If not which is common the ability to find investors is much easier than with just the idea.