Tuesday, April 05, 2011
With the risk on trade in so many things partying on, TMM are always wondering what could make the music stop not just for the markets at a whole but in particular what can really change the dynamics in individual markets and especially commodities. Tim Wu's excellent The Master Switch is mostly about information empires - AT&T, Microsoft, Google and others - but applies equally well to really disruptive change in other non-information based industries - like autos. Wu notes something oddly true about what drives changes in industries beyond the ebb and flow of GDP:
History also shows that whatever has been closed too long is ripe for ingenuity’s assault: in time a closed industry can be opened anew, giving way to all sorts of technical possibilities and expressive uses for the medium before the effort to close the system likewise begins again. This oscillation of information industries between open and closed is so typical a phenomenon that I have given it a name: “the Cycle.”
TMM think that this idea of information being a natural monopoly can equally well apply to other industries where network externalities are big - it is hard to be an auto company and require use of highly specialized parts without losing cost competitiveness. Ultimately if you are a small part of a big supply chain it is hard to stray too far from the template. As a result, Wu notes that the big shocks in IT come from people who kind of know what the existing platform is but have no vested interest in it:
Another advantage of the outside inventor is less a matter of the imagination than of his being a disinterested party. Distance creates a freedom to develop inventions that might challenge or even destroy the business model of the dominant industry. The outsider is often the only one who can afford to scuttle a perfectly sound ship, to propose an industry that might challenge the business establishment or suggest a whole new business model. Those closer to - often at the trough of - existing industries face a remarkably constant pressure not to invent things that will ruin their employer. The outsider has nothing to lose.
Disruptive industries tend to be a conundrum for the macro investor because macro primarily deals in cycles and existing paradigms - rewriting the rules is something venture capitalists think about all the time and which entrepreneurs claim they are always doing but it happens much less often than one might think. So, as a disinterested macro investor how does one determine when something might be changing in a big way? How do you tell the Steve Jobs from the whack jobs?
When it comes to equities chasing momentum can be messy - corporate profits are cyclical for most industries and great success breeds great competition over the medium term. Jeremy Grantham's unshakeable belief in mean reversion is no article of faith given GMO's track record. However, occasionally strong trending behavior is telling you something, especially in tech. To that end, look at Apple, Baidu, or others - value guys who get altitude sickness at >30x trailing PE ratios missed the boat on these names, bigtime. Things that trend this far and trade this rich do so because people slowly but surely realize that there is a paradigm shift going on - if there isn't, it is time to think about shorting. To that end, TMM have been noting some very strong trending behavior in the lithium space for some time: FMC, Rockwood, and others its time to ask - is this it? Are electric cars ready for prime time and how is this likely to play out?
The documentary "Who Killed the Electric Car" asserted that GM basically killed the electric car to defend its existing business. While the jury is out on this they certainly dropped a promising program way too early to focus on bigger SUVs with fatter margins. There were barriers to adoption before which were as below:
1) People need to be able to adequate range on a charge.
2) They need to be able to recharge quickly.
3) The EV has to be competitive on cost on a "total cost of ownership" basis - ie, NPV 10 years of driving costs and use sensible discount rate to work out what the breakeven EV premium is.
On all these counts the old EV1 with NiMH batteries didn't really stack up - charging time was hours not minutes, range was short, and the costs were high.
However, look at the Tesla Model S and some recent changes in battery technology.
- Lithium charging in minutes not hours.
- 300 mile range.
- Cost of ownership breakeven slightly under $100 crude depending on whose numbers you are using.
One major difference between what Tesla is doing and what others like Nissan's leaf, GM's Volt and others are doing is rebuilding the car from scratch. Induction motors which don't use rare earth metals and are easier to cool are used in preference of direct drive, there is no backup power generation which obviates the need for any engine or fuel tank and most other parts are largely off the rack - the design IP is in battery management and aesthetics more than anything else which makes for a very simple and easy to service design. Compare that to the various halfway house options being offered by other manufacturers - they are too invested in their existing infrastructure and designs to break cleanly. Similarly, look at the mind blowing stupidity of Chinese auto companies which are now getting cheap loans to make lead acid battery powered cars with a range even worse than the EV1. Until TMM had seen websites like this one from Baoya Auto we couldn't reconcile the fundamental outlook on lead with current spot - now we just know its another way in which China is creating GDP out of utterly pointless investment. Absolutely every single established player in the industry cannot bring itself to make the jump and it looks like the disinterested outsider is going to have to shake things up.
Tesla seems to be doing a lot of clever things right now and may remake the auto industry - if only because all the majors cannot bring themselves to start off with a clean sheet of paper. For slightly more low beta way to play this theme it is probably better to just catch the trend in lithium miners and chemical producers as there is probably going to be a lot of competition between battery chemistries and the intermediate parts of the industry. One thing is for sure though - if this is the way it goes the whole internal combustion supply chain is going to get gutted faster than Blockbuster was by Netflix and Apple TV. TMM have one thing to say about the future of Lear and Magna if they continue as a "business as usual" proposition:
And on lead, TMM think that the bigger they are the harder they fall - every $ rise in LME lead pushes more E-bike users in China to lithium ion which is lower cost on total cost of ownership even at a 25% discount rate. We are sticking with this one - given high silver prices are inducing so much lead production in China and the pending technological shift that will kill demand, this is more likely than not going to play out like whale oil prices.