Important lessons on investing that I learned

Over the weekend, I reviewed my portfolio and by extension, my performance as the CIO of my personal hedge fund (lol). I want to see how I have fared so far and importantly, if there is a lesson or two to take away going into the remaining four months of the year and 2022, what would that or they be?

In the first half of 2021, ending 30th June 2021, my portfolio’s return is 8.5%, compared to the return of 15.3% of the S&P 500, including dividends. Last year, Minh Duong Capital’s 2020 return was 21.3%, compared to S&P 500’s return of 18.4%. What does it mean? Obviously, I underperformed the market in the first 6 months this year, a fact that is particularly disappointing given that I outperformed the index last year. In other words, I overestimated my stock-picking power this year. Frankly, I didn’t do a good enough job. Instead of spending a lot of time looking at new ideas, I should have just bought the S&P 500.

That’s actually one of the big two lessons I learned: buy more ETF stocks. Take S&P 500 ETF ($SPY) and Vanguard Total Stock Market ETF ($VTI) as examples. In the last 10 years, they have an annualized return of 13.9% and 15.2% respectively. The beauty here is that investors don’t need to spend any time researching and regularly checking their portfolio. The ETFs just routinely deliver two-digit returns every year with minimal efforts or financial understanding of the companies.

At the moment, ETFs make up only 2% of my portfolio. I do plan to increase the ratio significantly in the next few months and next year. Don’t get me wrong. I still enjoy researching companies and finding winners which I believe will bring higher returns than that of the ETFs. But at the same time, I want to make sure that I at least have the same return as the market. You know, being realistic and all that. Does buying ETFs sound simple and easy? Yes, but it’s not in reality. Nowadays, it only takes a few phone taps to trade for a stock. When the barriers are that low and when you are tempted to prove that you are a better investor than just somebody buying an ETF, the illusion kicks in and the temptation is highly irresistible. Nonetheless, that’s what I plan to do in the near future. Buy more index and wait for only great opportunities.

That’s one lesson. What’s the other one that I learned?

In addition to stock picking and investing in ETFs, one can leverage the expertise of hedge funds. These guys get paid in the form of 2/20 (2% management fees and 20% of your profit) with an implicit promise to outperform the market. In other words, they are EXPECTED to deliver higher returns than what investors would get from the likes of S&P 500 or VTI. Here are the returns of a few funds in the first half of 2021:

Among this small sample, my personal return this year is higher than some funds’ and lower than others’. Of course, there are more funds spread out across the spectrum. The question, though, is how should I think about my performance in comparison with these funds? Well, not so much. Such a comparison is a slippery slope. If I want to make myself feel better, I only need to identify a few underperforming firms. On the other hand, it’s just unrealistic to think that I can beat the professionals whose full-time job is to find investing ideas and whose experience & resources far outweigh mine. The goalposts should stay constant, not move based on how I want to feel. In fact, Morgan Housel said: one of the most difficult skills in investing is to not constantly move the goalposts.

Hence, I decided to judge myself based on two things: did I avoid making the same mistakes twice? Am I delivering a higher return than ETFs? If the answer to both questions is yes, every time I conduct a review, then I will be a happy person. Otherwise, there is work to do.

Weekly reading – 28th August 2021

What I wrote last week

My review of three books: 1/ Stray reflections; 2/ An ugly truth and 3/ Obviously awesome

Business

Facebook says post that cast doubt on covid-19 vaccine was most popular on the platform from January through March. The fact that this article was published on a Saturday means that Facebook doesn’t want too many people to see it. I honestly can see the bull case for Facebook. However, it will be remiss to not mention the monumental challenge of content moderation that the company has to face. Because when false information runs rampage on its platforms, it may affect the engagement of users; which in turn can adversely affect advertising that is Facebook’s bread and butter.

Why You Can’t Find Everything You Want at Grocery Stores. Retailers are suffering from supply shortages; which is exacerbated by higher-than-expected demand. But if these hiccups are overcome, it means that there will be a growing retail segment in the coming months and by extension, likely, a healthy economy.

Diem: A Dream Deferred? Facebook has a lot going to their advantage: almost limitless resources, four of the most popular social networks in the world, 1/3 of the global population are its users, a money printing machine that is growing at a scary clip. But there are a couple of challenges that Facebook will have a hard time to overcome. First, it’s content moderation. Should I say: content moderation without pissing off anybody. As you can see, the task sounds almost impossible. When you moderate content by people with vastly different ideologies, you are almost certain to upset somebody. Facebook doesn’t have the luxury of having upset users or lawmakers. Hence, it’s not a problem that Facebook will easily solve. Second, public trust. The company has been around for almost 20 years and it has not garnered a lot of trust. As long as it continues to rely on advertising, capturing data and more importantly be embroiled in misinformation, the public trust will likely continue to evade them. As the article from Coindesk pointed out, trust is paramount in the payments/finance world. How on Earth would Facebook succeed in it?

The Digital Payment Giant That Adds Up. Merchants are going down the omni-channel route that allows shoppers to shop in multiple ways. This will be the key to Adyen’s growth. I like the fact that they prefer building in-house and maintaining the one-ness of their platform to acquiring capabilities from other companies through M&A and bundling different tech stacks into one. Working at a company that suffers from systems not talking to each other, I know first-hand how that could become a significant problem in no time. In addition, I really look forward to Adyen coming to the U.S with a banking license. I am not sure the folks at Marqeta share my enthusiasm.

Buying a bank turned LendingClub around. Now the fintech industry is watching. It requires a lot of work and preparation to get a banking license. The benefits of owning a charter; however, include less dependency and more control over your own fate, margin and operations.

What I found interesting

Inside Afghanistan’s cryptocurrency underground as the country plunges into turmoil. One can argue that cryptocurrency can be a savior in crises like what is going on in Afghanistan. The thing is that if something requires there to be a crisis to drive adoption, I am not sure that something is as good or revolutionary as some may think.

An immense mystery older than Stonehenge. It’s profoundly impressive to me that prehistoric people could transport stones that weighed tons to the top of a hill 6000 years ago. Think about that for a second. They must not have had all the tools that we came up with up hundreds of years later. It’s just extraordinary. If I ever have enough money and time, Gobekli Tepe, Machu Picchu, Egypt and Greece are where I wish to go.

Bigger vehicles are directly resulting in more deaths of people walking. Take a trip to Europe and you’ll see how absurdly big vehicles in the U.S are compared to those in Europe. And the implications aren’t necessarily positive. I’d argue that it’s considerably better to have smaller vehicles or fewer vehicles on the roads.

European Sleeper Trains Make a Comeback. I really wish that Americans would share the same enthusiasm about travelling by train as Europeans do. Personally, I enjoyed the train ride from Chicago to Omaha. If there were a reliable Wifi, I’d take trains every single time over flights and especially driving.

Apparently, there is a 2021 Global Crypto Adoption Index and Vietnam is ranked as #1. Below are the two reasons that experts say are why Vietnam’s adoption is so high. I am not sure how I should feel about it. On one hand, this index is not negative in nature. Hence, the #1 ranking certainly feels good. On the other hand, the alleged reason that young people don’t know what to do with ETF is alarming. That implies a lack of understanding in investing and a tendency to gamble in cryptocurrencies.

“We heard from experts that people in Vietnam have a history of gambling, and the young, tech-savvy people don’t have much to do with their funds in terms of investing in a traditional ETF, both of which drive crypto adoption,”

Source: CNBC

Stats that may interest you

In 2019, 70% of music in Japan was consumed via CDs

eCommerce made up 13.3% of total retail sales in the U.S in the 2nd quarter of 2021, indicating that the Covid effect has tapered off

46% of retail BNPL shoppers didn’t use their credit cards because they wanted to avoid high interest rates

The U.S online lottery ticket market will reach $2.3 billion by the end of 2021, a 25% YoY growth

Book Review – Obviously Awesome – An Ugly Truth: Inside Facebook’s Battle for Domination – Stray Reflections

In this post, I’ll briefly review the three books I finished recently. Let me know in the comment if you read any of them and what you think about it.

An Ugly Truth: Inside Facebook’s Battle for Domination

Written by two award-winning New York Times journalists Sheera Frenkel and Cecilia Kang, An Ugly Truth covers Facebook’s battle with misinformation and how the company, in my opinion, has failed so far in preventing bad actors from abusing Facebook’s platforms for their agendas. The book draws from hundreds of interviews with sources, including former & current employees who courageously put their career in danger to speak the truth, and takes readers inside the company and throughout the past few years when the conflicting interests came to their heads. Facebook has perfect recipes for a disaster.

The company’s purpose is to connect everybody on Earth. It means that you’ll connect not only the good guys, but also the bad guys. To Facebook, the engagement level is always one of the high priorities. The more engaged users are, the more money the company can make from advertising. As a consequence, any idea or initiative, no matter how constructive or beneficial to the company, would be shelved if it was considered hurting the user engagement. Additionally, the company is Mark Zuckerberg’s, plain and simple. He can fire the Board of Directors if he wants to and there is nothing anybody can do about it. At first, Mark didn’t seem to believe that his creation could be leveraged for harmful purposes. He seemed to actually believe that Facebook was a positive contributor to the world in a sense that since everyone should have the freedom of expression, his platforms were there to facilitate it. It is this belief that led to some of his controversial decisions when it came to content moderation. Last but not least, the bureaucracy and office politics at Facebook also played a role in this mess. Take Stamos and his threat intel team as an example. Alex Stamos was hired by Facebook to be its Chief Security Officer. Along with his team, Stamos unearthed how Russia misused Facebook to interfere in the U.S election. They tried to sound the alarm for months, but their efforts were thwarted and ignored by the upper management team. When they finally got a meeting with Mark and Sheryl, Stamos suddenly became the culprit and scapegoat.

Combine all of those factors together and you can see why Facebook was always poised for a disaster. There are other stories in the book that could highlight how efforts to rein in misinformation always took a back seat at Facebook for various reasons. While the theme of the book may not be anything new, the behind-the-scenes stories are riveting and interesting. If you want an easy read and like to learn about the inner workings at Facebook, this should be a good one to pick up.

Obviously Awesome: How to Nail Product Positioning so Customers Get It, Buy It, Love It

Product positioning is hard. It’s virtually impossible to create a completely new product or service without any direct or indirect alternatives. The challenge then becomes: how can you position your product so that your customers know what it stands for, among all the noises and distractions? In this book, positioning expert April Dunford offers 10 concrete steps to address your positioning problems, along with specific case studies to make her points. As a business student at bachelor and Master’s degree level, I learned about marketing and positioning. So, some of the points April made are not novel to me. Yet, it’s still interesting to look at positioning from her point of view and it’s great to brush upon what I learned in the past. Personally speaking, I think this book is more suitable for B2B products/services than B2C.

Her writing is easy to understand and doesn’t involve a lot of jargon. It’s quite witty in some parts; which makes the experience more enjoyable. I kinda like the book. You can learn quite a lot from a $7 book (the Kindle version), a cost-effective option compared to hundreds of dollars spent on a few credits in college.

Stray Reflections

Jawad Mian hails from Pakistan and is the founder of Stray Reflections, a macro research firm. Two of his obsessions are writing and finding truth in life; which are the inspiration for this book. In it, Jawad shares with readers some of his intimate personal experiences, from growing up in Pakistan to adulthood and fatherhood, as well as important lessons about life that he picked up along the way. In addition to his stories, the author puts to great use some excerpts from classic literature by historical figures. In a busy society full of angst and distractions, this small book helps readers pause, catch their breath and reflect on what matters in life. Reading it was invigorating and refreshing for my soul.

“No distance of place or lapse of time can lessen the friendship of those who are thoroughly persuaded of each other’s worth.”

I’ve grown up to believe there are no coincidences in life. We are always in the right place, and everything happens at exactly the right time. Instead of obsessing about our goals or destination, maybe we should remain in the present moment and just let the universe move about. Like the river, life has its own flow; we cannot impose our own structure on it. We can’t control it—all we can do is listen to its current. Sometimes, when the outside noise dulls down, the quietness within reveals a lot, but only if you listen intently.

I beg you, to have patience with everything unresolved in your heart. Try to love the questions themselves as if they were locked rooms or books written in a foreign language. Don’t search for the answers, which could not be given to you now, because you would not be able to live them. And the point is to live everything. Live the questions now. Perhaps then, someday far in the future, you will gradually, without even noticing it, live your way into the answer.

Life is a journey, and we are all just travelers. It’s okay to fall down or not know where you’re going. Nature has marked out a path for each of us, and it won’t let us stray too far from our course. There is no shame in falling, only in failing to rise and get back up on our feet. As Paulo Coelho said, the secret of life is to fall seven times and to get up eight times. Even success, it has been well said, is nothing more than moving from one failure to the next with undiminished enthusiasm.

Weekly reading – 21st August 2021

What I wrote last week

I came across a couple of posts from Afghanistan veterans on their experience there

My notes from the 2021 Debit Issuer Study

My thoughts on recent developments from PayPal

Business

Inside HBO Max’s Scramble to Fix Its Glitchy App. In the streaming world, the user experience is critical in keeping customers engaged and the churn down. HBO Max fumbled the ball terribly with their confusing brands, products and messaging in the beginning. I don’t think I am a dumbass, but I didn’t even know the difference between HBO, HBO Max or HBO Now. Then, they out together an app that was littered with bugs as summarized in the article. The reason, as reported, is that they merged the two legacy apps that were built for different purposes. One was built to offer ad-free content while the other featured commercials. It is not a surprise that bugs happened. What is a surprise is that an institution like HBO or Warner Media let it happen in the first place.

Amazon Plans to Open Large Retail Locations Akin to Department Stores. This move may be Amazon’s attempt to copy what other retailers like Target do. They fulfill online orders from their network of stores. It takes a lot of stores to cover the country and logistics management to figure out the inventory and the actual shipping. We’ll see.

Walmart’s e-commerce business is set to hit $75B in sales this year

Paying With a Credit Card? That’s Going to Cost You. If this trend is legit and merchants continue with the surcharge (which is not an uncommon practice in Vietnam), it and the growing popularity of BNPL will have adverse effect on credit card spend. Remember: BNPL is mostly funded through debit cards

How the Apple lobbying machine took on Georgia, and won. Apple is my largest position. However, I found the whole lobbying issue troubling. It’s nothing different from companies writing bills and lawmakers enacting such bills.

What I found interesting

‘Likes’ and ‘shares’ teach people to express more outrage online

China Passes One of the World’s Strictest Data-Privacy Laws

Another excellent post by Morgan Housel. In light of what happened in Afghanistan today, I can’t help but think about what small events in the past could have prevented this war in the beginning and what would happen to the people of Afghanistan in the future after the U.S pulled out

One is to base your predictions on how people behave vs. specific events. Predicting what the world will look like in, say, 2050, is just impossible. But predicting that people will still respond to greed, fear, opportunity, exploitation, risk, uncertainty, tribal affiliations and social persuasion in the same way is a bet I’d take.

Another – made so starkly in the last year and a half – is that no matter what the world looks like today, and what seems obvious today, everything can change tomorrow because of some tiny accident no one’s thinking about. Events, like money, compound. And the central feature of compounding is that it’s never intuitive how big something can grow from a small beginning.

Source: Collaborative Fund

Stats that may interest you

50% of surveyed Americans have no problem with false information online

Target’s Circle Rewards Program reaches 100 million subscribers

PayPal made strides towards being a Super App

PayPal amplified its efforts to become THE Super App for consumers’ financial needs with several big announcements in the past few days.

  • Giant Eagle enables PayPal and Venmo at all of its 474 stores. This is the first grocery chain in the country that accepts PayPal and Venmo at checkout. To complete an in-store order, users can simply open their PayPal or Venmo app and have the QR code shown in the app scanned by the store cashier. As an incentive to promote the adoption of this feature, PayPal will send $10 in cash back to anyone after they make the first purchase of at least $40 at Giant Eagle
  • ACI Worldwide partners with PayPal to bring mobile wallet options to ACI’s bill clients. ACI Worldwide is a leading company in real-time digital payments with numerous clients in various industries such as consumer finance, government, education, healthcare, insurance, telephone and cable, and utilities. By virtue of the new collaboration, bill payers can now make payments on ACI’s client platforms through their PayPal or Venmo wallet
  • Yesterday, Fiserv announced a new feature that enables business-to-consumer payments deposited to PayPal or Venmo accounts. PayPal or Venmo users will be able receive payments from gig economy companies, insurance firms or tax refunds from the federal governments to their PayPal or Venmo account
  • Last but definitely not least, starting October 1, 2021, the company is going to drop late fees for BNPL customers globally.

PayPal is one of a few companies that are known globally. Anyone that regularly shops online must be familiar with their iconic blue button on online merchants’ checkout page. Strong in processing online payments, PayPal; however, hasn’t been as popular with in-store checkout. Personally, I rarely see a store that accepts PayPal as a payment option. The company is well aware of that weakness and planning to address it. In the very last earnings call, the CEO mentioned that they were going to aggressively go into stores. The partnership with Giant Eagle is proof of that. Even though there are only 474 stores in the chain, this is a great first step. I imagine that PayPal will try to use data acquired from this partnership to demonstrate to prospect partners the benefits of allowing PayPal products at checkout. Plus, grocery is a staple category to consumers. If they are accustomed to checking out with PayPal/Venmo, they will be more likely to use it for other purchases as well.

PayPal has been growing its bill payment service for a while. In the previous earning call, the company cited growing bill payment volume as one of the reasons for its decreasing take-rate. The partnership with ACI Worldwide will likely grow the processing volume yet suppress that take-rate further for the foreseeable future. ACI Worldwide supports around 4,000 customers in the US and according to one study, Americans spends $2.75 trillion a year on recurring bills. Even if this move helps PayPal gain 1% of that volume, that’s another $27.5 billion a year added to the company’s U.S bill payment volume. Given that it processes $350+ billion in a quarter WORLDWIDE for ALL services, I suspect that’s the lift the management will be pleased with. I really like this partnership with ACI. Instead of going out there and going through hoops to work with numerous companies, PayPal can now be available on 4,000 checkout pages in a short amount of time. Bill payments are such a critical function in most adults’ life. Convincing consumers to use PayPal/Venmo to pay bills will create a usage habit that is difficult to break.

Here is PayPal from its 2020 annual report:

Transaction expense is primarily composed of the costs we incur to accept a customer’s funding source of payment. These costs include fees paid to payment processors and other financial institutions to draw funds from a customer’s credit or debit card, bank account, or other funding source they have stored in their digital wallet. Transaction expense also includes fees paid to disbursement partners to enable a transaction. We refer to the allocation of funding sources used by our consumers as our “funding mix.” The cost of funding a transaction with a credit or debit card is generally higher than the cost of funding a transaction from a bank or through internal sources such as a PayPal or Venmo account balance or PayPal Credit.

Hence, the more transactions are funded through bank accounts or PayPal balance, the better it is financially for PayPal. Asking consumers to transfer funds from a checking account to a PayPal/Venmo before making a purchase using that balance is futile. It’s inconvenient and cumbersome. The collaboration with Fiserv helps PayPal go around that challenge. Additionally, having a balance motivates users to be more active. If a friend of mine sends $50 to my PayPal account, I will be more willing to use it for my next purchase than I would without that $50 balance. A few months ago, Square bought the tax business of Credit Karma and integrated it into Cash App. I wrote in my thought on the acquisition

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App.

The integration of Credit Karma Tax into Cash App did happen. The same logic can be applied here. In addition to lowering its transaction cost, PayPal benefits in different ways from having more balance in its wallet. Instead of acquiring a tax filing business like Square did with Credit Karma, PayPal collaborates with Fiserv to enable not only tax refunds, but also paycheck deposit or insurance payments. Less capital, more applications. What’s not to like?

The BNPL market is hotter than ever. Recently, Square paid an enormous sum of $29 billion for Afterpay. Merchants are racing to enable the feature due to the fear of missing out. Banks like Citi, Chase or Amex scramble to offer their own BNPL version. Even Apple is rumored to develop its own service for Apple Pay transactions. PayPal launched its PayPal in 4 in August 2020. Since then, the service has processed more than $3.5 billion in transaction volume, $1.5 billion of which took place in the last three months alone. Yesterday, with its policy to drop late fees for consumers, PayPal took a bold step towards gaining more market share in this red hot market.

Let’s talk quickly about how BNPL providers make money. There are some providers like Afterpay or Klarna that allow consumers to break down a purchase into several interest-free payments. To generate revenue, these providers charge consumers a fee for every late payment and merchants a fee that is much higher than the usual interchange rate in exchange for new business. On the other end of the spectrum, there are other companies like Affirm that charge consumers no fees, but levy interest on the purchase. For PayPal, it originally belonged to the first group of BNPL firms that offer interest-free payment plans. As a late comer, PayPal lets merchants use this service at no additional charge, apart from the usual commission rate. Today, to attract the end consumers, PayPal decides to drop late fees, a move that will force other competitors to copy to avoid losing grounds. I expect them to follow suit soon. Late fees only make up 9% of Afterpay’s revenue. The problems for these pure BNPL players are that 1/ they don’t have multiple touchpoints to consumers like PayPal and 2/ they are already not making money. Dropping late fees will make the road to profitability even tougher. For the likes of Affirm, I mean, what can they offer consumers and merchants that PayPal can’t?

All of these developments have one common goal: to make PayPal the go-app application for all things financial for us consumers. Just take a look at the breadth of services that PayPal can offer below. There are few companies that can do the same, let alone having 32 million merchants on the network and a brand name that is widely recognized across the globe.

PayPal's Consumer Services
PayPal’s Consumer Services

I expect in the next few quarters, PayPal will have:

  • A higher TPV
  • A lower take-rate due to more bill payments, P2P, especially from Venmo, the drop of BNPL late fees and less reliance on eBay
  • Higher loss rates
  • Higher cost of transactions simply because PayPal has to compensate the likes of ACI, Fiserv and Giant Eagle
  • Higher marketing expense as % of revenue

However, as a shareholder, I can’t help but feel optimistic about the company’s outlook with these moves. I look forward to hearing the management team discuss the ramifications in the future earnings calls.

My notes from 2021 Debit Issuer Study

Every year, Pulse, a Discover company, publishes a Debit Issuer Study, which covers the debit card landscape in the U.S. This year’s version is the 16th annual edition of the study and comprises of data from 48 financial institutions of different sizes in the country. If you are interested in the payments as well as financial services world, you should have a look at this study. Below are a few things that stood out the most to me, accompanied by some of my own comments

Debit spend per active account increased as growth in ticket size more than offset the decline in transactions

Unsurprisingly, stay-at-home orders last year curtailed debit transactions as stores were closed and folks were forced to remain at home. As a result, 2020 saw a decline of 2.5% in the number of debit transactions, the first contraction of the industry ever. Most of the damage took place in Q1 and especially Q2 before the use of debit cards recovered in the back half of the year. Compared to 2019, last year saw an increase in debit spend per active account, from $12,407 to $13,550. The increase resulted from 10.5% growth in ticket size despite the drop of 1.3% in the number of monthly transactions per active card.

Annual Spend Per Active Debit Card Increased In 2020 By 9.2%
Figure 1 – Annual Spend Per Active Debit Card Increased In 2020 By 9.2%. Source: Pulse

Whether issuers are subject to the regulated interchange cap determines their unit economics

For issuers with $10 billion in assets or more, they are subject to regulations that cap debit interchange rates. Before we move forward, let’s take a step back to revisit what interchange rate is. Every time a transaction takes place, the merchant involved has to pay a small fee to the bank that issues a debit/credit card that the consumer in question uses. The fee is calculated as % of the transaction value and usually determined by networks like Visa, Mastercard, American Express or Discover. In this case, the Federal Government caps the interchange rate for big issuers that have $10 billion+ in assets. According to the 2021 Debit Issuer Study, exempt issuers earned 42.5 cents every transaction, compared to 23.7 cents for regulated issuers. Due to this difference, exempt issuers generated almost twice as big as regulated issuers in annual gross revenue per active debit account ($132 vs $71).

Exempt issuers earn much higher interchange revenue for debit transactions than regulated issuers
Figure 2 – Exempt Issuers Earn 42.5 Cents Per Every Debit Transaction. Source: Pulse

This is one of the reasons why neobanks can offer debit cards with rewards and no fees. Neobanks or challenger banks are usually technology startups working with exempt issuers to offer banking services. The startup in this partnership takes care of the marketing and the product development while the exempt issuer rents out its banking license and deals with all the banking activities such as underwriting, regulatory compliance or settlement. Because the exempt issuer earns higher interchange rates, it can afford to share part of that interchange revenue with its startup partner which, in turn, uses that revenue to fund operations and generate profit. However, I wonder if it’s really fair when a neobank or a financial service company becomes so big while still taking advantage of this “loophole”. Take Square as an example. It’s a $120 billion publicly traded company. It works with Marqeta and by extension Sutton Bank, which is exempted from the regulations over interchange rates, to offer Cash App. Is it truly fair for Square to be able to leverage this loophole when it has a much bigger valuation than many banks with more than $10 billion in assets?

The rise of Card-Not-Present transactions means the rise of fraud threats

When stay-at-home restrictions were in effect, consumers didn’t shop at the stores and instead switched to digital transactions. Consequently, Card-Present (CP) transactions per active card fell by 10% last year. On the other hand, Card-Not-Present (CNP) per active card increased by 23% and made up for one-third of all debit transactions.

Because CNP transactions are less secure than CP ones (due to lack of customer verification), the growth of CNP during the pandemic led to more fraud incidents. CNP and CP with PIN transactions both made up 34% of debit transactions in 2020. However, while the latter made up only 5% of the total fraud claims, the former were responsible for 81% of the claims. Among the CNP fraud claims, 47% were successfully recovered, meaning that consumers had their money back and merchants lost some revenue.

CNP Saw Many More Fraud Incidents Than CP
Figure 3 – CNP Saw Many More Fraud Incidents Than CP. Source: Pulse

Whenever a fraud claim happens, it brings an unpleasant experience to both the cardholder and the merchant in question. Hence, issuers may want to focus on ensuring that fraudulent transactions don’t even happen in the first place, especially with CNP.

Contactless and mobile wallet transactions are on the rise

According to the study, contactless is projected to be available on 64% of all debit cards by the end of 2021, up from 30% in 2020, and 94% by 2023. Even though contactless volume grew by 6 times in 2020, it still made up only 1.6% of total debit volume. As consumers become increasingly familiar with contactless and the feature is available on more cards, I expect the share of contactless volume to keep that impressive growth pace for at least a couple of years.

Meanwhile, mobile wallet transactions funded debit cards through three major wallets (Apple Pay, Samsung Pay & Google Pay) reached 2 billion in 2020, around 2.6% of the total debit volume, with the average ticket of $23, up 55% YoY. 57% of this mobile wallet volume were made in-app and the rest took place in stores. If we look at the competition between the aforementioned wallets, Apple Pay is the outstanding performer in every metric. In fact, Apple Pay had an overwhelming 92% share of all mobile wallet transactions using debit cards.

Starting 2022, Visa will put in place new interchange rules that are aimed to encourage more tokenized transactions such as mobile wallets. Hence, I expect that when we read the 2023 edition of this study or beyond, we’ll see a more prominent role of mobile wallet transactions in our society.

Contactless Volume Grew 6x But Still Made Up 1.6% of Debit Volume
Figure 4 – Contactless Volume Grew 6x But Still Made Up 1.6% of Debit Volume. Source: Pulse

A couple of Afghanistan veterans sharing their experience

I came across a candid post by an Afghanistan veteran, on what she thought of the U.S pulling out of the country. You should have a read, but here is an excerpt:

We use people up and throw them away like it’s nothing.

And now, finally, we are leaving and the predictable thing is happening. The Taliban is surging in and taking it all back. They were always going to do this, because they have a thing you cannot buy or train, they have patience and a bloody-mindedness that warrants more respect than we ever gave them.

I am Team Get The Fuck Out Of Afghanistan which, as a friend pointed out to me today, has always been Team Taliban. It’s Team Taliban or Team Stay Forever.

There is no third team.

And so I sit here, reading these sad fucking articles and these horrified social media posts about the suffering in Afghanistan and the horror of the encroaching Taliban and how awful it is that this is happening but I can’t stop feeling this grim happiness, like, finally, you fuckers, finally you have to face the thing Afghanistan has always been. You can’t keep lying to yourself about what you sent us into.

No more blown up soldiers. No more Bollywood videos on phones whose owners are getting shipped god knows where. No more hypocrisy.

No more pretending it meant anything. It didn’t.

It didn’t mean a goddamn thing.

Source: Laura Jedeed

Another vet shared this on his Twitter

What weighed heavily in my heart today and what angered me is that when a minority group of people have the influence and power to change other lives for the better, as it often is the case around the world, the outcome is usually that generations of innocent people suffer. Why does that have to be the case?

Weekly reading – 14th August 2021

What I wrote last week

I wrote about Square’s acquisition of Afterpay

Business

In the Streaming Wars, Sony Stands on the Sidelines. I think for the short term, it makes sense for Sony to adopt a zig-when-everyone-else-zags strategy as building a streaming service is not Sony’s strength. Of course, no strategy is risk-free. If the big streamers can create content on their own and don’t need Sony any more, the iconic Japanese firm will be in deep trouble. It is a big bet from Sony, but as the market stands today, I don’t think the company has too many options left.

Rappi’s poor service opens the door for competition, but users aren’t leaving yet. Two things from this article struck me: 1/ even though they were horrible incidents with services and customer support, there hasn’t been a customer exodus from Rappi yet. 2/ RappiPay is the most profitable and fastest growing part of the company. If the challenging delivery gig doesn’t work out for the company, it can pivot to be a full blown fintech.

Amazon’s $1.5 billion air cargo hub starts operations. In the arms race to compete with other retailers or eCommerce platforms like Shopify, solidifying or even adding to their advantage in infrastructure and last-mile delivery is the right move for Amazon. Just look at the price tag of the cargo hub. If anyone wants to compete with Amazon on this front, that’s at least what they should expect to spend. And it’s a tall order for many companies. With that being said, having another cargo hub doesn’t guarantee success, so it will be interesting to follow this market in the near future.

Excerpt: How Google bought Android—according to folks in the room. The founders of Google, especially Larry, do seem to have excellent foresight in acquiring Android. I look forward to this book.

What I found interesting

John Gruber’s excellent post on Apple’s new “Child Safety” measures. The nuances and details laid out by John are very enlightening and important in understanding what Apple is doing here.

Reality has a surprising amount of detail. The devil is in the details

Archaeologists discover 4,000-year-old ancient city in Iraqi desert. Imagine you see now something that existed 4,000 years ago. That must be a surreal feeling.

Believing In Yourself is Overrated. This is Better. I am not really a fan of the “fake it till you make it” mentality. So I am very glad that Ryan Holiday wrote about it since he is far more eloquent than I can ever be. In short, the more effort you put in something, the more confident you are in yourself

Stats that may interest you

Momo has 60% of Vietnam’s mobile payments market

Amazon has 11% of the U.S ads market

Amazon spent $6.2 billion on video and music content in the first 6 months of 2021. To put it in perspective, Netflix spent a tad lower than $8 billion on content in the same period

Why Square paid the big bucks for Afterpay

Last Sunday, Square announced that it was going to acquire Afterpay, the Buy Now Pay Later provider from Australia, in a $29 billion all-stock deal. A lot has been said about this merger and the one bear case that I have seen quite often is that people questioned whether Square could actually build its own BNPL in-house and is wasting $29 billion on this deal. Below is how I think about it.

Before we go further, let’s take a minute to talk about these two companies in general. Afterpay was founded in Australia in 2014 by Nick Mornar and Anthony Eisen. The company allows shoppers to break purchases into four interest-free installments paid every two weeks. Afterpay charges merchants 3-4 times interchange rate in exchange for customer leads and the underwriting of the loans. Merchant revenue constitutes the majority of Afterpay revenue while late fees make up around 9% of the top line. Currently available in Australia, New Zealand, the U.S, the UK and Canada, Afterpay is launching services in a few European countries such as France, Italy and Spain.

Originally started as a payment company with a little credit card reader, Square has grown leaps and bounds over the years to become a publicly traded financial company with over 30 different services, a banking license and over $126 billion in market cap as of this writing. Square’s revenue comes from different sources. Bitcoin makes up more than 50% of Square’s revenue, even though the gross margin is only around 2%. The company sells POS hardware at a cost to merchants and charges them for used services. If merchants and customers want to receive funds instantly, they must pay Square a small fee. Square also offers merchants loans from which it earns interests. Last but not least, there is interchange revenue from millions of transactions processed through Cash App.

Square used to have a BNPL option which was discontinued due to the effects of Covid-19. Then why the sudden change of heart and why wouldn’t Square reactivate Square Installments instead of paying an enormous sum for Afterpay? First of all, it’s about international expansion. While Square is available in some overseas markets, 85% of its GMV is from the domestic front. Meanwhile, more than 50% of Afterpay’s GMV originates from non-US markets. Acquiring Afterpay gives Square quick access to those international markets and reduces reliance on its home market. Plus, it’s not really easy to build up a BNPL service from scratch. In addition to having to acquire merchants and users, to be a BNPL provider, one has to deal with a lot of regulation hurdles. These are the things that currently Afterpay does better than Square in non-US markets. Hence, this purchase will help Square bypass all the trouble and acquire these skills quickly.

Second, customer acquisition. Afterpay’s main clientele includes Enterprise merchants wanting to leverage its popularity with consumers. On the other hand, while Square’s fastest growing segment is merchants whose GMV is higher than $500,000 a year, I doubt they are big enough that we can call them Enterprise. Hence, this acquisition enables the acquirer to move up the ladder and into a new market. The U.S is responsible for 62% and 43% of Afterpay’s active customers and GMV respectively. However, I’d say that in terms of reach to U.S consumers, Square is the far better company in this equation and has multiple touchpoints that it can use to acquire new users (Credit Karma tax, Cash App P2P, Bitcoin trading). Therefore, Square can definitely assist Afterpay in user acquisition. On the other hand, Afterpay gives Square access to the former’s high income customer base in coastal cities where Square isn’t as competitive as in the South.

Third, merchant acquisition and retention. Merchants pay BNPL providers because of not only consumer preferences, but also the new business that these providers bring due to their marketing reach. For instance, Klarna reported 22 million customer lead referrals in the U.S December 2020 alone. This extra revenue is what merchants, especially smaller ones, crave and are willing to pay for. With the Discovery tool from Afterpay, Square can strengthen the relationship with merchants and keep them in the ecosystem. The more merchants they have, the more their Cash App can appeal to consumers and the healthier the whole ecosystem will be. As a result, the addition of the Discovery tool is strategically beneficial to Square.

Last but not least, this merger is about the competition. Square ‘s main challenger in the race to become the Super Financial App is PayPal. Formerly a P2P platform and a primary checkout option on eBay, PayPal has transformed itself into a financial service and a formidable eCommerce player. It provides both merchants and consumers with multiple different services to facilitate in-store and online transactions. With PayPal, shoppers can pay in stores and online with QR Code, tap-to-pay, mobile wallet, debit cards, credit cards and PayPal Credit. In the past few months, the company has ramped up significantly efforts in cryptocurrency trading, one of the selling points of Cash App. Additionally, PayPal recently launched Zettle, its card reader, in the US, a direct threat to Square’s bread and butter. PayPal’s own BNPL, PayPal in 4, has facilitated $3.5 billion in GMV in a few markets since its launch in August 2020, $1.5 of which came in the last 90 days alone. As mentioned above, Square no longer has an installment service.

Outside of the U.S, PayPal and Klarna, the global leader in BNPL, share a lot of market overlap with Square and Afterpay. This acquisition of Afterpay gives Square an instant counterweight to these competitors. Could Square build its own BNPL muscles? Absolutely, I have no doubt about it. But it will take a lot of time and resources for Square to play catch-up. By the time the company could form a respectable presence in the markets, PayPal and Klarna would already sign more merchants, gain more market share and establish a purchase habit as well as brand name with consumers. It would be incredibly tough to overcome these advantages. With Afterpay, Square won’t have to start from scratch and can compete right away with their rivals.

In summary, from my perspective, there are legitimate reasons why Square made such a big splash. Afterpay brings to the table what Square needs for its growth plan and more importantly, it does so instantly. Of course, M&A deals fail all the time. Synergies are often overstated. Cultural clashes tend to be overlooked. Execution doesn’t materialize as expected. Management teams butt heads. All kinds of trouble can happen to derail a partnership. This one isn’t immune to such risks. But I hope that one day we can look back at this deal as an important milestone and lever that propels Square to incredible heights.

Figure 1 – An example of regulatory hurdles that a BNPL provider has to deal with. Source: Afterpay
Figure 2 – Afterpay can help Square move up market. Source: Square + Afterpay
Figure 3 – Afterpay can expand to coastal cities in the U.S and acquire higher income clientele. Source: Square + Afterpay
Figure 3 – Integration of Afterpay into Cash App. Source: Square + Afterpay
Fincog Overview of BNPL Providers, Ranked by Size
Figure 5 – GMV of Global BNPL Providers. Source: Fintechnews
Figure 6 – Klarna’s footprint. Source: Klarna

Weekly reading – 7th August 2021

What I wrote last week

I wrote about why credit card issuers should try to get into consumer digital wallets

Business

Pearson bets on direct-to-student subscription shift. I am never a fan of publishers like Pearson for a simple reason: books are murderously expensive in the U.S. In addition to the sky-high tuition fees, students have to pay easily a few hundred dollars or a thousand dollars a semester for books alone. There are ways to go around that challenge, but sometimes these guys work with professors and students are left with no choice, but to make a big splash on books. Pearson seems to be aware of the unsustainability of their current model. By going straight to students, they can establish a direct relationship and avoid relying too much on educational institutions. $15/month means students can pay $75/semester for access to all the books required. However, there are other publishers on the market. If students must get books from multiple sources, it can dilute the appeal of this new service from Pearson. I really look forward to seeing how this strategic move will pan out in the future.

Apple Is Now an Antifragile Company. A nice article on how shrewd Apple is when it comes to securing its chip supply while other struggle. I feel that not enough has been said about what a great job Apple’s management team has been doing. It takes a great deal of discipline to use billions of cash wisely quarter after quarter. The executives also have the foresight to develop their own chip M1 to keep more control of their fate and avoid being in the mercy of Intel. Additionally, the decision to make forward orders in bulk in advance has proven to superior. While others cite the struggle with chip supply as the reason for their relative subdued performance, Apple still posted strong results.

Music labels split over Spotify’s push to promote songs for lower royalties. I haven’t used the Discovery Mode yet, so I don’t know what it is like. I did have a less than stellar experience with the Spotify app; which I haven’t used for a long time. It’s not user-friendly at all. And if what is reported in the article is true, as a shareholder, I’ll be very disappointed. Sacrificing the user experience and the integrity of an algorithm like that over lower royalties and higher margin isn’t in the long-term best interest for the company, in my view.

Disney, WarnerMedia and NBCUniversal wrestle with balancing the value of cable networks and streaming services. I don’t think streaming is the best place for a newcomer with one cash cow to enter. The likes of Apple can arrive late at the part and compete because they have enormous resources and streaming isn’t their top 5 or 7 revenue stream.

The Verge interview with YouTube Chief Product Officer.

5 charts show Amazon’s growing logistics network as it puts inventory closer to consumers. Some great data and information, but I don’t think Amazon is playing the same game as Walmart. Operating huge stores with a lot of SKUs is not Amazon’s strength, at least compared to Walmart, for now. I don’t think it’s wise for Amazon to get into that arena. What I think Amazon is plowing money into is the last mile delivery. If groceries are what needs delivering, they are building out Amazon Go shops and can leverage Whole Foods footprint. However, if we are talking about non-grocery items, then Amazon is taking a very different approach to Walmart and staying at what Amazon has been great at: an online store with great customer services and unrivaled last-mile delivery network

What I found interesting

U.S. generates more plastic trash than any other nation. The amount of plastic bags in supermarkets in the U.S such as Target or Walmart staggered me. I don’t understand why they don’t implement policies that encourage shoppers to bring their own bags or boxes like Aldi does. At Aldi, you have to bring your own bag unless you are willing to pay for one every single time. I don’t think shoppers are bothered by that. If the likes of Target and Walmart can join the fight against unnecessary use of plastic, it’ll be a huge step forward given the reach and size of these retailers.

London’s Crossrail Is a $21 Billion Test of Virtual Modeling. Technology is mind-blowing. So is human imagination

Stats that may interest you

Luggage sales are up more than 460% year over year (Q1 2021)  on Amazon while swimwear sales have more than doubled year over year as of March and April 2021

From 2006 to 2021 per-capita volume consumption of juice and nectars in the U.S. declined 36%