What is the Worst Case Scenario for Alibaba? (Tech Strategy – Podcast 78)

This week’s podcast is about the current political risks around Alibaba. But also about the very important concept of Worst Case Scenario.

You can listen to this podcast here or at iTunesGoogle Podcasts and Himalaya.

Here is the Harvard Business Review case about Viva Macau.

Here is the book I mentioned, Dead Companies Walking by Scott Fearon.

Here are my 9 Questions.

Related podcasts and articles are:

From the Concept Library, concepts for this article are:

  • Worst Case Scenario (Question 9)

From the Company Library, companies for this article are:

  • Alibaba


I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.

This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.

——Transcription Below

Welcome welcome everybody. My name is Jeff Towson and this is Tech Strategy and the question for today What is the worst-case scenario for Alibaba? I mean, this has been the story of the last week for sure I mean big fine came down but really I mean this whole Alibaba Chinese government regulation anti-trust and financial Delayed IPO all of this and Jack Ma that whole thing a lot of this has been going on for you know, seven or eight months in various forms. And I think people are struggling with it, what to think about it. And one of the questions that’s been coming up a lot is, okay, is this an opportunity to invest? A lot of regulatory uncertainty, a lot of political actions. Is this an opportunity to get in to a very, very, almost uniquely high quality company? Or is the trajectory of the company fundamentally altered than what we understood it to be a year or two ago? At least from the political side. Well, that would mean something else. So anyways, I wanna talk about that today, how I see it, how I’ve been taking it apart. And also I wanna take apart this idea of worst case scenario, which is one of my sort of core nine questions when I take apart investments is what’s the worst case scenario? I spend a lot of time thinking about this and it’s actually not easy. It sounds easy. Oh, what’s the worst case scenario? It’s actually pretty hard to take it apart. So I’ll sort of talk about how I think about it, how I would apply it to Alibaba, but I’ll give you some frameworks that other people use, which are obviously much, much better than mine. These are sort of the Munger Buffett way of thinking about it from my impression. Okay, so that’ll be the topic for today. The main company we’re going to cover is Alibaba and the main concept is worst case scenario. So if you click on the company library you can always find this under Alibaba. If you click under the concept library you’ll see worst case scenario is kind of one of my main concepts. Now for those of you who are subscribers, I’ve sent you some articles this week on Juhu and I just sent one out about Sun Art Retail which is actually an Alibaba question. case as well. Sort of digging into those. I think they’re both interesting like from an investment perspective. I think they’re interesting. Definitely Sun Art was suggested by a subscriber. Thank you for that. That was tremendous recommendation. I really have been thinking about that one a lot since I started looking at. There’s a lot going on there that’s really interesting. I sent you a couple thousand words about that today. I’ll send you a couple thousand more in the next day. But anyway, some interesting stuff there. So anyway, Sun Art, Juhu, and more Sun Art on the way. And for those of you who aren’t subscribers, you can go over to jefftausen.com, sign up there, free 30 day trial, see what you think. Well, join the group. Okay, am I standard qualifier? Nothing in this podcast or in my writing or on my website is investment advice. The numbers and information by me and any guests may be incorrect. The views and opinions expressed may be incorrect or no longer relevant or accurate. Investing is risky. Overall, this is not investment advice. Do your own research. And with that, let’s get into the subject. Now, the latest news in a long series of news reports about Alibaba, which just came out, was that Alibaba might be looking to have Jack Ma exit his interest in Ant Financial. I mean, he is a major shareholder of Ant Financial. Well, actually they renamed it Ant Group. and he is controlling shareholder far beyond his actual percentage the way it’s structured he has 50 plus percent operational control so that’s that’s his thing right and then he’s got a major ownership well the rumor going out is there is some discussion about him divesting his ownership of that who knows if that’s true the more reliable bit of information came down last week which was a 2.7 billion 2.8 billion dollar us dollar fine on Alibaba as part of an antitrust investigation by the Chinese government. That one, interesting, I’ll talk about that one. Prior to this, we heard rumors a couple months ago that Alibaba was maybe going to be forced to divest its media assets. It has TUDO, has South China Morning Post actually. It’s hard to know what sits under what because there’s a lot of structures, but yeah, there are significant media assets there. And then prior to that, obviously, there was the issue of Ant Financial and Ant Groups IPO being delayed at the last minute. Yeah, so there’s been quite a few of these issues sort of rolling along. And I would look at this at two levels. And one, I think… is a lot of speculation and maybe just made up stuff. And that is sort of the high level. This is the Chinese government, putting big tech on notice. And this is them rolling them back. And oh, this is palace intrigue. This is Jack Ma said something that made that person angry and therefore the IPO got delayed and blah, blah, blah. That may be true. I have no idea if it’s true, and I don’t know anyone who knows if that’s true. And all this stuff that’s being reported in the press, those people don’t know if it’s true. There are probably some people who are in those back rooms who know, but I’ve yet to meet anyone who actually isn’t just sort of repeating what people are saying. So interesting, might be true, might be totally made up and bogus. I would take it down to the second level where I think you can get a handle on this. And that is okay. The Chinese government has been very, very active in the regulation of large tech companies for a long, long time. That’s true. Going back decades, you know, that they are engaging with big tech is not true for the first time is not true. We’ve seen this over and over and over. We’ve seen them halt the gaming licenses of 10 cent for years, which was really hit their stock price hard. We’ve seen them clean up the credit system. We’ve seen them get rid of Bitcoin trading. We’ve seen them get rid of online gambling. We’ve seen them roll back, basically clean up the P2P lending. Fiasco is the right word where you know hundreds of billions was rolled into PDP lending and they just basically closed all those companies So we’ve seen them very very active That’s nothing new The area where they have been active for a long long time. I mean, I always start with the question. Okay, what is their interest? Do they care and I would use the word the state because there’s a lot of different dimensions to this Let’s say the Chinese state. What do they care about and we know that they have an active interest Maybe because they’re concerns, maybe because they’re not just a regulator, but a player. Are they both referee and player, like they are in say, Telco? Okay, on the short list of stuff, they are the most concerned about credit has gotta be in the top three. And they’ve said this openly, like shadow banking, which is basically lending that happens outside of the state and traditional banking sectors of China. Back 2010, was 50% of all lending in China, and the government designated it as one of, if not the single largest systemic risk to the country was shadow banking. So if it’s credit and you’re doing anything, you are deep in the political weeds, the regulatory weeds. So that Ant Financial got rolled back on that one was not a surprise at all. In fact, the government had telegraphed quite openly that we don’t want companies issuing lots and lots of credit. if they’re not banks or they’re not acting like a banks, which was kind of what Ant Financial was doing is we process the loans, but we don’t hold them. We just take a technology service fee, but the loans are held by banks, not us. And the government has said for a long time, no, no, no, no, no. So we knew that was coming. It looks like Ant was trying to rush to IPO before that regulation hit. Everyone knew it was coming. I don’t know. That’s what I’ve heard. I kind of believe that. And then when they did halt them, the regulation they came out afterward, but says, look, if you’re going to issue credit, you have to have a 30% ownership of the loan. You have to basically be like a bank. Not a hundred percent, but at least 30%. Okay, fine. Reasonable. That’s one end of the spectrum. The other end of the spectrum would be e-commerce. What is the government’s interest in e-commerce? Not much. I think that’s the other end of the spectrum. They don’t, you’re selling soccer balls and people are buying sneakers and cans of Coke. I mean, there’s normal level of regulation, which is health and safety and things like that. But generally there’s not a major state interest in people buying, you know, smartphones and socks. I mean, it’s a pretty private market world. And most of the regulations have been fairly standard health and safety stuff, you see. However, one area would be, okay, Are the platform business models, Alibaba, JD, Penduto, is there an out of balance power relationship between them and small merchants? And that’s actually what the antitrust regulation spoke to because the answer to that question is clearly yes, that there is such a major power differential between a small business selling on Taobao and Taobao, that Taobao can basically say anything. Here’s our new rules, take it or leave it. that that dynamic on the supply side, not on the consumer side, but on the supply side was out of whack. And that was the regulation that came down pretty much. There’s other stuff, but that was a big part of what they talked about. And that struck me as pretty reasonable. That struck me as, yeah, that actually is a problem. And the regulation they hit, or the fine they hit them with, $2.7, $2.8 billion, struck me as kind of reasonable. It’s like they didn’t cripple them. They hit 8, 9% of their operating cash flow for the last year. So significant, it’s going to change behavior, but it didn’t hinder their development at all. It struck me as about the right level. They didn’t just give them a little slap on the wrist like when Facebook gets fined, which is a joke. It was significant, but it’s not going to hinder them. So anyways, I always thought, OK, that seemed reasonable. So, I mean, you can kind of play it out this way. And then in the middle of those two scenarios, major government involvement, minimal government involvement, you can look at media, okay? Yes, the Chinese state has always had a very significant interest in the control of information, which used to be viewed as a negative by most people. And now most countries are… pretty much adopting the same, some degree of the same posture. That it turns out control of information really does impact culture, society, politics. And so you see a lot of countries around the world starting to ask the question of, look, we’re the Indonesian government, we’re Indonesian newspapers, media. Why is what you can say in Indonesia as an Indonesian and what you can’t say being determined by six billionaires in Palo Alto? That doesn’t, this shapes our culture. It shapes our values. It definitely impacts our political system. That doesn’t seem right. And so you see a lot of countries pushing this sort of info-nationalism. People have been saying techno-nationalism. I don’t think that’s right. I think it’s control of information, culture, society, values, and politics is gonna be national level. And you see more and more countries doing that exact posture, which China kind of did it first. Australia just did it where they, you know, they basically told Facebook, you know, you, this is how you have to deal with our local newspapers from now on. And interesting, the US did it too. What was the US’s big problem with TikTok? That content decisions and data control decisions were being made by people in China and those decisions needed to be moved to Oracle, a US company. It was basically the same idea. We need certain level of information control and data control to be national and not by a group overseas. So it’s kind of the same argument. Anyways, you could put media in the middle there. Okay, so there’s a quick rundown on that and you can kind of think about it at a couple levels. But okay, what is the worst case going forward? If they mean this is overwhelmingly a political risk that we are assessing. We’re not assessing consumer risk. We’re not, you know, consumer behavior risk. We’re not assuming, you know, looking at technological risk. I mean, competitive risk, because Alibaba’s really strong on all of those. No, we are trying to assess political risk going forward and then asking, what is the worst case scenario here? Now I did a previous podcast called My Nine Investment Questions, which was podcast 75. And this is just sort of my process I go through. And the last question, question eight, question nine on the list is always what is the worst case? You work out the best case, you work out the base case, based on those scenario projections, you can put sort of valuations around them, and you work out the worst case. But most people spend sort of, okay, I’ll spend 30% of my time on each. I spend the vast majority of my time thinking about the worst case scenario. I’m heavily weighted that way. and trying to take that apart. And it’s not an easy question. I mean, what’s the worst case for a shopping mall? All these companies that were projecting shopping malls two years ago, three years ago, was COVID on their list of scenarios that they should have seen as a possibility and they should have priced that in. Well. You can keep thinking up worse and worse case scenarios and depending where you end up drawing the line, that’s gonna factor in what you’re willing to pay. Well, you can, if you assume too many worse case scenarios, you’ll never do anything. Or if you’re just too much, the price you want to get in will never be met. You’ll never do anything. If you had looked at shopping malls and stuff two years ago, and then you looked at now, you probably wouldn’t have priced them in, and you probably would have passed, but nobody factored those in. How bad is so bad that we should think about it? And typically what people do is when you ask them what is the worst case scenario, they look at the worst thing that has happened in an industry in the last eight or nine years. That seems to be about how far we remember. You know, that’s why a financial crisis is always a surprise to most people because they come along like every nine years and we only think about the last five to eight and then we get hit, oh it’s another one. But you know, there’s major events all the time. That seems to be what a lot of people do. If you think back over the last 50 years, what’s the worst case? So it’s kind of like, what’s the worst thing I know of that can happen? And then there’s this other question of what’s your unknown unknowns? What is the worst thing that could happen that’s never happened? So that would be your known unknowns. And then there’s your unknown unknowns. What is the worst thing that could happen that’s never happened that I’ve never thought of before? I mean, do you factor all of those in? Kind of makes it hard to say yes to anything, or at least at the right price. Now, when I talk, I have a class I teach called Worst Case Scenario. It’s one of my classes in investment class. And one of the people I brought in for years and years is an old friend of mine named Reg McDonald, Reginald McDonald. Super cool guy. Lives in Taiwan, very interesting. Engineer by background, fluent in Mandarin, fluent in Japanese, taught at the University of Tokyo. Morgan Stanley became a private equity guy. I mean, just rock star, really, getting really cool guy. And he was involved in a scenario in Macau in 2009, 2010, that has since become one of, if not the most popular. Harvard business case on emerging markets. Like it was number one for years and years. It is called Viva Macau. And I will put the link in the notes, but I’ll give you the basic story of what happened. And this case is basically about Reg. And this is him and a couple friends of his, colleagues. They started a private equity shop in Macau, 2005, 2006 range. And this was really the very opening of Macau. This was when the gambling monopoly was sort of broken up from one person to multiple licenses, multiple casinos got built, a ridiculous amount of money got invested. And Macau went from a very small gambling center to three to four times Las Vegas in 10 years, more or less. I mean, this was a super boom. And he was on the ground and he started like basically the first PE shop in Macau. And you couldn’t really buy companies back then because there was nothing to buy. So they started building companies, small companies, travel agency, online HR. If you take the ferry from Hong Kong into Macau, the video screens that you watch, welcome to Macau, which is basically advertising. That was them. I mean, they had a bunch of these businesses. Most of them were very, very cool. And then their crown jewel was a company airline called Viva Macau, which was a low-cost carrier that… could fly directly from the airport in Macau. And there is an airport right next to the strip. It’s just like Vegas, like you can fly into Vegas and you’re right next to the strip, like two blocks away. The same thing happens in Macau. There’s an airport right there. And they said, there was only two licenses. Actually, there was gonna be three private licenses given out by the Macau government. They got one of them for their group to start this low-cost carrier airline. And they were gonna fly into… you know, Tokyo, Singapore, Vietnam, basically everywhere that wasn’t mainland China because Air Macau, which is part of Air China, was doing those routes. So they were kind of doing these international routes direct into Macau that nobody was servicing. If you wanted to go to Macau, you had to fly into Hong Kong and then take the ferry and it’s pain. So they started this airline, Viva Macau. Incredibly, you know, well-run, top tier management, top tier safety ratings, you know, it’s like. hired people from Qantas and great team. And then unfortunately the timing was a problem because then basically the financial crisis hit, oil prices spiked, some infections, I mean they’re really horrific timing and they struggled and struggled, but then they basically fought through that for years and years and Reg was the guy who overseed it and ran the company. And they basically fought their way back. And I mean it was brutal. And 2010ish or April 2010, they’re getting ready to sell. And they’re, well, I mean, not sell, but bringing in investors and then go public or sell it. And Reg was basically saying, look, Wednesday, Thursday, he’s talking to major investors like Ryanair and big, big dollars. And they’re talking terms, this is on a Wednesday and Thursday, but a week later, he had to call them back and basically say, yeah, there’s no airline anymore. the airline’s gone. And the Harvard Business case is what happened in those five days, where it’s like, you know, we’ve got our airline, couple planes, not big, you know, lots of routes, lots of planes, and flying back and forth, you know, ready to sell, and then five, six days later, the company was basically just gone. And you can read the case, I’m not gonna go through it, but basically, more or less, what happened was there was some political issue, which is not clear who or what, but on a Friday afternoon, he got a random call sitting in his office basically saying, oh yeah, the fuel trucks won’t fill up our planes. And we’ve got a plane sitting on the tarmac waiting for fuel full of passengers to go to somewhere, and yet they won’t fill the planes, even though they prepay all the fuel. And he’s like, that’s crazy. We prepaid it. It’s a mistake. Don’t worry about it. We’ll take care of it. And then over the course of the day, then other things got happened. They started to be government press releases against them. And you know, somewhere around Sunday, they realized, look, I think someone’s trying to shut us down Friday to Sunday. And then Sunday, they got a fax and said, your air license is revoked, which had never happened to any airline in history. And so then Monday, and their bank accounts got closed, and people rioted and you know, Basically by Tuesday, Wednesday, the airline was just gone. Anyways, so my point is, I’m not gonna go through the whole story, but you should read the Harvard Business Case. I’ll put the link in the show notes. It’s a phenomenal story. But the takeaway is, did anyone see that as a possible worst case scenario? That a government, and it wasn’t really clear who did it, but some government at some level decided to sort of shut them down and did it. And if you factor that as a political risk, well, what do you do about that? How can you do anything then? And I like that story because it’s what I think about when I think about worst case. How far out of the box are you thinking on this? You spend years and years working and then five days, you’re like, yeah, it’s gone. Okay. And to be fair, I mean, we shouldn’t point this directly at let’s say a political risk emanating out of China, because there’s political risks everywhere. I mean, that could just as easily happen in South Africa, Saudi Arabia. You know, there’s a lot of places where, you know, the government and the private sector can be deeply intertwined. Happened in the US too. I mean, look at TikTok. When TikTok said, hey, we’re gonna expand to the US, we have a popular product that people love, we’re gonna invest a huge amount of money. They spent a crazy amount of money advertising in the U.S., mostly on Facebook, which is funny, in order to build that business. And then randomly, President Trump turns around and says, this is a national security threat and you have to sell. I mean, was that in their planning? Now, I mean, I think the sort of first question here is just to think about risk versus return, which, you know, there’s there’s some subtleties in there. I don’t think people necessarily talk about the most. that often. It’s like the idea of, okay, if you’re going to go after higher return ROI, then generally people chart that out as you’re going to have to take on greater risk. And when people chart risk versus return on a graph, it’s always a line that goes up to the right. Now the problem with that, of course, is everyone talks about return because you can put a number around it. 18%, 12%, 25%. Risk, it’s not clear what risk is. And If you can define it, you can’t put a number on it. I mean, there’s no way to actually measure risk. You know, what is the probability? I mean, to understand risk, you’d have to understand all possible outcomes, and you’d have to be able to look back in time and see all the outcomes. It’s just not doable. So everyone talks about return, and then risk tends to be kind of funny, or fuzzy, let’s say. And people, you know, it’s interesting to think about how People like Howard Marks, Seth Klarman, they talk about risk. Howard Marks, I believe the term he uses is permanent loss of capital. The standard is like, let’s talk about a volatility number, which I don’t buy that at all. So Howard Marks, who’s unbelievably smart, he says it’s a permanent loss of capital. In practice, and that’s kind of, let’s say, theory, in practice, risk is mostly about paying too high a price. And he kind of says, look, people are very good at calculating the amount of loss. They’re just not very good at projecting the probability of that scenario. Okay, because many futures are possible, but only one will occur, and to actually figure out the risk, you’d have to be able to chart out all the potential alternate futures. So that’s one way to think about it. I kind of like the Warren Buffett phrase, which is like permanent loss of purchasing power, which would be different than capital. I mean, permanent loss of capital. You invest 100, something changes. The thing you bought is only worth 80, and that’s not going to change. That’s a permanent decrease. There’s where you’ve lost 20 permanently. It’s not coming back up. I kind of like subbing in the word purchasing power instead of capital, because what is capital? view your capital versus the inflation in your economy and then against that you will have a certain amount of purchasing power and that’s really the number you care about. So you could argue investing is really about delaying current purchasing for future purchasing power, for greater future purchasing power, depending how much you want to get into the numbers. Anyway, so people talk about this. I kind of like Seth Klarman. Seth Klarman, the Baupost founder who’s wicked smart. His sort of take, which I’m paraphrasing badly, is everyone talks about returns, like, hey, we wanna make 21%, we wanna make 23%. And he says it’s madness to try and target any sort of return, you don’t know the future. And what people wanna do is they wanna have a certain amount of risk and then they wanna boost up your returns, he’s like, you’d almost be better doing the opposite, you’d almost be better saying, look, I’m just trying to make over 10%. and my goal is not to increase the 10%, it’s to reduce the risk of getting to the 10. So I’m not trying to get from 10 to 12 to 15 return on investment. I’m just trying to get to 10 and systematically decrease the risk to get there every way I can. So he’s almost playing the other side of the board. Now, when I think of worst case, I call it the four P’s. I’m basically gonna four P’s. I’m looking for the probability of permanent loss of purchasing power. So four piece, probability, permanent loss, purchasing power. Just because I find it easy to remember. Another person, Tom Barrick, incredibly successful real estate investor, Colony Capital. You know, he talks about sort of adverse systemic events when they think worst case. I’m paraphrasing what I’ve read they’ve said, but when worst case it’s about adverse systemic events, which makes sense if you’re doing real estate. you know, because you are kind of at the mercy of the system. You know, the real estate market’s going to go up or down together. Credit’s going to go up or down together. You know, your one building is pretty much just going to go up and down with everyone. So he’s looking for financial contractions, crises, a lack of credit availability, cyclical downturns, economy goes down, economy goes up. So it’s kind of OK, you could think about worst case scenario as adverse systemic event. That’s Tom Barrack. I think that’s a useful one to think about. You could think about company specific events, regulatory changes, concentrated regulatory exposure, changes in a large contract, license or patent, customer base that’s highly concentrated, a tech or business model disruption, unpredictable management, bad capital allocation, bad underwriting. This is kind of my own little list I run through. Next bucket, known and unknown unknowns. Okay, what are the things we don’t know about and what are the things we don’t even know we don’t know about? So what has not happened in the in the past 10 years that could be a known unknown? What things could happen that we’ve never seen or even thought of before? Howard Marks thing is like one of the biggest problems investors have is our worst-case scenario is never bad enough. We are just too overconfident. We’re too over optimistic. Usually in practice the worst case is the worst thing we’ve seen in the past. Okay, Thomas Russo, another one of my sort of favorite investors. When I read him, he mentions things about worst-case protection against inflation. He does a lot of CPG companies, ketchup, beer. And pricing power is important because inflation can be a big deal. So you want brands that are protected against inflation. Money in non-U.S. markets to think about currency devaluation. Interest rate changes. Exchange rate changes. Big deal if you’re operating internationally. The exchange rates can hit you pretty bad. Protection against bad management. This tends to be a problem with companies that are actually producing cash flow. You know, you often see bad management in companies that are very profitable because you can. You know, companies that are lean and mean because they’re in a really difficult market tend not to be, have a lot of behavioral problems because you can’t. But if you got the fourth son of the rich founder, you know, his great grandfather, Anheuser-Busch, and they’ve been living on cash flow forever, business is easy, well, that’s when they tend to start doing dumb stuff with their cash. The punch card test, which I’ve mentioned before, which is this idea of if you could only invest in 20 companies your whole life, would this be one of the 20? That’s a nice way to put a floor. Because oftentimes when you start thinking about problems, you just kind of gradually slide down. Well, there’s that problem, but that’s not that bad. Oh, and then there’s the regulatory risk. Okay, that’s a little bit worse, but I guess it’s okay. And then there’s some. You just kind of gradually keep sliding down and it’s hard to get to a point where you say, nope, that’s it, I’m walking away. The punch card test is kind of a way to force yourself to walk away when it’s in a gray area. It’s easy to say no to the terrible companies and it’s easy to say yes to the great ones, but it’s the muddy middle where it’s kind of, it’s hard to know when to walk. Say, ah, worst case scenario is too bad, I’m going to walk. I think the way Buffett does it, but this is a guess, is… He calls it Charlie Munger, the abominable no man. Where his joke, which I’m summarizing, he says, you know, I have an idea for a company I call Charlie. Charlie says, that’s the worst idea I’ve ever heard. Says, okay. Another company calls later. Charlie says, that’s a terrible idea. Okay. Calls again. Charlie says, oh, this new one with a new company. Charlie says, that’s really bad. That’s when he buys. It’s like when Charlie goes from that’s the worst idea I’ve ever had to that’s a terrible idea to that’s just bad That’s when he buys and Charlie’s role is to be the no man The person who says no and you know, he’s like a he’s like a floor So he just you know, his only interest in this is saying no and when his nose get weaker and weaker That’s about when you’re probably okay. So there’s often a lot of value in having a separate person You know Here’s the person who comes up with the idea. Here’s the partner whose only job is to kill the idea and to be the no person, the no man. That’s pretty useful to have sort of a structural solution. I like to think about, could I kill this company? That’s one of my nine questions, is I always think about competitive advantage, what’s the competitive strength and defensibility? You know I’m obviously obsessed with that question, especially when it relates to digital. And then, you know, I spend time trying to think, how could I hurt this company? How could I take 30% of their business? If I’m a well-run, well-funded competitor, could I take 30% of their business over three years? And I try and be the opposing party. And then if I can’t do it, I’m like, all right, maybe this one’s all right. Anyways, that’s a lot of sort of random people’s thinking on this question. I don’t know of any definitive answer to this. I think about it a lot and I try and piece together how I think other people think about it. and I write down their thinking in checklists. And I run, literally I run all of those checklists when I try to think about worst case scenario. I have my Munger list and my Russo list and my Klarman list of how I think they think about this. And I run those lists. But let me give you at least one more solid resource you can use. There’s a really good book, solid, great thinking book called Dead Company Walking, or Dead Companies Walking. I’ll put the link in the show notes. But this is a book that’s, you know, is written by an investor who is looking for good companies and along the way just realized, look, most businesses fail. The ones that survive are actually not that many and the ones that really do well and create wealth are even smaller. Says you’re kind of probably better studying the ones that fail. And, you know, his famous thing, which people, I think it came from him, but people say this all the time, is you look for frauds, fads, and failures. And most things are failures. Frauds are, hey, the person cheated you, fad, it’s like, ooh, we all really love the hula hoop this year. We all love oat bran. And then three years later, nobody cares. But the big bucket is failures. Look, the business just didn’t work. Or it worked for a while, and then it failed, and its competitors beat it, or it became obsolete technologically or something. But he just has lists of how to identify these companies, which he calls dead companies walking. And That’s a pretty good way to do it, and it’s a pretty comprehensive list. This is Scott Fearon, F-E-A-R-O-N, and I think he mostly does shorts now, as opposed to longs, but I’m not totally sure. Now, I’ll give you some of his, but there’s just big lists there. It’s a great book, definitely just, it’s pretty comprehensive, I think. So he says, you know, look for fads, look for frauds, look for failures, and this was kind of the issue with, you know, let’s say luck in coffee, which was a famous failure, and then it turned out to be a fraud. And the question was, was it a failure that then became a fraud? Was it like, look, the business is dying, we’re not surviving here, we have to bake the numbers? Or was it a fraud from day one? Oftentimes failures, you know, you get bad behavior when people are failing. I mean, he says, you know, look for… Biggest sign of a walking dead company, falling revenue and rising debt, which usually means, hey, they’re borrowing money to cover their operating expenses. Now that gets you into bankruptcy. He talks a lot about over optimism, especially by management. Most people think their businesses are better than they really are. Companies that have big growth ambitions, growth can kill you pretty easily. It’s also a good way to destroy capital. Management that looks like they’re gonna fail. I mean, really high quality management is quite rare. There’s a lot of solid management, but high quality, really good management is a pretty rare, intangible thing. It’s sort of a special sauce to make that work out. So bad management is all over the place. So he says, look for overconfident, overoptimistic management. management that relies too heavily on one specific formula for success, because often times those will change over time. Companies that misread don’t understand their customers or that they alienate their customers. New Yorkers are famous for this. Like New Yorkers, especially investment bankers, people that live in New York, you know, They go out to the rest of the country and they assume people in Omaha and Ohio are drinking the same beers and eating the same types of cookies they do. It turns out people in New York are kind of high brow and they’re kind of out of touch with a lot of customers sometimes. Last couple from him. Company falls victim to a mania. People get super excited about something. Ooh, bike sharing is going to be huge. Well, it wasn’t huge, but it was all right. failure to adapt to tectonic shifts in their industry, pagers got wiped out, blockbuster got wiped out. I mean, that’s kind of where I tend to live in this digital disruption bucket. Management that’s physically or emotionally removed from their company’s operations. This was kind of a red flag on Anheuser-Busch. I mean, Anheuser-Busch was sort of a famous company in that it was very, very successful. This is Budweiser, basically. And, you know. the third or fourth generation of the founder was running the place and he had all sorts of legal problems and I think he was running, they bought like a stadium and an airplane and they were doing all the classic bad management stuff and I think the manager, the CEO, was sort of a young guy, he decided he wanted to run the company from the football stadium and so the company was on one part of town and he was hanging out there. Like if you see a CEO that’s physically not in the building, like just stay away. Like that. It almost never works. Maybe, in case you could argue it works better now because of digital than in the past, but I still don’t buy it. Anyways, let me wrap this up, because I know I’m giving you sort of a lot of fuzzy, random ideas today, because it’s a fuzzy question. How do you assess the worst case scenario of a company? It’s not easy. I don’t know of any sort of real clear way to think. I just sort of compile everyone’s thinking and I put it in lists and that’s what I use. And now, what I do like about Alibaba to bring it back to the point, I’ll finish up. What I like about the Alibaba situation is this is clearly political risk only. The worst case scenario is a political question, regulation. It’s not tech, it’s not consumer, it’s not competition. They are really strong on all of those dimensions. It’s just assessing the regulatory and political risk. And when I take that one apart, I’ll give you my answer. When I take that apart, I break it into multiple buckets. I break it into, okay, the credit financial services bucket, the payment bucket, the media bucket, and the e-commerce bucket. And then I, okay, what is the government state interest in those? Clearly, credit is deeply political. That doesn’t mean it’s not profitable, it just means you have to, you know. You have to understand that world. And if you’re investing in that without understanding the political size and regulations of the financial services industry of China, you know, I don’t, I think you’re guessing. And I tend not to do that because that is a really complicated subject. I mean, you have to be a specialist in financial services, regulation in China to get your brain around. It’s really complicated. So credit, no idea. Payment. Payment is separate and the government has, as far as I can tell, said this multiple times, you need to separate payment, Alipay, from credit, consumer credit, supplier credit. I actually kind of like that because the payment side is not that complicated. You can figure out what percentage market share Alipay versus WeChat Pay will likely have. You can figure out the worst case there quite easily and they’re only taking 20, 30, 40 basis points per payment. So that’s already quite low. So you can actually figure out the worst case scenario on the payment aspect quite easily. And when you look at Ant Financial, the two biggest sources of their revenue are credit and payment. Okay, so I can’t figure out the first one. I can figure out the second one. We move to media, TUDO, things like that. Well, okay, let’s say there’s political risk there. What’s the worst case? Well, Tudow and video, these things are already losing tons of money. This is already a cash strain. Like when the sort of rumor report, this was a media report but I put it more as a rumor, that Alibaba was going to have to divest its media assets, I was like, oh, I think the stock price is going to go up. These things are cash drains. So I can figure out the worst case scenario there because we’re already in it. And then it comes down to e-commerce, which is the engine of everything. for this company. You know, it’s the biggest engine is e-commerce. Second to that is probably cloud and third is probably payment. And that’s in my world, that’s how I see the company. Okay, I can figure out cloud, I can figure out e-commerce, it doesn’t look very bad to me. Because I don’t think there’s inherently much politically going on in either of those. In fact, I think if anything, the political aspect probably helps them more than anything else. If you’re doing AliCloud, Google is not going to be allowed to sell web services in China in a major way. They’re not. It’s too sensitive politically. The political issue is mostly going to hit competitors, not Tencent, Alibaba, and Huawei and Baidu once again. That’s a nice barrier, if anything. So anyways, worst case scenario, I don’t want to put a number on it, but I think you can sort of get my feeling that I feel pretty good about it, generally speaking. you know, the credit bit, that would be the number I’d have to think about a lot. Not a lot, I’d have to work that number out. But the other one, I’m like, okay. Anyways, is that too vague for you? Yeah, I know this is a bit of a fuzzy talk. Anyways, that’s kind of the points for today. The takeaways, you know, worst case scenario, I think it’s super important. It’s one of my nine questions. You know, that’s one of the most important ones. It’s when I spend the most time around. I think generally people don’t spend a lot of time on, or not enough in my opinion, but I don’t know what everyone’s doing. And I think they tend to get spooked in this area when it becomes political risk, especially with regard to China, because it tends to seem so foreign. And my kind of advice on that is don’t be spooked by it. It’s not that complicated. It’s just a skill. You know, if you can figure out industry A versus industry B and then spend time and figure out industry C. you can figure out the sort of political regulatory system of China for things like e-commerce. It’s not that complicated. Now, if you go into something like financial services, okay, that’s a lot more complicated. But for the most part, don’t be spooked by it. Don’t overweight it. Don’t feel like you can’t figure it out because you can. It might take some time, but it’s no harder than anything else you take apart when you’re looking at a company, in my opinion. But I get that a lot from people in the West who kind of just, you know. don’t know how to think about it. And I think they get spooked. I think they really do get spooked by the political system that seems so different than their own. Anyways, that’s it for today. I hope that’s helpful. And I was sort of on Twitter the other day, and I kind of made the point, look, trying to avoid this stuff isn’t gonna work. It’s getting harder and harder every year to avoid digital China as a subject if you’re an investor in sort of the digital space. How can you avoid it? I mean, how many of the IPOs in the last couple of months, the major tech IPOs of the world were from this part of the world? Jingdong Logistics, Coupang, Quaishou. Now we’ve got ByteDance coming up. We’ve got Didi coming up. I mean, if you look at the major tech IPOs of the world in 2020, like half of them will come from China, Asia, and then half will be from the West. So the idea that you’re just gonna not do this because it seems a little spooky or cloudy or hard to get your brain around, especially the political aspects, I’d say you gotta let that go and you gotta sort of commit to digging into it over time. And if it’s hard to avoid this now, imagine what it’s gonna be in five years. I mean, imagine what it’s gonna be very soon in the future. How many of the world’s leading digital companies are coming from there? For those of you who… listen to Charlie Munger and Li Lu, who’ve been sort of in the press doing, well, not in the press, but they’ve had some lectures and talks in the last couple of weeks. I mean, I think it was Charlie Munger who basically said, look, the strongest companies in the world today are not in the US, they’re in China. That’s where the real strong companies are, the top top. And I think he kind of tipped his hat that he owns Alibaba. I wasn’t 100% sure, but that seems like, yeah, I think they own that now, but I’m not 100% sure on that one. So yeah. Avoiding it’s just not an option. Anyways, okay. I’ll leave it at that. Everyone have a great week. I’m hanging out in Bangkok. I’m hopefully gonna get on a flight in the near future. I’m just sort of waiting, ready to go back to the US. And yep, any day now I think. But yeah, it’s great. And I hope everyone’s doing well, especially if you’re in Bangkok with the sort of current spike in cases we’re all dealing with. Hope everyone’s staying safe. But otherwise, that’s it for me. And if you have any company suggestions, the ones I’ve gotten have been super helpful, super interesting, I really appreciate it. Please send it my way, that’s a great help. Otherwise, that’s it. Have a good week, talk to you next week. Bye bye.

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