Theranos – little new under the sun

Blain’s Morning Porridge – Jan 5th 2022: Theranos – little new under the sun

“You don’t do something like this without embracing failure constantly… we’re just not going to make the same mistake twice.”

This morning: Guilty is Guilty, but Theranos still raises a host of questions for investors – how to trade risk, opportunity and due diligence, and who and what can you trust?

I wish I had more time to write the Morning Porridge. If I did I would set myself to deliver a five act Shakespearean Tragedy in iambic pentameter about Elizabeth Holmes and the web of deceit that was Theranos. A good tragedy requires the protagonist to willingly make the choices leading to their own destruction.

The environment that offered Holmes the opportunity to destroy herself is critical to the plot. The underlying thread would be how Holmes played an irrational market running away with itself, fuelled by an abundance of easy money, desperate capital chasing any and all opportunities, a mood of infectious credulous belief, a supporting cast of enablers, and the market background of upwardly sloping charts. Tick all the boxes for Elizabeth Holmes as a product of her times who willingly chose her path – and got caught when the grand vision she espoused proved a hollow sham.

But something deeper is happening. Holmes is a product of her time. Whatever happened to our sense of honesty? The last few years have seen a grudging acceptance of folk like Trump and Musk and a host of other robber barrons at the top of markets and politics. They exaggerate, tell massive lies, make unsupportable promises, and just shout their lies louder and louder when we call them out. Their false truths come to dominate. Do we stop them? No. We enable them.

Funny thing is… it’s kind of all happened before…

I was chatting to a major fund client yesterday about valuations in Tech markets. We had a moments remembrance of Blackberry (or Crackberry as we called it then for its addictive type pad), being shut down – they were once ubiquitous in markets. The pair of us are old enough to remember the Dot.com crash of 2000 in detail. The South Sea Bubble? Not so well.

I’ve made the point before how anyone under 35 working in financial markets wasn’t there for the crash that was the Global Financial Crisis in 2008. You would need to be in your mid 40s to remember the Dot.Com bubble popping. Yet, the parallels to today’s markets are striking. And if you ever attend a disruptive tech conference – well the only folk in the room over 50 might be me or Cathie Wood.

Let’s go back through the time tunnel to 1999….

Back in September 1999 a wise fund manager was being pilloried by the press and investors for the comment: “I find the speculation on the Internet a little worrisome”. He scaled back further investments in the new internet market stocks, sold anything unconvincing and watched the market soar ever higher.  And in March 2000… he was proved right when Dot.coms imploded. (He was Brian Berghuis of T.Rowe Price in case you think I might be toying with the actuality and making this up.. but you’d have had to have been there to know that… It’s where my mantra: “Missing the last 10% of the rally is better than catching 20% of the Crash” comes from.)

The underlying theme driving the fervid dot.com market in the late 1990s was the apparently unlimited upside of information technology. The then recent innovation of the internet as a commercial medium was driving insane valuations of digital sellers like online pet-stores and fashion companies to stratospheric levels, while I was busily buying into exciting but ultimately short-lived Palm computing and dead-evolutionary-end information services.

It was age studded with newly invented buzzwords and jargon around the theme of the information age. We all manically bought into it – and punished the old fashioned dinosaurs missing the boat by enthusiastically embracing exuberant internet valuation metrics.

The WSJ questioned the “quaint idea” of profits. Concepts like “mind-share” and phrases like “get large or get lost” dominated the narrative. Employee stock options made founders instant paper-millionaires. The tech-heavy Nasdaq surged 400% from 1995 to March 2000. In 1999 Qualcomm made Tesla look a lame snail, posting a 2600% price gain. But, the really big gains were actually limited to a relatively small number of stocks – most IPOs performed badly. Most firms on the Nasdaq underperformed. (If you want to see how that works today – just take a look at ARK’s portfolio: One big performer. Lots of smaller losers.)

What caused the Dot.com bubble to burst? Rising interest rates is one story, but the reality is the market woke up to the overpromised, under-delivered reality.

There is always a crescendo: a story I love is an educational software company called The Learning Company – for 15 years it steadily built its brand and profitably sold its products, before a hostile acquisition at the start of the bubble in 1995. The new owner sacked the staff and hyped the business, selling it to toy-company Mattel in 1999 for $4 bln in stock. The following year Mattel dumped the bits for less than $30 million – a massive mistake in terms of expectations management and due diligence.

Back through the time tunnel to 2022 and Elizabeth Holmes……

You need to kiss a lot of frogs to marry a prince. When the Dot.Com bubble burst 90% of companies imploded or vanished into the nether regions of penny-stocks. (I wonder if there are parallels to mass-extinction asteroid impacts? Probably, but Don’t Look Up was the topic of Monday’s Porridge.) Some dot.coms ultimately thrived like Amazon and Google – because they were profitable. There will be winners.

The trick of good tech investment is to spot the winners, and not get sucked in by the ultimate losers. Its part great due diligence, and an element of luck. Other new firms later emerged into wrecked landscape and made the tech work for them. Everyone who’d been burnt by their Dot.com experience swore they’d never get caught again.. but you can’t completely discount the future.

Today the buzz is all about Disruption – which now means whatever a stock barker wants it to mean. The valuations being put on innumerable profitless “disruptive” technology concepts in the current fervid IPO and SPAC driven tech feeding frenzy of start-up gristle, (because most have zero meat on the bones), is just like 25 years ago. Just the jargon has morphed a little.

The universal diagnostic tool Theranos told investors was coming would be a marvellous thing. It could genuinely change health provision. But, raising billions by telling investors it worked when it clearly didn’t is simply fraud. I’ve got this great business plan for a personal transporter beam that will disrupt every form of transport on the planet – but until it works… I accept its worth nothing.

But what if it sort of worked…? Is “Fake it till you make it” really an acceptable way for tech to work? At what stage does the vision get replaced by an outright lie? That looks a blurry line.

For 10-years a leading EV company has promised autonomous driving tomorrow, but is apparently no closer to delivery. A tech firm (that simply rented office space) promised the market extraordinary returns – and nearly folded leaving the founder rich and his investors wounded. A former US media idol banned from Twitter has achieved a spectacular valuation on a new media empire SPACed without even a cigarette packet business plan. Someone thought up a new name and way of booking a taxi and made billions.  I could go on… There are half a dozen other firms following Theranos to the courts. There will be more.

Where does that leave Elizabeth Holmes? Does she deserve our sympathy or contempt? Villain or victim? Just another shameless self-promoter. The stories emerging of her repression of internal dissent and a toxic workplace sound a pretty standard tale of a dysfunctional greedy person. The prosecutor said in his closing arguments: “She chose fraud over business failure. She chose to be dishonest with investors and patients. That choice was not only callous, it was criminal.”

The bottom line is she was found guilty. Just like a string of other financial shysters since the day we invented markets. We will always have fraudsters. They are a regrettable factor in markets. Easy money, abundant capital and blithely unaware investors lend them credibility. To my mind the blockchain is little more than technobabble garnish that’s been seized on by the crypto-mafia as suitable hi-sounding jargon to spin their ponzi-con around.

The only way to avoid the frauds is to be smarter and spot them early through due diligence, and not to let the market’s crazy exuberance and acceptance of the glib lie suck you in.

Addendum…

I was struck by the way the screamingly guilty Holmes was allowed to walk away from the court after posting a bond prior to her sentencing hearing. She will delay incarceration with appeals and maybe a baby or two. I suspect a girl convicted the same day in the same court of stealing nappies from a local grocery store would have gone straight to chokey. It makes me think I’ve stumbled on to a new theme for 2022 – Unequal Justice.

It’s an angry concept as we wake up to rising income inequality and the widening rift between the top and bottom of society. When it starts to impact the bourgeoise – ie us – then it becomes a revolution.

Ghislaine Maxwell’s moment in court as as procurer for Epstein might had the whiff of a Roman “bread and circuses” show-trial about it. Yet, the brutal reality is that if even half the media effort that went into securing her conviction went into to ensuring any kind of justice to the millions of women around the globe trafficked, raped, groomed or otherwise abused, then the world would be a much fairer place.

Corporate lies have become so common they are largely ignored. Every firm on the planet makes grand yet utterly hollow statements about inclusion and diversity – but few actually deliver. Promises of equality have become background noise. You are fool if you take them at face value.  In recent months I’ve been sickened by the corporate abuse I’ve seen from an “leading” asset manager which claims to be a leader in female empowerment and diversity, yet treats its senior women as disposable commodities.

Justice has become a commodity rather than a right. It’s time we started naming names…  (and I shall…)

Five Things to Read This Morning

FT – China’s Covid Policy will be wild card for markets in 2022

FT – Investors gear up for “gold rush” in metaverse hardware

WSJ – Toyota Overtakes GM as Bestselling Auto Maker in US

BBerg – Stocks Slip as Tech Drops, Fed Outlook Mulled.

Thunderer – Household borrowing shoots up as consumers throw off the shackles

Out of time, and back to the day job..

Bill Blain

Shard Capital – Strategist