Tuesday, April 15, 2014

I Want It Now: Oompa Loompa Investing

I Want It Now: Oompa Loompa Investing

In recent weeks, we’ve been treated to three examples of financial behavior that make no sense, except perhaps for the very short-term interests of the people making the investments.  The markets and the economy don’t reap any meaningful benefits and are left more vulnerable by these activities.

Let’s begin with bitcoin mining.  The computer program that creates bitcoins continues to spit out new currency, albeit at a diminishing pace.   It takes enormous computing power to mine for the coins.  As a result, miners have to incur huge costs for electricity to run and cool their computers.  Some miners have therefore located to Iceland, where they can use cheap electricity from hydropower and the natural cooling produced by placing their operation on glaciers.  It’s become the digital version of the California or Alaska gold rush.   Lately, these efforts have started to fail because the costs of searching for the illusive bitcoins outweigh the substantial amount of capital that goes into one of these mining operations.  Fewer and fewer speculators are finding nuggets.
New Kid On the Block (1998)
Next, there’s the hundred of millions of dollars that have been invested in fiber optic cable and tunnels to shave a couple of milliseconds from trading times.  Michael Lewis’s book, Flash Boys, is the latest attempt to document this behavior.  While those precious slivers of a second can mean huge profits to high frequency traders and lucrative contracts for companies that dig tunnels and manufacture fiber cable, there’s no real value to this exercise.  The high frequency traders are simply scraping away pennies that rightfully belong to other investors.

Finally, we have venture capitalists, hedge funds, and even mutual funds investing substantial amounts of money in companies that don’t need cash.  David Gelles and Michael J. De La Merced[1] document the growing practice of tech companies raising additional capital simply because it is available.  Apparently there’s so much money chasing deals that investors are willing to park their cash inside companies that have no immediate plans to use it.  Moreover, according to Messrs. Gelles and De La Merced, the frenzy has become so great that there’s no time to do proper due diligence, even though the investors are paying substantial premiums.   Traditionally, start-up companies were forced to run as leanly as possible.  Typically, they only received enough capital to get them from one critical milestone to the next one.  Venture capitalists used to tout the discipline created by spoon-feeding capital to newly emerging companies.  Not anymore.

This game will not end well.  The folks playing the game are betting that the public markets or strategic buyers will pay even higher prices for the companies.  Although a handful of these companies will undoubtedly prove attractive, many of them will fail when it becomes apparent that there isn’t a greater fool to prop up the valuations.  The private markets have become infected with the same disease that is afflicting the stock market: momentum investing.  There’s a certain irony to injecting unnecessary cash into private companies.  Many of the same investors who are clamoring to put their money into the latest start up are lambasting public companies like Apple for retaining too much cash in their businesses.

There’s a common thread that ties together bitcoins, high frequency trading, and pumping cash into growth companies.  We’re experiencing an epidemic of short-term thinking.  It reminds of lyrics from Willy Wonka and the Chocolate Factory:

I want today
I want tomorrow
I want to wear them like braids in my hair and I don't want to share them
I want a party with roomfuls of laughter
Ten thousand ton of ice cream
And if I don't get the things I am after
I'm going to scream!
I want the works,
I want the whole works!
Presents and prizes and sweets and surprises in all shapes and sizes,
And now!
Don't care how I want it now!
Don't care how I want it now! 

[1] http://dealbook.nytimes.com/2014/04/13/rich-start-ups-go-back-for-another-helping/

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