The SportsFolio Journal - October 25, 2021
The (Sweet?) Future of Finance
Candy. Fanatics’s new NFT business, Candy, is up and running with MLB. Fanatics recently raised $100 million at a whopping $1.5 billion valuation; not bad for a company that is less than two years old. Fanatics does not wholly own Candy; but they are the majority shareholder. Mike Novogratz, an early crypto adopter and CEO/founder of Galaxy Digital, a diversified blockchain and crypto-focused company, owns a stake and he is on the board. Gary Vaynerchuk, a serial entrepreneur who started out his journey by growing his family’s liquor business, is also on the board.
While the valuation may seem rich, it pales in comparison to Dapper Labs’ $7 billion, who has a similar arrangement with the NBA and offers NBA digital collectibles called Moments on the Top Shot platform. Top Shot burst onto the scene in February of 2021, then cooled off a bit, and has since regained some strength. As of this morning, the “market cap” of all moments stood at a little under $900 million (though everything else being equal, the more NFTs are issued on the platform, the more inflated this number becomes.)
The creation of Candy was somewhat inevitable after the early success of Top Shot. Fanatics, which has recently toppled Topps for the MLB sports card business and potentially derailed its SPAC deal, was already looking to diversify its revenues. With the Canadian-based Dapper Labs making a splash in the NBA and also winning the NFL business, it was natural to jump to the next league.
What does this mean for the future of finance? Well, for starters, let us note that we don’t think there is anything wrong with digital collectibles; we own a few moments ourselves. Nevertheless, this is clearly a step that further blurs the critical boundary between speculation and investment.
Benjamin Graham, whose seminal work titled The Intelligent Investor is the #1 bestseller in finance on Amazon as we write, was worried about the distinction between speculation and investment being lost. To be clear, the ‘Father of Investing’ wasn’t against speculation per se, and neither are we:
Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone.
Rather, Graham just wanted to make sure that people are aware of what they are doing:
There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose.
Benjamin Graham had it easy! For the most part, investing was about stocks and it was up to the trader to decide whether something was, in the words of Graham, “an operation which, upon thorough analysis promises safety of principal and an adequate return.” That was his definition of investing.
The market was ultimately a triangular compact: point 1, companies needed capital; point 2, there were investors who were willing to provide the needed capital; and point 3, the SEC facilitated capital formation by solving the information asymmetry problem between the recipients of the capital (who unfortunately have the incentive to not be truthful) and the providers of it. Investor protection and capital formation, both of which are explicitly stated missions of the SEC, were simply the sides of the same coin.
Times have changed. Information asymmetry is still a problem today, but it is not the main problem. The main problem is that anything and everything has become “investing.” Even daily fantasy sports is promoted as such; we hear that the talk show hosts on the SiriusXM network have weaved in gambling “investments” to their conversations. FanDuel, of course, likened daily fantasy sports to investing back in 2015 when they were in hot water in the state of Illinois.
Finance today looks more like cigarettes and alcohol, catering to similar desires of pleasure. The most important disclosure then, is not a 100-page document that almost nobody will ever read, but is a disclosure that does not even exist yet: "this is not an investment product."
Here is the bottom line: if you like owning an NFT, that’s fine. If you believe the price will go up and you will make some quick dough, that’s fine, too. But if you think you are investing, you are simply wrong and that is exactly what makes somebody else rich at your expense. What gives you pleasure in the short term is not necessarily good for you in the long term, just like eating candy. How much time and effort do you think went into the naming of the MLB NFT platform, Candy? Fun? Check. Sweet? Check. Popular? Check. Addictive? Check. We think this is a slippery slope with real consequences.
Wither Cash Flows? You may or may not have heard of David Einhorn. Within financial circles, though, he is a celebrity. He was the most outspoken voice against Lehman Brothers; here is that story, as told by the New York Magazine. His earlier battle against Allied Capital is chronicled in a book Einhorn wrote himself: Fooling Some of the People All of the Time.
For a moment, let’s consider the alternative. Might the cycle never turn? Our strategy relies on the assumption that the equity value of a company equals the market’s best assessment of the current and future profits discounted at the company’s cost of capital. Our ability to outperform often comes from our skill in finding opportunities where the market has misestimated current or future profitability or miscalculated the cost of capital by over- or underestimating the risks.
Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss? It’s clear that a number of companies provide products and services to customers that come with a subsidy from equity holders. And yet, on a mark-to-market basis, the equity holders are doing just fine.
He called it, all right. This was before meme stocks and Musk tweets. Four years later, this alternative paradigm is even stronger and David Einhorn seems to be losing hope that the markets will come back to their senses. Below are a few more excerpts from a recent interview. These are the types of comments that belong to history books.
The discussion now isn't even necessarily about the viability of a business. There's not a lot of people doing financial analysis. There's just, 'Hey, people are going to buy the stock, and they're going to hold on for dear life.
Indeed. Benjamin Graham must be turning in his grave. His concern was that the investor’s analysis may not be ‘thorough.’ Now, it’s arguably worse, much worse. These days, it feels like the concern is not about the adjective, it’s about the noun itself. For, an analysis cannot be thorough if there is no analysis in the first place.
Companies can report stupendous news and have very, very minimal share-price reaction to it. It's not that the stocks are hated; there's nobody actually listening. There's nobody on the call, there's nobody performing analysis, there's nobody recommending the stock. There's nobody there to buy the stock.
Same theme. As David Einhorn eloquently explained in his investor letter that we cited above, investing used to be about cash flows, and if through thorough analysis, you could predict those cash flows better than others, you made a good return on your investment. Now, what matters more is whether Elon Musk tweets about you or the Reddit crowd likes you. There was always a beauty contest element to the stock market, but this is on another level.
There's a lot of things going on right now that I just put in the 'too hard' bucket. Crypto is too hard for the time being, at least for me. It's unregulated. It's unlimited. On the other hand, it has a real appeal. It kind of goes with the fraying of the social norms of the society. I don't have a strong view that it's an enormous waste or some phenomenal opportunity.
Well, we have strong views and there are nuances to them. First, we need to separate crypto from the underlying technology. Blockchain, in all likelihood, is a phenomenal opportunity. Second, let’s call a spade a spade; crypto coins are essentially a competition of 5,000 or 6,000 private forms of money, a competition that the government, more or less, decided not to interfere with. A charitable view could be that this is a better way of picking the digital currency of the future; that the market, rather than the government designing it, makes society better.
Of course, if that’s the goal, it would have been better to frame the narrative that way from the outset. Instead, people are sucked into the speculative frenzy, not realizing that they are simply speculating and not investing, and there is a real possibility that most of this paper “wealth” will vanish with the next economic crisis. As a result, crypto is a waste in the sense that it distracts real capital away from productive uses.
Underneath all of this lies a very real opportunity to educate people. Unfortunately, the market forces are more interested in teaching people how to trade crypto rather than teaching them what it is in the first place. We are taking a different approach with SportsCore®, the best way (dare we say the only way) to bring people and finance together.
Some people think, 'This is where we are right now, these are the kinds of things that you need to own, and they will go up and you should own them.' I have trouble with it because I don't really understand why they're good investments. Those people have done much better than I've done because they've owned things that should be owned right now.
As mentioned earlier, the whole point of investing is to raise capital for those who need it (offerings), let the providers of capital share in the collective success of the economy (investing in the stock market), and ensure that investors make informed decisions based on the proper information (securities regulation). As David Einhorn predicted, we seem to have given up on that compact, replacing it with an alternative paradigm where the entire market is reduced to a giant universe of like buttons. This is certainly a cause for concern.
There's an offchance that owning a share of stock still represents a proportional ownership in the cash flows and profits of the company. And on that offchance, I'm positioned to do very well if that proves to be the case.
Mr. Einhorn, we wish you the best of luck, and we genuinely hope that you do very well.
That said, that off chance will likely never come if we just sit around waiting, and hoping for the best. We have to create businesses that allow us to make that off-chance scenario a reality. If true investing is all about cash flows, which it is, we must Make Dividends Great Again™. That’s where AllSportsMarket will help.