Writing Fiction, Raising a Thief, Internet Stocks

Sunday June 20, 2021

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My name is Larry Bernstein.
What Happens Next offers listeners an in-depth analysis of the most pressing issues of the day. Our experts are given just SIX minutes to present. This is followed by a Q&A period for deeper engagement.

This week’s topics include Raising a Thief, Writing Fiction, and Investing in Internet Stocks.

Our first speaker today is Mark Mahaney who is an equity analyst who covers internet stocks. He has consistently been ranked among the top analysts by Institutional Investor for internet equity research. Today Mark will discuss why we should buy stock in Amazon, UBER and Spotify. Mark has a new book coming out entitled Nothing but Net which provides 10 lessons for internet investing including focusing on revenue growth and customer metrics and NOT earnings are what matters most to tech investors.

Our second speaker is Scott Turow. Scott is a legal fiction writer who has sold more than 30 million books. He is most famous for his works 1L and Presumed Innocent. Scott has a new legal thriller entitled the Last Trial which is his 11th book set in Kindle County. The Last Trial is based on one of the long-standing characters, attorney Sandy Stern, who represents the CEO of a pharmaceutical business on trial for murder, fraud, and insider trading. Scott will speak about the conflict of interest inherent in corporate participation in the testing of new drugs. I also plan on chatting with Scott about writing fiction, adapting novels to films, and the creative process.

Our final speaker is Paul Podolsky who is the author of Raising a Thief about his adoption of a 16-month-old girl from Russia who grows up to be a criminal. Paul will speak about lessons learned including the importance of attachment at an early age, how a troubled child affects family life, and why early intervention is more valuable than support later in life.

I would like to expand the What Happens Next audience so that more people can enjoy our programming. I started a social media outreach using Twitter to increase listener engagement. I am going to continue an experiment today where I include twitter questions on the live program, so please tweet me and I will do my best to include your comments. Our twitter username is whathappensin6, where six is the number. I want to hear from you. So please tweet, whathappensin6. You can always email me at larrybernstein1@gmail.com.



Mark Mahaney

Bio: #1 Ranked Institutional Investor for equity research in internet stocks
Topic: Investing in Internet Stocks


Larry Bernstein:
Our first speaker today is Mark Mahaney.

He is the longest lasting and oldest equity research analyst in internet stocks. He works at Evercore ISI. Mark has a new book coming out called Nothing but Net, based on his 25 year experience and picking internet stocks. It includes 10 lessons for investors. Mark, go ahead.

Mark Mahaney:
Okay. Thanks a ton, Larry. Yes, the book is already available for pre-order on Amazon.com a company I’m pretty familiar with having covered it since 1998. What I wanted to do today is go through what I think is happening with the internet sector. And by that, I mean, some of the internet advertising names, the Google’s and the Facebook’s, the internet subscription names like a Netflix or Spotify, the retail names like an Amazon or an eBay, the travel names like an Airbnb and Expedia. I want to talk about the fundamental trends that these businesses are seeing as we emerge, hopefully permanently, from COVID and then talk about valuation trends. And then I’m going to pitch some stocks here. My favorite names in the mega cap, large cap and small cap space. Some of these names should be familiar to you, some of them probably won’t be so I’ll try to cover them and I’ll try to do all this in about six minutes.

So here we go, what’s happening to fundamental demand trends in the internet today. Net advertising, internet advertising, I think is one of the most interesting sectors. So, this includes Facebook, Google, Pinterest, Snap, Twitter, most of those are household names, Roku. That is what’s undergoing a super check mark recovery. This was probably the biggest surprise to me over the last 18 months, internet advertising like all advertising just got crushed for a couple of months last March, April and May. But the growth rates have recovered since then. And more than recovered, they are exhibiting a super check mark shaped recovery. I.E., growth rates exiting 2020 we’re faster than it was exiting 2019 and continued to accelerate in the March quarter and are continuing to accelerate into the June quarter. There a variety of factors behind this. But I think one of the biggest ones is what we’ve really seen as this surge in new business formation in North America in the last nine months. And a lot of these new businesses they get their product or the service, their launch ready, and then they go look to market it and they market it on these ubiquitous digital platforms like Facebook and Google. So ironically COVID in some ways has really been an accelerator for these businesses. So anyway, I look at internet advertising as kind of a super check mark shape recovery.

Online retail surge, that was initially just surge, whereas net advertising got cut, online retail got boosted. Amazon saw these record growth rates. So did eBay, eBay grew faster in the middle of 2020 than it had in 15 years. Other companies like Etsy, relatively well-known names. So online retail had this initial surge in growth. And then the question is, as we go facing these tough comps now, how sustainable is that growth? And some of these companies are going negative. eBay’s growing negative. What’s interesting to me is that Amazon is actually sustaining premium growth despite really tough COVID comps. I refer to them as being a permanent pull forward of demand winner or a COVID winner.

The web presence category dramatically benefited from the COVID crisis. I’m talking about Shopify, Wix, GoDaddy, companies like that that helped small businesses and large businesses make sure that they were on the internet as physical stores shut down, companies had to have a digital presence. These companies were there, they saw a surge in growth for their businesses, and I think it was going to be reasonably sustainable post COVID.

Then there’s the ride sharing category. I’ll just do two more, ride sharing and online travel. Ride sharing, I’m talking about Uber and Lyft. That business is still on its back feet that got knocked down, demand declined as much as 70, 80% in some markets. And you still have parts of their business-like airport trips, which is one of the biggest use cases for Uber and Lyft, airport trips are still down 50% year over year. Now, leisure airport trips are down less than that, but of course, business airport trips are down more than that. So that was a COVID loser. It is a recovery play and it’s going to be a long-tailed recovery play; it’s going to take them a while to really get back to 2019 bookings levels, but they will.

And then finally online travel kind of similar to ride sharing, that category was really clipped, cut off at the knees. And I’m talking about names like Airbnb, Booking, Expedia. They probably won’t recover to their pre COVID levels, Airbnb actually already has, but Booking.com and Expedia won’t until sometime in 2022, it may well be deep 22, but as they do, those have already had a nice recovery in their stock prices to capture that. I think Airbnb is particularly interesting though, because I think they’ve actually had a couple of structural wins from the COVID crisis. I think we’re going to see leisure travelers in particular broaden their usage of alternative accommodations, which is Airbnb’s power alley, sweet spot. So those are kind of the fundamental trends.

There’s one key valuation trend I would highlight. We may be at the end of this trend, but I’ve called it the great de-rating. You saw multiples in this group, go through a great re-rating in the back of 2020 through the end of 2020, just to throw out a few numbers, you had the average forward multiple on cash flow or EBITDA reach 23 times at the end of 2020 for a sector that typically traded around 15 times. So those were almost record high multiples for the group. And what would you expect? You would expect the reversion to the mean and that’s what you’re seeing. You’ve seen these multiples start trimming down since the beginning of the year. It’s one of the reasons that growth stocks have underperformed versus value stocks this year. It’s not because estimates have come down it’s because multiples have come down and probably rightly so.

There are a few cases where what I’d love to see is give me stocks or companies where their forward growth rates have actually accelerated because of COVID, but their multiples have come down. Boy, that would be an interesting combo to invest in. I’ve got two ideas for you, Roku and Amazon, and I’d also throw in Facebook, it’s multiple hasn’t come down, but it’s future growth prospects have increased. Most other stocks though re-rated or the multiples went up as their growth prospects increased. There’s a few of these interesting exceptions.

So now I’m going to wrap up here in about a minute with our top picks. In mega cap I think the three best ideas here are Amazon, Uber and Facebook. Amazon, again, forward growth rates have accelerated because of COVID yet its multiple has come down. So that’s that dislocation. It’s obviously a super high-quality stock. Yes, there’s some debate about how well Amazon does in a post Bezos world, but Amazon is so well set up in terms of its retail business, advertising and cloud computing for the foreseeable future. So high-quality asset somewhat dislocated top pick. Uber is our kind of COVID recovery play. I liked it last year too, but it’s one of our top three picks. The delivery business that they have, Uber Eats, is actually been a beneficiary of COVID. And I think ride sharing will come back, it’s just a matter of when not if. This stock could go through a material re-rating, trades at around three, four times EV to sales, I think that multiple could go up to 5, 6, 7 times EV to sales. So, you can get 50% growth in the stock just on a re-rating, you don’t get that too often.

And then Facebook is the number three pick for us. It’s started to perform nicely; I think they’re a great beneficiary of what I call social commerce. The idea that people are going to start shopping, doing retail on social media sites. And it’s still a company that’s got a couple of really interesting option values and probably faces the least antitrust risk of all the major tech platforms, because they don’t have this conflict of interest owning a marketplace and competing in it that Google has, or that Amazon has, or that Apple has.

In the second category of stocks is what I call large caps. So mega caps, the three I just listed Amazon, Uber and Facebook have market caps above a hundred billion. Large caps are between 20 and a 100 billion. Spotify, I just think has about one eighth the market cap of a Netflix yet I think its end market is probably relatively similar. Just how many people have smartphones around the world that will use those for music? Most of them use it for video. Most of them. And the price points are relatively similar, at least on the subscription side. Spotify has been a dislocated stock and had a really nice run last year on its move into podcasting, and then the market fell out, the stock fell out of favor. It’s also one that’s not really dramatically profitable. So those stocks have traded off in a focus on value. But as we recover to growth, I think the market will come back to Spotify. This year, it has its first ever price increase. We think that will be successful. They’ve got an 86 country or market expansion, and they’ve also rolled out a bunch of really nice new product innovations, both on a consumer side and on the advertiser side. So, I think you’ve got a fundamental inflection point, i.e., revenue growth acceleration, margin expansion. So, Spotify is a number one pick in this large cap space.

And then in the small cap space, I’m doing less than 20 billion in market cap and that may be too generous, but I’m doing it anyway. Wix is our number one pick, great digital presence company, with millions of users and a couple of hundred thousand of paid subscribers. This has been a very consistent management team. I’ve tracked this since their IPO eight years ago. I just love to see these highly innovative companies, very consistent management teams against large market opportunities. Wix is our top pick. Stitch Fix, an online fashion subscription business, highly controversial call here, reasonably high short interest on the name, but I like it. I think they’re a nice COVID recovery name, and I think they’ve also got some really nice product innovations that we can go through.

And finally, GoodRx is our number three pick. That’s a somewhat recent IPO, at about six months ago. Their recovery play, as physician and pharmacy visits start to recover, and just one of the best, what I call crucial combo stocks out there, i.e., they’ve got high revenue growth and high margins. They’re doing something like 35 to 40% revenue growth with north of 30% EBITDA margins. You don’t see that combination too often. I know it’s got a high multiple, and it’s well warranted based on what I call that high crucial combo. So those were our top three picks in the small cap space. Larry, that’s my pitch. Back to you.

Questions for Mahaney

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Scott Turow

Bio: Author of Presumed Innocent among others with 30 million books sold
Topic: Writing Fiction
Reading: The Last Trial is here


Larry Bernstein:
Our next speaker is Scott Turow. Scott and his wife, Adriane are very good friends of Julie and mine. Scott is one of the leading legal fiction writers. He has a new book out called The Last Trial, which is set in Kindle county and his 11th book in a series that started with his book Presumed Innocent.
The Last Trial is a story about a trial of a pharmaceutical CEO charged with murder, fraud, and insider trading. Scott will tell us about the conflict of interest that the pharmaceutical industry has in testing new drugs. Scott, take it away.

Scott Turow:
Thanks, Larry. You know, I decided that, although I expect to get beyond this in my discussion with Larry, that it’s hard to deliver a soliloquy about the creative process, and that generally, when you’re talking about a novel, it’s easier to focus on issues, and because I am a lawyer by training, I tend to gravitate toward social policy issues.

I wanted to talk a little bit about what has been on my mind and these pandemic days. The Last Trial came out in May. It was first published in hardcover in May 2020. And that, of course, was right at the height of the pandemic, which for authors, it was a good and bad time. For well-established authors, it was fine. For the less well-known authors, it was not, but it turned out that there was something topical about the novel and that the pandemic itself had focused immense attention on the clinical testing process, in the hope that there would soon be a quick approval of various vaccines that would be effective against the disease, something, that in point of fact, came to pass.

And so people often said to me, “Gosh, how were you so prophetic? Everybody wants to know about the clinical testing process, and because of the COVID vaccines and here’s your novel that focuses on the clinical testing of another medication, this extremely successful anticancer agent.” And not only does the novel talk about the testing process, which is not usually the fodder for popular fiction, but it also demonstrates some of the hazards of rushing a product like that to the market, which of course, the vaccine, which was in the way people were thinking about it, a proxy for the vaccines.

And much of, I think, the vaccine hesitancy that we’re seeing in many populations now has to do with that sense that the hazards of the vaccine may not be known for decades, which frankly is true. You balance it against the known risks of COVID, which all I can tell you is I’ve rushed to get vaccinated myself, but certainly I’m no prophet, and I’m no expert on pharmaceutical testing either. Everything in The Last Trial I learned from research and as my friend, the late Robert Parker once said when we were doing a panel together during the Scargo Amenities festival, I’m just a good typist. And what Parker meant in the case of his own research was that, and I would say the same for mine is all I did was to write down what I’ve read. So, I don’t offer the following remarks as somebody who professes to be expert in the subject. I’m just basically another lay person, who’s thought about it a little bit.

But the pharmaceutical testing process has been criticized from many angles. Health advocacy groups often contain bitterly about the way the FDA belabors the approval process. Some of that, the outside pressure from agitated voters who contact their congressional representatives can, perhaps, contributed to the recent approval of an extraordinarily expensive Alzheimer’s medication which the FDA had originally turned down because it found the research unconvincing, and by the way, when I say the FDA, that usually involves an outside panel of experts who are assisting the agency. Then, the same data was reanalyzed, both by the drug maker and the pressure of these advocacy groups who said Alzheimer’s is a horrible disease. We have to be able to do something about it. This is the only hope we’ve got.

And now, the drug is on the market. There are often complaints about… and well-founded ones about the incredible increase in drug costs that the testing process precipitates, both because it’s so elaborate and because as a result of it, many, many more products can come to market founder, and the huge costs that have been spent on testing and research end up getting rolled into the margins on the drugs that do make it to market. And then there, just the famous episodes where the drug testing process has fallen on, it’s behind, the one that’s always nearest and dearest to my heart is Vioxx, where it turned out that researchers within Merck were well-aware that the medication seemed to be causing heart problems for a select group of patients. And they basically threw with sort of a typical corporate communication through multiple levels eventually made a collective decision, which went along inch by inch, to suppress that information.

And it’s always bothered me because I have bad back. I took Vioxx. I loved it. It was really successful for me, and my internist has always said, based on what he saw, had the debilitating heart effects been published, he still would have recommended Vioxx for me, at least 20 years ago when I was younger and certainly as now, without a history of heart problems, or you have Elizabeth Holmes and Theranos, which was just fraud.

So, the question is, is there a better way to do this? And what gets thrown out in the middle of the novel is a supposed to be an article that was written by the government’s FDA expert, who was testifying in this prosecution of Kiril Pafko. And what she’s written is as follows, “If Massachusetts announced tomorrow that it was going to license persons to operate something as potentially dangerous as a motor vehicle, on the basis of a test that drivers had given themselves, the response would almost certainly be national outrage and yet, with billions of dollars at stake and more important, hundreds of millions of lives, we allow America’s pharmaceutical industry to test the safety and efficacy of their products for the public marketplace on their own. With limited government oversight. We can hardly profess surprise when that process produces unreliable, even fatal results.”

And I have to say that… I’m sort of spit-balling here, but having thought about it for months and recognizing that there may be powerful counterarguments, I still think that’s a better way to run the railroad for several reasons. Presumably, the government would bill the pharmaceutical company for the cost of the drug testing. We would presume then that the entire operation takes place inside the government, inside the FDA, or perhaps a separate agency that were necessary. And then basically, the drug manufacturer would pass the costs of testing back to consumers the cost of the successful tests and the unsuccessful products.

And I can’t see that at the end of the day, that would increase costs very much because that’s exactly what the pharmaceutical manufacturers are doing now, they’re passing along their drug testing costs in the cost of medications. And I became far more sympathetic to the pharmaceutical manufacturers in the process of writing the book when I realized how many medications fail in the testing process and that they are far, far, far more numerous than the number of drugs that come to market, but the unsuccessful drugs are still being paid for by the successful drugs. And I would imagine that the cost recovery scenario, if we suddenly had a government agency in charge of drug testing, would be exactly the same.

What it comes down to is the usual liberal versus conservative arguments about whether the government can do anything well. But I do think that the current hybrid system where private industry first tests the product, and then he has to go through an elaborate approval process within the FDA, and that may be giving us the worst of both worlds.

It’s got to be more efficient to have a single set of governmental actors involved, rather than letting industry do it. Usually, they hire a clinical research organization. They pay the CRO to do research all over the world. They recruit patients and doctors and so-called investigators. And then, the government comes along and looks at everything that they’ve done. And as I said, I think a unitary system might be more efficient and probably could lead to a faster approval of medications, and certainly one with less uncertainty about the potential corruption of results that comes when drug companies are testing their own medication.

The other thing about this that amuses me is that… a drug testing regimen exists side-by-side with the ultimate free market model, which is imposed by the law. We have, in the current tort regime, a system where instead of buyer be aware, its manufacturer beware. And the pharmaceutical products are one of the few products that come out to the marketplace with strict liability attached to them. Meaning, something goes wrong with the drug that somebody gets sick from taking it, the drug manufacturer is liable without any proof of negligence or any other kind of misconduct.

And yet, certainly, that system hasn’t made anybody feel safer or more secure on its own. We still have all of this misfiring and all of these additional costs. So, as I said, I just float that out there at the start of our discussion, Larry, as one possibility, which is when it comes to drug testing, would we be better off if the government just took that over and pass the costs back to the drug companies with the understanding, of course, that consumers would pay for it eventually.

Questions for Turow

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Paul Podolsky

Bio: Writer and formerly at Bridgewater
Topic: What Happens if your Child is a Criminal?
Reading: Raising a Thief: a Memoir is here


Larry Bernstein:
Our next speaker is Paul Podolsky. He has written a book Raising a Thief, A Memoir. Paul, what happens if your child is a criminal?

Paul Podolsky:
In 2001, my wife and I adopted a 16 month old child from Russia. She had been treated badly before we took her in, starved. Our belief was that because she was so young, our warm home would allow her to bounce back and our family to blossom. I was wrong. I wrote the story about the lessons learned and three stand out. First, the roots of conscience, curiosity, and resilience begin with the relationship of child to primary caregiver. This is called attachment. This process was first documented by English psychiatrist, John Bowlby in the 1930s. When this bond is ruptured, a child’s brain changes, which can lead to lying, stealing, even homicide. Number two, a family with a difficult member often requires structural shifts. While the specific type of challenge varies in each family, be it mental illness, alcohol dependency, et cetera, a difficult family member forces a reckoning.

In our case, I had to up my game as a father. And lesson number three, an ounce of prevention is worth pounds of attempted cure. Once the child has been damaged, it can be surprisingly difficult to treat. In our case, multiple approaches failed. The US spends about 0.5% of GDP on early childhood intervention below the OECD average. I think the risk reward of very high investment in early spending is probably enormous.

So a little bit more on each lesson below. The first lesson about the relationship of the child to a caregiver. The next time you watch a parent with a very young child, pay close attention. I witnessed this scene with friends last week. An infant, getting a bath, utterly defenseless. The infant slipped in the tub, got scared at the sudden movement, and squawked. Mom instantly picked her up, wrapped her daughter in a dry towel and said, “You’re okay.”

Neurologically something fundamental just occurred. The child was distressed, heard, and soothed. This micro interaction built trust in mom and the world. Dr. Bowlby was initially trying to figure out why children steal. At the time, psychiatrists were in the thrall of Freud, and believed childhood theft was due to repress sexual fantasy. Bowlby disagreed and found that in many cases, the tie to the thieves primary caregiver had recently been severed, due to death, illness or war. Bowlby said theft was quote a childhood disease, end of quote, like mumps. Both the timing and the severity of the disruption are predictive. The earlier it occurs, the worse the effects. Lying on a cot in a Russian communal apartment, her screams for food unanswered, our daughter’s brain was being rewired. She developed an attachment disorder. Attachment disorder leaves the child emotionally disjointed even if they are physically and intellectually robust. Like many mental health issues, the severity exists on a spectrum.

My wife was kidnapped as a child in Pakistan, yet she is not only intact, but flourishing. The difference, according to Bowlby’s theory, is the timing of the disruption. My wife was eight.
Lesson number two, the need for family structural shifts. It’s easier to see how things are put together when they fall apart. That’s true in financial markets and it is true in families. When we adopted our daughter, we were ecstatic. My wife and I had been married for six years. We had an adorable biological son, so we were broken in as parents. I worked as a banker, my wife as a teacher, we also knew Russia well. My wife is Russian. We met when I worked as a reporter there in the early 1990s. However, as soon as our daughter could walk, she tried to run away. As soon as she could talk, she began to lie.

When she was old enough to be out of an adult’s field of vision, she began to steal. These behaviors continued right through to adulthood when she was convicted of fraud. She’s now 21. Many of her childhood transgressions were in isolation, insignificant. She lied about toothbrushing or homework or washing her hands after the toilet, or cleaning her room or logging into another family member’s computer, petty theft bullying, etcetera. All kids lie. Her inability to interact in any other mode was what made her behavior notable. She forced us all to shift. I had to up my game. Too often, I had subtly dismissed my wife who was faster than I was at seeing what was going on. I have also had to set firm boundaries with our now adult daughter. There are conditions to unconditional love, both in terms of what I had to expect from myself and others.

And the last lesson about early childhood spending. My wife and I tried every intervention modern medicine has to offer. Psychotherapy, behavior modification, pharmacology, residential treatment, wilderness therapy, parenting coaching, diet, neurofeedback, nothing fundamentally changed her underlying antisocial behavior. Dr. Bowlby believed early intervention was key. While we took our daughter to a leading hospital in Boston and had a team of specialists evaluate her, no one either warned us about the risk, or once symptoms were present, accurately diagnosed her until she was nine. Too late. My conclusion is that you want to do everything possible to prevent this from happening in the first place. Of all the models that seem closest to preventing this, what Jeffrey Canada has done with Harlem children’s zone, makes the most intuitive sense to me. They begin working with families the moment the child is born, in the belief that, quote today’s newborns are tomorrow’s college graduates, as they say. My motto, based on our experience would be socialism for infants, personal responsibility for adults.

Questions for Podolsky

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