Sanity Zone 2-24-2014 The $500 Millon Man

Finding nuggets of stupid is like a pig finding a truffle. Yet discovering old stupid is not quite as delicious as finding new examples. While it may seem as if we are knee deep in the ridiculous, the truth is that we are only experiencing waves of epic stupid which mask a low level of basic inanity. There is a new monster wave of stupid crashing in and it's of the same level as "it's the internet - stupid" stupidity. It's the acceptance that an app (a freaking phone app!) is worth more than the entire infrastructure that delivers that app. WhasApp sold for $19 billion and it barely has sales. Unfortunately, this is only one high profile transaction that represents the current tsunami of stupid about to restructure the Investment (not investment) community.

When you look at an opportunity, you have to look at alternatives and threats. Alternatives are easy, so we won't dive deep there. Threats are hard. What factors undermine the opportunity's economic model? Great question, and it deserves a great answer. For WhatsApp, it sells text messaging service for a buck. How can something that sells for so little and provide so much value get undermined?

Hmmm. Let's see. 1) ATT et al., can sell their text messaging for free. This is the main reason anyone uses WhatsApp. The marginal cost of a text message is Zero, so service providers can wipe out WhatsApp in about 6 months. 2) Ubiquitous nature of imbedded texting makes domination of this space nearly impossible. Just look at Words With Friends. Monetizing is going to be difficult when downward pressure on user fees begins; have fun wading through all that advertising. 3)Feature creep is the main strategy used by business models that have no other protection (see point 2), and is the main cause of economic model collapse due to the proprietary strategies used by managers vs. using open model access to features. Writing and maintaining state-of-the-art features and code is a disaster waiting to happen.

When Investors start over-paying for marginally productive assets, it usually means there's a bubble. It's stupid money chasing stupid projects. I applaud the 35 WhatsApp employees for their creativity in developing a project that has dislodged wealth in their favor. Unfortunately, there will be losers in this game. Facebook is playing with OPM - Other People's Money. They have the freedom to bid up marginal assets because they aren't really risking their own wealth. The price Facebook was willing to pay is directly based on silly Twitter, King (Candy Crush), and their own valuation. But they really have no choice. If FB were to bid a more realistic valuation, it would undermine their own valuation. It is a classic insider manipulation with a heavy dose of vested interest.

My suggestion is to be careful. With all the OPM floating around, over-pricing marginal assets, the odds increase that someone on the inside decides to cash out. This is classic game theory, where everyone goes along because cooperation benefits all, but the minute one person defects (because the payout is huge), everyone defects. That day is rapidly approaching. It may be wise to go to cash for two reasons.

First is that the banking system is padding profits and their balance sheets with all these inflated valuations. It is entirely possible that we may see another round of government bailouts and you don't want your money at risk while the politicians figure out how your deposits will pay for the mess. Second, inflation is fueled by this mad money surge, and unfortunately it's not hard money, it's electronic. Since inflation is low and growth is weak, this could set off a deflationary cycle, which means hard cash is king.

Find a safe haven. Don't play chicken with your money against the insiders who know when they are going to defect. If you're ahead, cash out. You'll be your own $500 million man, and savor the tasty stupid from the safety of the sidelines.