'Buy the Umbrella' - Issue #33
Hi there!
Here is your latest dose of ‘Buy the Umbrella’, a short list of interesting things I’ve been reading and thinking about during the week.
Quote
"If you care too much about being praised, in the end you will not accomplish anything serious. [...] Let the judgments of others be the consequence of your deeds, not their purpose."
— Leo Tolstoy
Tweet
Nassim Taleb, most known for his 2007 book 'The Black Swan', minces no words. His tweet highlights the challenge that faces markets today, with rising interest rates bringing free/cheap money to an end.
As Taleb points out, with the changing backdrop, cash flows become the key focus point once again for most investors (rather than just some investors). It will be interesting to see how these developments will impact companies that rapidly burn cash, especially those that were funded by venture capitalists at elevated valuations over the last few years.
Charts
Softbank's 5-year Credit Default Swap hits highest level since global financial crisis
This week, Japanese bank Softbank's Credit Default Swap (CDS) hit the highest level since the 2007/08 global financial crisis as investors worried about its financial position, due to its significant exposure to unprofitable and highly valued technology companies.
CDS refers to a financial derivative that allows a lender to offset their credit exposure to a particular entity. For example, a lender of Softbank could swap the risk of default by buying a CDS on Softbank from another investor who agrees to reimburse the lender if the borrower defaults. Investors can also buy a CDS contract if they want to bet on a company defaulting on its borrowings.
Softbank, which led Klarna's $639 million funding round last year at a valuation of $45.6 billion, was hit by more bad news this week. The buy-now-pay-later company is expected to raise a $650 million round at a valuation of $6.5 billion, a fraction of its prior round. This will likely cause some pain at Softbank's second Vision fund, which manages $56 billion. In Q1 2022, the fund reported $800 million in investment gains. This will now mostly be wiped out by Klarna's write-down.
Some may remember that two years ago, Softbank was hit by a massive valuation reset at WeWork, whose valuation in 2019 hit a high of $47 billion and subsequently was slashed to $2.9 billion. Softbank had invested a reported $18.5 billion in the company. Now publicly listed, WeWork is valued at $3.6 billion.
Given the track record of the first Vision fund which manages $100 billion, Softbank struggled to convince investors to invest in a second fund and as a result, Softbank is believed to be the only investor in Vision fund II.
In 2021, Softbank was overtaken as the "world's busiest venture capitalist" by Tiger Global Management, according to Bloomberg.
Update: Hours before publishing, Rajeev Misra announced he was stepping back from his main roles at Softbank Group. This marks the exit of one of the key architects that drove the conglomerate's evolution into one of the largest technology investors in the world.
Credit Suisse 5-year CDS hits highest level since 2009
Credit Suisse CDS hit an alarming level not seen since the global financial crisis. The bank has been scaling back its leverage exposure but continues to get caught up in various scandals. The bank has vowed to push ahead with its risk management and compliance overhaul while navigating what the CEO described as a "challenging" environment.
Articles
SEC rejects Grayscale's application to convert its Bitcoin trust into an ETF
The U.S. Securities and Exchange Commission (SEC) put together an 86-page rejection document, detailing that "the record does not support a finding that the Exchange has demonstrated that the bitcoin market as a whole or the relevant underlying bitcoin market is uniquely and inherently resistant to fraud and manipulation".
The commission's possible sources of fraud and manipulation in the spot bitcoin market include (page 73):
"Wash" trading (i.e. buying through one broker while simultaneously selling through another broker)
"Persons with a dominant position in bitcoin manipulating bitcoin pricing"
Hacking of the bitcoin network and trading platforms
Malicious control of the bitcoin network
"Trading based on material, non-public information" or based on "the dissemination of false and misleading information" (example: plans of market participants to significantly add or reduce their holdings in bitcoin, how a bitcoin-based investment vehicle will respond to a "fork" in the blockchain)
"Manipulative activity involving purported "stablecoins" including Tether (USDT)" [it is interesting that they specifically mention Tether - we wrote about Tether in BTU Issue #8]
Fraud and manipulation at bitcoin trading platforms
The SEC has now rejected over a dozen spot bitcoin ETF applications during the past year, while approving several bitcoin futures-based ETFs.
Five countries seek to delay EU fossil fuel car phase-out
The current energy crisis gripping Europe is pushing some countries to re-visit their energy transition plans. Italy, Portugal, Slovakia, Bulgaria and Romania want to delay an EU plan to effectively ban the sale of new petrol and diesel cars from 2035 by five years, according to Reuters.
Brussels believes the 2035 date is critical due to the fact that the average lifespan of a new car is 15 years, enabling the EU to reach net zero emissions by 2050.
Interestingly, Germany's finance minister broke ranks by stating that he does not support his own government's agreed position.
Until next time...
Thank you for reading this week’s issue. If you found it interesting, consider sharing it with someone who would enjoy it.
Do you have any questions or thoughts? Please feel free to reach out.
Have a wonderful week.
Why ‘Buy the Umbrella’?
Individuals, many of whom also run businesses and governments, tend to not think of the downside when the present is stable, and the future is looking positive (usually when we feel most in control).
Just because it is currently sunny, does not mean it will never rain. If we are not prepared, once it does begin to rain, we will end up running around looking for an umbrella in the middle of a storm, when they tend to be in short supply. We therefore need to ‘buy the umbrella’ before it rains.
Simultaneously, we cannot allow our awareness of risk to make us fearful, pessimistic, or paranoid, as this too works against us over the long-term.
Having the right mindset in advance is critical. The challenge is getting the right balance between being optimistic about the future and being able to not only withstand future crises, but in fact grow stronger due to the opportunities they tend to present.
It is not enough just to be conservative. One needs to be willing to put our cash to work when others feel least comfortable doing it. To do that with confidence, we need to have a foundational understanding of history, business, markets and human psychology.
Our mission at BTU is to learn as much about the world as possible, and in doing so, to try to find investment opportunities with favourable risk/reward characteristics. These should, over the long term, help build sustainable wealth.