Reflecting on the 2020-2021 Investing Bubble

Warren Buffett once said “It's only when the tide goes out that you learn who has been swimming naked”. Now that rates have risen exponentially, it's becoming clear that 2020/2021 was a massive bubble.

Reflecting on a crazy couple of years of euphoria: We were clearly in a bubble in 2020/2021 – but it was tough in hindsight for most of us to stop drinking the Kool-Aid. The way unprofitable tech traded in hindsight was wild – but look for everyone that’s a little younger, this is a time to reflect, assess, and correct your mistakes. It’s a good time to realize “I should’ve done more research” or “I didn’t appreciate this point of the thesis” or “I kept buying when valuations were too high/I overpaid for an overvalued asset” or “Oh okay, SPAC sponsor incentives weren’t aligned with retail investors” or “I should’ve recognized the changing macro environment” or “Ya a lot of crypto is a total ponzi.”

So let’s reflect – in this edition I will go through 7 Investing Trends/Events over the past couple of years (such as SPACs and absurd tech valuations) that represented clear investment euphoria.

But first - I need to give some color about 1) the launch of the referral program and 2) the relaunch of the merch store. 

The Relaunch of the merch store: The Merch store (www.highyieldharry.com) is back with coffee mugs, a tumbler, a beer mug, and a shot glass. I had the merch store up last Nov & Dec as a way to get product out to everyone who wants some high yield gear. Just like last year - the merch will be live going into the holiday season - from now until year end. Why do I only do this once a year? 1) 4Q is the best time of the year for e-commerce given demand for holiday gifts 2) It's a headache - operating a merch site takes a lot of legwork and setting up shipping to countries all over the globe adds a lot of complexity to get things in order 3) Print on Demand (PoD) is low margin - the costs needed to PoD, hold inventory, and ship safely eats a lot into margin. I like to think I'm a *relatively* transparent person, so I'll say this: I try to price at a fair market value, but some of these costs are brutal. For ex, I LOVE this beer mug, but look the cost of goods sold (COGS) is pretty high. I'd LOVE to price lower, but the cost to manufacture and ship doesn't allow for this to be the case. So, hey I'd love for everyone who wants some merch to grab some, but get if you don't want any.

 The Mugs are also my go-to (when I make coffee at home), as the 15-oz mugs are bigger than the mugs advertised across other meme merch stores. 

Okay - so - back to 7 Investing Trends/Events over the past couple of years that represented clear investment euphoria.

1) Twitter

I’ll start with the most recent/relevant one – overpaying for an overvalued asset - Elon having to buy Twitter for $44B. Sure, this isn’t as egregious as the rest of the bubbles I’ll talk about – but even Elon himself admits he overpaid for Twitter.

As someone who is usually an Elon hater (massive hater), this is pretty hilarious. My take throughout this Elon/Twitter has always been the following:

1)      Alright he’s obviously overpaying for Twitter, this LBO math doesn’t make sense, but I guess it’s a nice hobby for him.

2)      Ah okay, the stock market went down a bunch and obviously he wants to find a last minute excuse out of this. Pretty sure he’s paying at least $1B or they’re going to compel him to fulfill his merger agreement.

3)      Alright now he’s clearly stuck with closing on this acquisition unless the government somehow says he isn’t allowed to buy it.

So this all comes to a head Friday 10/28 – the banks are on the hook unless the government thinks he shouldn’t own Twitter because he posted sus stuff about Ukraine/Russia and whether he should shut down Starlink access above Ukraine.

But here’s the fundamental issue - the math doesn’t work: Projected cash interest expense on the $13B in debt is expected to be $1.2B, right around where 2022E and 2023E EBITDA is..

But do the synergies work? Can you actually fire 75% of twitter? No – you can’t in an orderly way. Sure, there’s probably some redundancies within Twitter, but c’mon, even if it looks like Twitter hasn’t innovated in years (I’d argue we’ve actually seen a lot of product rollout on Twitter in the past several months) headcount is needed to ensure Twitter is safe and secure. But if Elon does make significant cuts, these are going to be some brutal severance charges regardless of the actual %.

How is Elon going to exit? Some of the best ways to drive a successful exit after a take private include 1) Multiple arbitrage (expanding your EV/EBITDA multiple on exit, maybe some accretive tuck-in acquisitions were made here via a rollup strategy) and 2) cost-cutting/professionalizing the business/reducing redundancies. Step 2 should play out – but how is he going to get step 1 to play out?!? Twitter is going private at a $44B valuation with limited FCF – there’s going to be limited ability to divy recap and I doubt the business will be able to go public at a $100B valuation.

This one looks doomed and like a classic poorly timed, late cycle LBO, but hey maybe Elon proves me (massive hater) wrong.

Let’s dive into the craziness from 2020 and 2021. It really was easy for everyone to get caught up in the mania – remember this gem?

2) Upstart: When that guy went on CNBC and had no clue what Upstart did. This should’ve been a clear cut moment to sell a bunch of stocks. Many of you will recognize this photo immediately – but here’s the video if you need a refresher. 

Investing guru Mark Minervini was asked on CNBC in November 2021 what the stock he was pitching, Upstart, does and he suddenly went radio silent and said he couldn’t hear the question. Mark’s defense was that he actually lost connection with CNBC – but from reading the verbal cues in his response this doesn’t seem to be the case. Btw – here’s what Upstart does – they are a lending platform driven by AI  that use their sophisticated machine learning models to approve more applicants than traditional lenders…so yeah, that sounds awesome going into a credit crunch.

It has not been a fun year to own Upstart stock – with the stock down over -93% in a year.

3) SPACs: Some of my earliest followers probs remember me ripping into these back in 2020.

There were some ridiculous SPACs over the past couple of years that in reality were in no position to go public. Several SPACs were ESG focused, driving investment demand and interest because it fit a bright and rosy investment mandate, but were not yet viable public businesses. Several other SPACs such as Buzzfeed, Bird, Virgin Galactic, Opendoor, WeWork, and other “exciting” tech, cannabis, and healthcare companies that easily lured in greedy investors later floundered in the public markets. At least as the market turned, some of these deals got called off and retail was spared. The $1B Manscaped SPAC, which got called off in Aug. 2022, had some pretty hairy EBITDA add-backs.

One of the most noteworthy was EV company Nikola (which used to trade >$65/share and now trades at $3/share) – best known for Founder Trevor Milton being found guilty on one count of securities fraud and for being caught rolling a truck down a hill without a working drivetrain…

There were some ridiculous celebrity backed SPACs – Shaq, Peyton Manning, Jay-Z, A-Rod, Martha Stewart, Colin Kaepernick, Channing Tatum, Paul Ryan, and Steph Curry all backed SPACs in order to drive investor interest. The SEC had to put out a statement in March 2021 urging investors to not get involved with SPACs just because there’s a celebrity involved. 

Beyond poor companies that are being brought public far too soon, there’s significant misaligned interest embedded within SPACs

This is old news – but here’s a brief explainer on SPACs for anyone who needs it: SPACs raise equity capital to take a private company public via a reverse merger over a 18-24 month timeframe. As compensation, the SPAC Sponsor receives a 20% stake in the Company for a minimal amount of $ around $10/share. Additionally, Sponsors receive penny warrants that have a strike price around that $10 ballpark that can be exercised starting within a year or earlier.

The reasons why there are misaligned incentives within a SPAC: 1) the 18-24 month timeline to get a deal done adds pressure for a sponsor to hurry up and get a deal done to avoid having to unwind the SPAC, 2) A 20% sponsor promote is a brutally high compensation given little $ put into the deal, 3) those in early on SPACs are institutions, while ownership upon de-SPACing later got dumped to less sophisticated retail investors 4) Sponsors are able to monetize relatively quickly (within 18 months) and can easily reduce their stake to $0. Given favorable equity structures, it’s hard for them to take a loss on a SPAC, meaning almost any deal (no matter how shitty) usually leads to a favorable outcome for Sponsors. 

JP Morgan found in 2021 that the average sponsor return on equity as a whopping 650%!!!!! Quite the haul – but obviously this game of hot potato did not end well for everyone. 

The obvious antagonist in the SPAC era of course was “The King of SPACs” - Chamath.

The Jerkiness of Chamath was pretty wild. The obvious top was the February 2021 Bloomberg article calling Chamath the next Warren Buffett.  He has said outrageous things and in January 2022 said ‘nobody cares’ about Uyghur genocide in China.

Another one that riled me up was when a kid who looked like he was in his late teens/early twenties asked Chamath why the price of one of his SPACs was going down and Chamath told him (something along the lines of) “stop crying and do your own research.” I mean, that’s totally something Warren Buffett once said too, am I right.

A lot of people realized that he was a jerk that didn’t care about you way too late. On March 5th, 2021, he cashed out completely of Virgin Galactic (<18 months after going public) while the stock was still at >$27/share (~$4.45/share now) – but wait it’s all good! Chamath at the time said “I remain as dedicated as ever to Virgin Galactic’s team, missions and prospects” – Ah, okay – got it – all good! All good right? That was certainly the mentality a lot of bagholders had – and they learned the hard way when the clear takeaway is you should probably sell when someone with a lot more visibility into the company completely cashes out. 

As you can see below – there’s some brutal performance among Chamath SPACs (which have fallen even more since this photo) – with relatively little $ put in to acquire these shares.

One of his portfolio companies, Opendoor, which “revolutionizes” the buying and selling of homes through making instant cash offers for homes online, making repairs, and then relisting the homes, was co-founded by quite the character – Keith Rabois.

Over a month ago, I was in an out of nowhere spar with Keith Rabois, a VC who fits the “PayPal mafia” bucket (a lot of the people involved in the early days of PayPal went on to be successful VCs and founders) and is a co-founder and the Chairman of Opendoor. I didn’t really know much about this guy except that he was mean to people on Twitter sometimes. But man, he did not like when I called out a bullish tweet about Opendoor at the top that was brutally wrong.

The fact that this guy keeps going down a rabbit hole arguing with anons on Twitter given his net worth is wild. This “beef” with Keith lasted a week, with a lot of twitter chiming in , and cumulated with him feeling the need to get on CNBC – where he somehow showed that he was an even bigger jerk than we all thought (pretty high bar).

During the interview he called CNBC anchor Deirdre Bosa stupid after she had to clarify that Opendoor was not profitable on an operating basis, with Rabois saying “do you not know what gross margin and contribution margin are?”. Rabois changed the goal posts from an “operating” basis to being profitable on a gross margin basis (very impressive, that’s quite the feat) and said that stock based compensation is “fake”.

The jaw dropping part here is that Keith for some reason, cannot buy any more shares of Opendoor. You heard it right. The biggest defender of this company who is talking about how he’s super bullish can’t put his money where his mouth is.

That anecdote with Keith, as well as the misaligned incentives with SPAC Sponsors really show that You need to take what’s said with a grain of salt when the person talking has no skin in the game and their actions don’t meet their words.

4) Cathie Wood

To be fair – Cathie NAILED her Tesla prediction. Kudos to her on that. But wow she’s been horrifically wrong on everything else once the macro environment changed. Her most recent biggest positions of "innovative" companies were Roku and ZOOM. Ridiculous. Her full portfolio is public here and see she’s down -78% from the peak and over -70% in the past year. If you’re paying 75bps for this performance (for beginners, 75bps management is absurdly high for something you can reconstruct without any fees in your own portfolio) you’re NGMI. Her analyst team is full of young academics/VC types rather than the traditional hedge fund analyst (someone who spent a few years in banking and then moved from PE to a hedge fund) and it really shows it terms of quality of output.

5) Crypto:

I’ve gotta include crypto in here – I personally have a little bit left and was selling (or paper-hands-ing) BTC and ETH on the way down once I realized that Macro was going to trash crypto. Clearly NFTs were a joke IMO once they came out. I mean, kudos if you have pumped your way into making $ on it tho, but man u can’t pretend that a lot of crypto has actual utility today. Beyond general staking projects, other hot buzzword projects like a decentralized metaverse and digital real estate have fallen flat in 2022. There’s legit only 36 daily active users on Decentraland… I’m sure next cycle Crypto will be hot again but man…some “inflation hedge” huh. Prior to hiking rates, all we’d hear from crypto heavy folks was about how this was an inflation hedge – but once we actually started hiking rates, crypto tanked.

There’s probs a decent probability that the most relevant cryptocurrencies will stay relevant and rebound – I won’t discount this – but clearly this is a highly cyclical and a highly “wild west” style asset that can lead one from riches to rags in short order.

6) The Metaverse: Ya this should’ve been recognized as something no one wanted to do (at this time being) given we were in lockdown for 12-15 months and wanted to get back outside and socializing. Facebook/Meta spent $10B in 2021 for graphics that look like this…absolutely brutal.

7) Lastly, we did a terrible job determining episodic growth vs. sustainable growth. There were several stocks who maybe had a path to be a mid-sized company and generate modest FCF, but their ability to compete long term got significantly overvalued during these crazy times:

Peloton

Oh so gyms are closed/you’re stuck WFH/you don’t want to work out with other people with masks on? Here’s an alternative – use a Peloton or Mirror at home to work out! Naturally every bored Suburbanite or City Yuppie hopped on the Peloton craze. For some reason, Peloton thought this demand was sustainable and doubled down on hiring and production efforts.

Shockingly, the purchase of a one-time, highly cyclical & expensive product with usage driven by a short-term episodic event was something consumers weren’t going to regularly use. Once people started returning to the office, got bored of this hobby, or you know, went on a jog or bike ride outside instead, people were looking to sell their bikes at a discount on facebook marketplace. Now Peloton is an absolute mess and has already gone through 4 rounds of layoffs, with an end to the restructuring and a path to profitability still not in sight.

Kudos at least to Mirror for selling to Lululemon for $500mm at peak WFH in 2020. 

Zoom and Docusign:

There’s a reason I’ll never touch Zoom and DocuSign – in my view these products are commodities. I never really viewed these products as full suite solutions – but rather apps that allow me to do one particular thing 1) dial into a video call and 2) sign an electronic document. By calling these products commodities I mean that they are easily replaceable and there’s no distinct advantage to use one over another.

Peloton, Zoom, and DocuSign all should’ve tried to sell themselves at a massive valuation to a strategic versus doubling down. The year over year chart relative to the Nasdaq 100 is brutal:

Other stocks that fit this bill – Shopify (everyone’s side hustles cooled off after 2021 and e-commerce gave some share back to brick & mortar) Roblox (kids are socializing more now) Coinbase and Robinhood (day trading is TRANSITORY – I made this point back in early 2021 – there’s going to be significantly less crypto and stock trading among retail investors that see falling prices and are running out of $ to invest) Rivian (originally had zero sales at a $100B valuation? What could go wrong!) Netflix (Everyone was stuck inside and they lost their best shows to rivals who developed their own streaming platforms) Facebook/Snapchat (more people went outside, TikTok ate into share, Apple changed the advertising game, and for Facebook they’re investing heavily in capex for a product that it’s unclear if ppl want).

What can we learn from this? 

One of the takeaways apparent to me is obvious – Don’t fight the Fed – especially on the way down. If the Fed is saying “okay time for QT and to raise rates” – it’s probably time to get out of or reduce the stocks that trade at 100x EV/Sales and don’t generate FCF. Secondly, don’t catch a falling knife when Macro is against you. “Oh wow, the stock is down -25% - this is a bargain!” isn’t true if the stock still trades at 75x EV/Sales – there’s a countless number of stocks that looked “good” to the unsuspecting investor down -70%, but then they fell another -70%. A lot of these businesses need a serious shakeout and to find a path to profitability. In a time where the cost of debt and equity capital is expected to remain increasingly high – the high flying, higher beta, negative FCF businesses that excelled in a ZIRP environment are probably not going to be outperformers in a higher cost of capital environment that will favor businesses with scale and real FCF. These coming few years are going to be a good time to ride companies with a real competitive advantage, a path to strong and sustained FCF, and macro and industry tailwinds that give them a leg up over the long run.

That’s for all now, make sure to check out the merch store before it closes again after the holiday season. Until next time!