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The Diff is a newsletter exploring the technologies, companies, and trends that are making the future high-variance. Posts range from in-depth company profiles, applied financial theory, strategy breakdowns and macroeconomics.
## Elsewhere
### Capital Structure
Public market investors who want to bet on AI have three basic options:
1. large tech companies with the resources to develop and deploy AI tools, but who also face the risk that someone else will build an AI-first version of their product before the AI-second version is ready.
2. Smaller companies that have refashioned themselves as purer bets on AI, or at least that have a narrative that this is true.
3. Nvidia.
The AI trades that involve betting on a company that is mostly doing AI, and that isn't an attempt to gin up investor interest ahead of a secondary offering, is mostly restricted to private markets. And any time investors' preferred investment is outside their asset-class habitat, there's an opportunity. So SuRo Capital shares rose 22% on Friday after the company disclosed investments in OpenAI and CoreWeave. Aficionados of this particular kind of market history may recognize SuRo Capital from one of its previous incarnations, NeXt Innovation, which also had the strategy of investing in privately-held companies. That stock did well in the first few months of 2012 ahead of the Facebook IPO, and then lost two thirds of its value in a few months after the IPO happened.
Disclosure: Long META.
### Designer Brands and Transaction Costs
Economists do a good job of constructing models of mostly rational agents, but obviously have a lot more fun explaining seemingly irrational behavior. Why, for example, does putting a designer's name on a piece of clothing make it worth more? It doesn't change the comfort of the product, but it's a signal to the buyer that it's high-quality, and signals the same thing to whoever sees them. So it's a similar function to the signaling model of education: it isn't changing the underlying reality so much as it's providing a high-bandwidth, low-latency way to communicate that it's true.
In this model, those brands get pricing power from an environment with just the right cost of information—low enough that it's possible for people to recognize a brand name, but not so low that they can buy cheaper but otherwise identical replacements. The latter is increasingly the environment in which fashion companies operate: either their suppliers, or competing suppliers with a knack for attentive copying, can sell copies of their products that are almost identical, but that are substantially cheaper. This market has existed for a long time, but two parts have gotten cheaper: first, it's much easier for people to find and vet sellers of these products; it's a purchase that naturally leads to bragging rights, haul videos, and the like, which means the goods are being constantly inspected in public and unreliable sellers get shamed. And those communities lower another barrier to entry: it doesn't occur to many people to even look for identical knockoffs at low prices, but the existence of these online communities makes the option hard to ignore.
### SMBs
Sometimes there's a shorthand way to describe different investing strategies: you might use "satellite images of store parking lots" as a metonym for alt data signals, and "measuring whether the weather in Paris predicts the outperformance of Brazilian stocks whose name starts with the letter 'P'" as a shorthand for data mining-flavored quant approaches. The strategy of a search fund or PE firm buying a service business, often a blue-collar business with a founder approaching retirement age, tends to get summed up as something like "buying out HVAC contractors in the midwest." There are even memes. And the WSJ has done the meme, by writing about PE rollups of blue-collar services businesses like HVAC repair.
The thesis is similar to the thesis for any other roll-up (The Diff has profiled a few examples which all focus on the specific opportunity of baby boomer entrepreneurs retiring ($)). If there were intrinsic economies of scale, the industry wouldn't have been so fragmented in the first place—but there can be moderate ones, from borrowing ideas across different companies, cutting a better deal with suppliers, and just getting the basic accounting right. And there's the natural social status factor: many of the people who ought to run these companies are similar to the people who started them, and, if they'd been born a few decades earlier, might well have started such a company. But now such people are identified early, sorted into better schools and then better starting jobs, and end up with a massive social status gap—even if they'd earn more running a small business than working as an investment banker, it would be a step down in status. Wrapping it in a financial transaction, especially one with jargon and terminology, is a good way to direct that talent back to where it can do the most good.
### Top-Down Market Reform
The Diff has been covering efforts in Japan, on the part of companies, exchanges, and regulators, to raise their market values. Korea has been following a similar mix of policies, and is also seeing results, with the value of shares canceled after buybacks more than doubling in the last year. In the US, trends in buybacks are more driven by which companies are public and by how margins are doing, but in markets where companies retain more of their earnings, and reinvest in lower-return activities, the aggregate direction of buybacks is less of near-term macro indicator and more of a long-term policy indicator (which, in a nice symmetry, feeds back into the macro picture in the form of higher long-term growth).
### Chosen Obligations
In light of this morning's news from Sweden, a good little institutions story: one of the ways people who focus on institutions and property rights frame their view is that one of the most important rights people have is the right to be sued. Without it, there's no ability to make binding commitments. This is useful as an object-level observation about how property rights work, but it's also useful as a more general claim that there's sometimes value in deliberately constraining one's future behavior. This shows up in markets, too; handbag maker Vera Bradley adopted a poison pill plan, making it harder for the company to agree to a takeover, and shares rose. This entrenches management, which is negative for long-term returns, but it also means that anyone who wants to fix that problem needs to pay a premium to do so. In this case, at least, the marginal shareholder believes that shareholders as a group are better-off when some of them have fewer rights.