The Three Body Problem

I read The Three-Body Problem by Cixin Liu, originally written in Chinese and translated by Ken Liu.

And where do I start?

I think former President Obama nailed it with the blurb in the back of the book: “Wildly imaginative”. This is not a political endorsement or anything like that. I don’t put much weight on book blurb but these two words like I said, nailed it and should complete the post. The rest of is side dish.

Since I can’t use “wildly imaginative”, I found it eye opening. Surprising. Out there. Unusual.

Ken Liu did a excellent job translating it. Ken is also a legit accomplished sci-fi author himself. I’ve read acclaimed foreign work in the past and the translation can be clunky. I appreciated the English version of Metro 2033 (Russian), it felt that some of the original flow was lost in translation. I had the same feeling when I read bestseller Gomorrah by Roberto Saviano.

It was also very interesting to dive into Chinese culture and history. I had to google stuff about the cultural revolution to get fill in.

The book has been recommended in the past. And after seeing it on a few list, why not give it a shot. I was looking for something different and it delivered.

What is it about? Because this book is so out there (in a great way), I find it hard to talk about without ruining it. Or to even make sense. You just have to pick it up and go for the ride.

The Three-Body Problem is a complex work. It’s a blend of physics, science, astronomy, and technology with a dose a philosophy. Put all that stuff in the blender and you get a Hugo Award-winning.

This is the first book of a trilogy. I think it was setup that way because the first book doesn’t end. So I will need to read the second and third book. The body of work is over 1,200 pages. The trilogy have now sold more than nine million copies.

Netflix announced that Game of Thrones co-creators David Benioff will adapt Liu’s award-winning trilogy. I look forward to see how to adopt such a complex work. They already did a stellar job with the fantasy stuff, let’s see how they do with sci-fi.

The Three-Body Problem, the story of humanity’s first contact with an alien civilization inspired by @cixinliu’s renowned novel, will be adapted as a Netflix series from David Benioff, D.B. Weiss and Alexander Woo. pic.twitter.com/Dily05j2Vw

— NX (@NXOnNetflix) September 1, 2020

Chinese sci-fi certainly seems to be having its moment in the spotlight. It’s definitely attracting Western attention.

The Wandering Earth, a collection of shorts by Liu Cixin, was adopted as a movie. Apparently it was the third highest grossing film of 2019, behind only Marvel Studios and Disney’s “Endgame” and “Captain Marvel” and nobody noticed. $700m of that was in China, so maybe that’s why. The movie was on Netflix, so I checked it out with English subtitle. The special effects are on par with anything Hollywood produce. However the script, or the subtitle in my case, was pretty bad. It reminded me of some corny action movie from the 90s. So watch it for the graphic.

Worker Shortage, Inflation, Rates, Biden-Putin

Worker Shortage

Job openings soared to a record 9.3 million in April as the economy reopened but 3.5 million Americans are still on weekly jobless benefits and more than 9 million remain unemployed. The economy is still 7.6 million jobs short of pre-pandemic levels.

The numbers are very contradictory. This means the U.S. is experiencing high unemployment at the same time as a labor shortage. There are many reasons for the hiring scarcity like shifting employment choices, programs such as enhanced unemployment benefits, lingering COVID-19 worries, unqualified labor, and the need to raise wages. The last job report indicated that wages are rising. 

I didn’t look up the numbers for Canada but I’m sure we are in a similar situation. A quick tour around town shows a number of restaurants, small businesses that have restricted their hours, that aren’t serving lunch, or aren’t open at all because of the workforce shortage.

The solution is a set of policies to help train more people for in-demand jobs, remove barriers to work, and attract legal immigrants. Also we need new efforts to connect employers to undiscovered talent.

Inflation

Inflation is the big word on the block. I don’t need to remind you that prices are rising everywhere. The main question is will it stabilize, go higher, or go away? The answer to that will help determine the direction of interest rates.

There are different schools of thought on the topic of inflation. On one side, you have the Fed saying that inflation is “transitory”. The source of inflation is supply related. Solve the supply shock and you solve inflation. There is some truth to that. Take lumber prices, the symbol of inflation during the pandemic. It fell 14 of the last 16 trading days. It’s down 41% since its peak in May ($1,711 thousand board feet vs $1,009 yesterday). Copper prices are falling. The semiconductor shortage is getting fixed too. The only exception is oil. Oil continues to hold the line above $70/barrel. But oil was always it’s own different beast. Under Fed’s school of thought the inflation problem will solve itself once the supply shock is fixed. The market seems to have bought that narrative with the 10-year bond yield falling.

But that can’t just be it. It’s more than just supply chain bottlenecks. I think downplaying concerns about inflation is dangerous. Wages are increasing (see paragraph above), so this suggests that some of that “transitory” inflation is here to stay. The world central banks also flooded the market with cash with no indication of taking off the foot off the accelerator. 30%+ of the U.S. money supply was printed during the pandemic. The government is not reigning in spending any time soon. If history provides any indication, this will not end well, as an economic 101 textbook will tell you. What helps in this case is the U.S. is currently the world’s reserve currency. If it were to lose that status, to something like Bitcoin (I know outrageous thinking but cryptos are a thing), interest rates would increase and limit government borrowing.

Interest Rates

The Fed has a big meeting today and a policy announcement later in the afternoon. Nobody expects a change in rates (now at 0.0%-0.25%)  but the market will look for clues on when it will slow its aggressive asset purchase program ($120 billion/month). I think the market will really be looking at the set of economic projections mapping out forecasts for economic indicators like inflation and unemployment. The dot-plot chart shows expectations on when Fed officials expect interest rates to start rising. So far the economists consensus is around 2023-2024.

I find that hard to believe. Another 2-3 years of more gung-hoing? You telling me the economy can’t support a 0.25% raise in the next 2-3 years? With inflation gathering speed, a job market tightening, and the economy improving, I’m not sure what else policy makers need. Is this even responsible? Are they waiting for the market to overheat? If there’s overeating and rates start to spike, there will be enormous risks to an already fragile and over leveraged global economy. 

The key here is for Powell to communicate clearly and not make any surprises (2013 taper tantrum due to sudden policy change). Powell needs to give advance notice of when it plans to trim its asset purchases. Also the Fed need to be careful on trying to paint themselves in a corner with their inflation is only “transitory” position. They should soften their stand on that.

Biden-Putin Meeting

Joe Biden is the fifth President to meet Vladimir Putin (Clinton was the first).There’s already a history between both leaders. Biden was VP and former Chairman of the Senate Foreign Relations Committee. He knows what’s up. If this meeting helps defuse the tension between both countries, then good.

Republicans have attacked Biden for giving Putin an undeserved audience. I don’t know about that. Russia is a major power with influence. Biden knows exactly who’s meeting.They both called each other “killer”. So it’s not like Biden is bringing roses to a tea and cookie meeting (plus the tea might be poisoned). 

Politicians are hard to take seriously. It’s funny how the table changes when another party is in power. Where was the Republican criticism when Trump met Kim Jong-un without any conditions? Or Putin? I get it. They are playing political games. Democrats did the same thing (acting tough on Russia when Trump was in power).

Political games aside, there’s serious business on the table. It’s good that they meet face to face. I don’t expect much from the meeting. But if it can help defuse tension a bit, the better. The U.S. and Russia both have a lot to address (Ukraine, nuclear, cyberattacks, election meddling, Alexey Nalvany etc…). This is not a Hilary Clinton “reset” moment.

There’s no reset here. I think Biden will make it clear where the U.S. stands. If Russia wants to play cyberattack games, the U.S. can too. If the meeting ends with more stable relations and a roadmap to addressing major issues, then I would call that a good meeting.

The Cold War was what it was because of the almost non-existent communication between both powers. Both sides thought the other side wanted to blow them up.

The Big Four+

I wrote an update on the big four American banks by asset size (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo). I also looked at crypocurrencies, govcoin, regulations, fintech like Stripe and Square, and Power Corp.’s reorganization.

It’s published on Seeking Alpha and it’s probably available for free for a while. The first article is available here.

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Summary

• Banks had fantastic results. The question is what follows?
• The pandemic hasn’t made the banks weaker; it’s made them stronger.
• The health of the banking system is akin to taking a blood sample of the economy.
• Banks have deposit problems. They have too much cash and are not making enough loans.
• Regulatory relief expected as banks are flush with capital. Buybacks and dividend raises are expected to follow successful Fed stress tests.

This is the opening of a front-page article in the WSJ on U.S. banks: “Everyone is clamoring for a piece of U.S. banks.” This is quite the sentiment change from my last article on the big four U.S. banks back in October 2020; nobody wanted a piece of them. But in stock market age, that was a really long time ago. At the time bank results and stocks were getting hammered. The mood was grim. Yet seven months later the banks are still standing and look better than ever. The bank stocks on track for what could be their best year on record compared with the S&P 500. The S&P Bank ETF (KBE) is now trading at about twice their pandemic lows and has risen 30.3% year to date, outpacing the 12.6% gain in the S&P 500. Despite the strong push, the banks remain cheap when compared to the rest of the market. Banks trade at around 13x their expected 2022 earnings, while the S&P 500 trades at more than 22x.

Banks’ Q1-2021 results have come and gone. I wanted to take the time to digest the results. With the backdrop of an improving US economy and strong results, the shares of JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC) have rallied higher since my October 2020 article.

Today I wanted to provide an update and insights on the big four, the banking industry, Credit Suisse (NYSE:CS), regulations, fintech, and crypto.

I don’t track quarterly earnings like a hawk. But I particularly pay attention to bank results. They give you insights into the economy. They are alternative data. Just like Walmart and Home Depot gives you an idea of the health of consumer spending and the housing market. Bank results are like taking a blood sample of the economy. If the banks are not doing well, or worse they fail, it can have massive repercussions on the economy, like we have seen with the financial crisis of 2008-2009.

Thanks to heavy monetary fiscal stimulus, the doomsday scenario didn’t play out, at least at the moment of writing this. Bank results came in better than expected and are healthy.

Who would have thought that a year ago when we were wondering how bad the pandemic fallout will be? Who would have thought to bet on banks? The question is what follows? Investors are waiting to see how the banks will fare long term, as reserve releases are a temporary phenomenon.

But first, let’s resume how we got here?

The pandemic forced central banks in many nations to lower interest rates to rock bottom level.

Savers were not the only ones affected. In practice, interest rates on deposits cannot be lowered much beyond zero (negative rates may lead to withdrawal of deposits). Low interest rates reduce the interest spread (bank margins), the difference between the rate banks pay their creditors (deposits) and the rate they charge their customers (loans).

Because of the low interest rates environment, banks have been making their profit outside traditional credit and savings operations. They have focused on trading fees, asset management, and their capital market arms. When markets are chaotic, traders can still turn big profits. When the economy is flailing, investment bankers can help nervous companies raise cash or sell themselves. Deal-making activity has been strong, thanks to SPACs and a rich IPO market. Banks earn money on both sides of the SPAC equation—underwriting the IPOs and advising on the mergers. Capital markets activity has been a source of strength for banks throughout the crisis, helping them offset declines in revenue from core banking functions such as making loans.

You can read the full article on Seeking Alpha.

Another Discovery Post (with some numbers)

Another Discovery post. The more I write about Discovery, the more the price goes down (DISCA). So this is the last Discovery post for a while. Here are the previous posts if you are catching up Part I, II, III, IV). I started looking at DISCA after the Archegos fiasco and the merger with AT&T added content to cover.

Update since the last post: We have a name! The new company will be called Warner Bros. Discovery. This is playing it safe. Warner Bros. has a rich legacy and is culturaly entrenched. I also wonder if, strategically speaking, that going with Warner Bros instead of WarnerMedia is a way to rewind the AT&T chapter. But that’s just me overthinking.

We have a setup for Warner Bros. Discovery as the next big scale player in entertainment. Direct-to-consumer (DTC) is a content arms race, and scale is most necessary. More content leads to stronger engagement, which reduces churn, creates pricing power and drives margins. This is the playbook of Netflix and Disney. Warner Bros. Discovery. will be a top 3DTC player. Amazon is also a big player getting bigger but their strategy is different, that is expanding their prime business.

Why is the stock down? There’s a lot to digest in this massive merger. I think the merger announcement, the complexity of the deal, the different class of shares and AT&T’s bungling of their media assets leads to investors being turned off. The deal will only be consumed sometime next year, so it’s far away for an investor timeframe. The merger is a tough sell. There’s a lot of debt involved. You might also have Discovery’s investors being skeptical on taking on a massive media empire of scripted TV and movies. Discovery’s bread and butter is reality TV. Cheap to produce and addictive. Now you are alternating the DNA of the business. Basically, there’s a lot of uncertainties and it will take a couple years for results. So investors are not warm and are out.

I’m also trying to work out the numbers. If you can’t work out the numbers, how are financial analysts supposed to model out? If they can’t model out, they don’t have visibility on the outlook of the business. If you don’t have visibility on the business, you sell. That’s how the business works. They like that word a lot: ”Earning or revenue visibility.”

The numbers don’t seem to be good for AT&T, well for the shareholders. The only good part for AT&T is that they are getting out.

I said many times in the past, I don’t get AT&T. AT&T kept saying how great this Time Warner deal was everytime they had a chance and now they are celebrating the exit. I don’t get them. I also don’t get that 2-3 years after the merger they realized tha they don’t have the money for both their connectivity business and the media business.

AT&T Total Purchase Price (Enterprise Value) of Time Warner in 2018: $102b ($79b of cash and stocks + $23b of Time Warner debt.) That’s according to its 10K. The media are poor at explaining. They keep reporting $80b-$85b, that’s for the equity and they ignore debt. The real number is $102b.Merger (technically not a sale) involving something called a Reverse Morris Trust. Details of which haven’t been announced.

There are two part.

1. AT&T gets $41.5b cash and Discovery assumes $1.5b of AT&T debt
2. 71% of NewCo. The shareholders are getting the stock. Not AT&T.

• Estimated 2023 revenues: $52b (39b at closing)
• Estimated 2023 adjusted EBITDA: $14b ($12b at closing)
• FCF (60% conversation rate estimated): $8.4 b
• Debt: $55b
• Leverage 5x at closing. 24 months after closing 3x. Long-term leverage target 2.5x-3x.
• Content spending: $20b (They already spend today close to $20 billion per year on content)
• The company is planning to reinvest the $3+ billion of expected run-rate cost savings into content, which could bring the total content spend to $23 billion.
• Expected Synergies: $3b

These numbers are questionable. There`s no way of really knowing. They are built on questionable assumptions, like the expected synergies. Deleverage is another. The market seems to be worried that leverage will reduce the company’s flexibility in terms of content spend.

Streaming subscriptions: David Zaslav said anything between 200m and 400m. It just sounded like something he pulled out of the air. No timeframe given. Not sure how it is based on. We know Discovery+ has 15m, and no clue regarding HBO Max (44m but those are mostly just HBO). So we can assume he expects at least 10x the current number.

What’s that 71% worth? There’s a lot of number shuffling here. Well let’s work with these loose estimations. Discovery is trading at 9.1x EBITDA. ViacomCBS at 7.8x, Comcast at 11x, Netflix 40x. But let’s work with 9x. The implied Enterprise Value is $126b. Remove $55b of debt and you have $71m of equity left. 71% of that is $50b. So $43+$50=$93b. That’s less than the $102b they paid for. Of course I’m ignoring the money they took out and the value of their stake will fluctuate. But because AT&T shareholders are getting NewCo shares, is it right to think that AT&T is getting a lot less, like $60b less than what they paid for? Am I getting this right?

The transaction is anticipated to close in mid-2022, so these numbers are highly subjectives.

Despite being down at the moment, once the chips fall in their places I think this company will do fall. In a sense, the lower it is the better the opportunity. Streaming is all about acquiring users, and then retaining them. You retain them with the best content. The stuff people want to see. And that’s the company’s strenght.