A Follow up on Zillow: Tracking Strategic Progress

I fleshed out my thoughts on Zillow (“Z”, “ZG”) more since my last write up and I will share them here. This includes a clearer idea of the strategic game that Zillow has to play, as well as how to track progress. Using these criterias I added a little to my position after the latest earning.

The Long Game

As a reminder, we're playing a very long game here. What matters strategically is being closer to end customers and the transaction itself. Achieving that would flip the power dynamics of the industry in Zillow’s favor.

Here’s a tweet storm I put out a while back on how Zillow has to change its role in the transaction flow.

1/x. Everything Zillow $Z $ZG does (inc. iBuyer and lending) should be judged on how it helps them get closer to consumer and transaction. This goes hand in hand with how data flows through the value chain.

— mspacey (@mspacey4415) April 3, 2019

As a clarification, Zillow Offers will help generate listings instead of “stealing” them from agents (as the accusations go). Here’s how.

Prospective sellers can check out binding offers from Zillow before awarding that listing to an agent. At that point two things can happen: a) if they sell to Zillow, then Zillow obviously controls the seller listing for that property; b) even if they don’t sell to Zillow, Zillow would have came across this clear intention to sell before the agents - a “pre-seller listing” if you will. This is incredibly valuable information in the industry.

In short, by beating agents to listing generation, iBuyers change the entire power dynamics of real estate value chain.

This shift in leverage toward the platforms is why even Keller Williams is getting into iBuying, as seen in this article:

“I feel like I have no choice now,” CEO Gary Keller said during a presentation in January. “I can’t allow Opendoor or Zillow to go out and be the only player in the iBuyer space and then begin to dictate terms and build brand around ‘they buy houses.’”

The key words are "dictate terms". Once you win the game and control the listings, there are many options for monetizing. For now investors are still worrying about Premier Agents, but in a few years what matters won’t be Premier Agent, but "Premier Listings" or whatevers Zillow choose to call their product.

How to Track Progress; Status from 1Q19 Earning

In judging Zillow’s strategic progress, I’m looking for a few things. First, I want to see the iBuyer market taking off. Second, I want to see ZG mitigate the pressure to sell inventories at inopportune times (most likely by addressing holding cost via renting). At some point down the line, I also want to see proof that iBuyer proliferation is giving Zillow greater leverage over the value chain.

Regarding the 2nd point, here’s another tweet storm (sometimes I find the condensed format of Twitter explains things better).

1/x. Today's Barclays report on $Z $ZG has a good point - if you try to flip homes but it's on market too long, then selling price & iBuyer margins are going to take hits.

— mspacey (@mspacey4415) March 15, 2019

So how are we doing? The latest quarterly earnings from Zillow and Redfin showed clear signs of market demand for iBuying. Zillow Offers revenue ramping from zero to ~$130mm to $240mm for the coming quarter is no small feat. More importantly, inbound seller requests are impressive:

“In Q1, we received more than 35,000 seller request and that demand is rapidly accelerating. We now receive one request every two minutes, which is nearly $200 million in potential transaction value per day.”

Redfin’s program, although on a smaller scale, also shows strong market demand.

“From the first quarter of 2018 to the first quarter of 2019, RedfinNow quadrupled the number of homes we sold. This was still less than 50 sales in a quarter, so we are far from the scale of competitors… Demand in Dallas and Denver, the markets we opened in December and March, has been stronger than we anticipated.”

That’s enough for me to conclude that iBuyers are gaining traction, and that the game is changing in Zillow’s favor. So I added to my position.

What I have not seen so far is the second progress criteria - mitigate pressure to sell by controlling holding cost. On the other hand, this could actually be an upside opportunity for the stock. The day Zillow announces some single-family-for-rent REIT is the day that bear thesis of “Zillow is getting into capital intensive home flipping game” goes away.

Remaining Questions

There are some remaining questions I'm still considering. The biggest one is how the game works in a multi-polar iBuyer world.

The iBuying game is on, and obviously Zillow can’t buy all the homes for itself. So this will not be some winner-take-all, monopolistic market. In that world do you really have power over agents? Yes, iBuyers will control a good chunk of listings, so agents have to go to them. But won’t agents pit one iBuyer against another?

The answer is to be determined, but I would say in any case Zillow will still have better power vis-à-vis the agents, and thus profit potential, compared to now.

Buy the Dips for Bright Horizons (BFAM)

I have been following Bright Horizons (BFAM) on and off for years now, back in 2015 I even had a post arguing why an expensive stock works for them.

The problem is I never bought. I kept waiting and waiting for a "cheap enough" valuation that never arrives. A few years later the stock has tripled, while that long awaited recession never came either. (Yes it’s beyond frustrating.)

Here I would recommend accumulating BFAM on the next 10-15% pull back.

Summary Upside

• Sustained high single digit/low double digits top line growth.
• Margin boosts from operating and financial leverage.
• Ability to roll up small operators using high price stocks = "equity leverage" / reflexivity.
• Option to open up centers to unsponsored families.
• Possibility of franchising /capital light model in the future.
• Stability from solid free cash flows. 

Summary Downside

• Corporate sponsored model would be hit in a recession
• Trend toward smaller companies and work from home could hurt BFAM

Business
Bright Horizons operates almost 1,100 child care centers, about 70%/30% split between North America and Europe. North American centers have an average capacity of 126 children per location. European centers can cater to 81 children per location.

Instead of going direct to consumer, the company finds employers who want to subsidize childcare for employees. Typically the employer builds the center, while BFAM manages the operation.

The employer based model allows BFAM to attract parents/kids in bulk, so the company enjoys efficient sales and marketing costs. But it exposes BFAM to the job market as well as trends in corporate market.

• Anecdotally, there is political will to rein in, or even break up big corporations, the type that’s most likely to provide these childcare benefits.
• In general there is a trend toward smaller companies or startups – these are less likely to be BFAM clients.
• The trend is also for more working from home / remotely. Both would decrease the need for child care centers near office sites
• M&A among clients can lead to consolidation of work force or child centers. This can lead to closures for BFAM.

BFAM has two operating models for real estate. In the employer sponsored model (that’s most centers), an employer sponsor funds the development and ongoing maintenance of the center, and BFAM has an operating contract to manage the center. In the lease/consortium model, BFAM leases the property itself.

Next, let’s take a look at valuation and analyze if BFAM can grow into the valuation.

Valuation
After several years of unsuccessful waiting, I’m starting to think BFAM’s valuation is not so bad.

A nice chunk of capex is growth capex. If you deduct only maintenance capex, management says they expect ~$250mm-$275mm of free cash flows for 2019.

So at ~$130.5/share or $7.6bn market cap, this is about 29x FCF. That’s actually not too bad in today’s environment, if growth can continue for the next few years.

Remember, this is the sort of consumer facing stock that never gets cheap. If fundamental performance holds up, floor multiple is probably around 20x FCF. If that FCF grows ~15% a year (which it does right now), then in 3-4 years this grows into floor valuation – i.e. you get your principal back and the rest is upside.

An expensive stock actually juices earning growth for BFAM, as it allows management to pay for acquisitions accretively (e.g. buying a center that has earning yield of 10% and pay with stocks that yield 3% will grow your EPS). It's also a competitive advantage whether BFAM is trying to enter a new market or further build out its presence in existing markets and go for local density.

Despite fairly frequent acquisitions, management did a great job the past few years keeping debt controlled while using buybacks to decrease share count.

But let’s be very clear - this is a valuation that requires growth, so that's what we will discuss next.

Drilling down on growth
There are 4 sources of revenue growth. The first three increases enrollments: 1) new centers, 2) natural ramp, 3) cross selling. The last is price increases.

• New centers. This could be new employer clients, or existing clients adding locations. Going to market via corporations requires a dedicated sales force.
• Cross selling. One way to do this is to add backup care to existing full service centers to increase utilization. BFAM can also open up its existing centers to non-employer sponsored families.
• Natural ramp of existing centers (takes 4 years to reach full utilization)
• Price increases. Could be 3-4% a year.

The company has a long way to grow before fulfilling its total addressable market (TAM). In the latest earning call, management estimated that there are about 14,000 work sites in the U.S. that could use an onsite childcare center. To put that in context, BFAM has less than 800 centers in U.S. now.

Looking at these drivers, I’m fairly comfortable that Bright Horizons can continue to grow its revenue. With its operating and financial leverage, margins should increase as well. Sure, a recession could hit, but that would be a temporary setback as opposed to the end of growth.

How Bright Horizons Can Navigate a Recession

The only worry is corporate clients scaling back, which BFAM is especially vulnerable to in a recession. This is why I never liked their corporate focused model, even while fully acknowledging its benefits.

Ultimately though, BFAM has options. In a recession if corporations pull back, it’s possible for BFAM to 1) take over the real estate responsibilities, 2) open up to non-corporate sponsored public.

Most sites operate under the employer sponsored model where employers own or lease the property. In the event that an employer client want to close down its location, BFAM can take over the real estate, perhaps by bringing in a triple-net provider like STORE Capital (where STORE would own the real estate and lease to BFAM).

In that case Bright Horizons can keep the center open, but will still lose employee clients and employer subsidies, so BFAM would have to open up the center to the public and charge parents full price. But child care demand should be fairly consistent even in a recession. As long as BFAM can keep utilization at an adequate level, it can keep cost and price under control.

Even more drastically, BFAM can pursue the direct to consumer channel and do it via franchising. It certainly has a strong brand name it can leverage.

In conclusion, BFAM has years of growth ahead. It's not immune to a recession, but it has plenty of options to mitigate a recession's impacts and perhaps come out stronger. I believe the stock can grow into its expensive looking valuation.

More on Teladoc (TDOC) - Why I Am Not Holding

My previous write-up about Teladoc (TDOC) did not leave a clear conclusion as to what to do with the stock. The answer is I'm planning to exit the small starter position I have.

While Teladoc's revenues will continue to grow at a healthy rate, I'm doubtful that it can ever achieve the margin necessary to justify stock valuation.

Here's some simple math on where margins needs to be in 10 years to call this a buy. Right now TDOC trades at $58/share, or about about $7.9bn enterprise value. Let's say I want 2029 EV/EBIT to be 10x to call it a buy, so by 2029 I need them to have EBIT of $790mm. Annualized revenue are getting close to $500mm. If revenue grow at 30% CAGR for the next 10 years, by 2029 revenue could be $7 billion. This implies an EBIT margin of 790/7000 = ~11%.

Can Teladoc get to this 11% margin? I doubt it. As I illustrated in my previous article, TDOC is less a tech company than a "sub-insurer" that its payer clients outsource to. Insurers like UNH and ANTM operate at 6-8% EBIT margin, and it doesn't make sense that TDOC can capture higher margin than its clients since it has a weak bargaining position relative to them.

Weak Strategic Position Limits Margin Upside

The problem is telehealth itself is not a thing, not if it's just doctors using video chat. What IS a thing, is the creation of a business model that 1) adds value to the overall system, and 2) captures part of that value. 

Teladoc creates value for the overall system - many patients would simply not visit a doctor without TDOC. So they're creating value by competing against non-consumption.

To capture value though, disruptive entrants should have a separate value chain to avoid being co-opted by incumbents. TDOC does the opposite, it contorts itself to fit into the incumbent value chain. 

In order to grow revenue quickly, Teladoc uses health insurers as distribution, so insurers ended up owning the end-customer (patients) relationship and TDOC's leverage is weakened. As I argued in the previous article, TDOC's true value proposition for payers (as opposed to for the overall system) is to control cost by turning a visits based variable cost into a per member per month based fixed cost. This is a nice to have, not a must have for its payer clients. 

TDOC's margins already suffer from this weak position. It is forced to spend on marketing to drive utilization, even as that benefits clients (insurers) directly and hurts TDOC's margins (higher costs of service and marketing costs). 

Nor is Teladoc integrated enough with patients to own that relationship and impose high switching cost on its payer clients. Although Teladoc has a separate registration, it's the insurers that really own the patient relationship. Not only because patients still go first to insurer portals, but also because the current TDOC value proposition simply isn't able to stand alone. Consumer cannot just use TDOC and leave their regular insurance plan - because if conditions get any worse they'll need to physically visit a doctor, which would be outside of what TDOC can offer. The perils of fitting yourself into incumbent value proposition!

Not owning the patient relationship leaves TDOC replaceable. Payer clients can swap TDOC out for another telehealth provider the second TDOC tries to go direct to consumer. 

In this way, the center of gravity is with payer clients. They've managed to keep the most valuable part of the job and outsource what's NOT valuable to TDOC. Not only that they do it in a way with minimal tie-in, making TDOC replaceable.


Conclusion

An inherently flawed business model leaves TDOC at the mercy of its payer clients. This means low pricing power. This means the higher margins needed to justify stock valuation will be hard to achieve. It also means I should exit my position.

Going direct to consumer and owning that relationship would be a good fix, but that requires Teladoc to further differentiate itself in terms of value proposition and value chain. My own recommendation is to achieve that through 1) focus on chronic care, 2) use of nurse practioners, and 3) ideally hire them as employees.

Teladoc's Business Model and Implications

I’ll start with an short hypothesis of how Teladoc (TDOC) could play out to the upside (or else why bother right?) then analyze the business model, implications and options to change that model.

Summary Upside Case

• Continued organic revenue growth at 20-30% CAGR. Growth comes from both membership increases and price increases.
• Government expansion of telehealth coverage for Medicare Advantage plans beginning in 2020 should help membership increases
• Operating leverage kick in as TDOC drives utilization, proving its worth to clients, which in turn justifies price increases. Management expects EBITDA to inflect positive this year.

TDOC trades at 8x EV/revenue while still unprofitable, so buying it requires us to think 10 years+ forward and project sizeable revenue and margin increases. That calls for an understanding of Teladoc’s business model and its place in the healthcare value chain.

Business Model

For the most part, Teladoc gets revenue from payer clients (health insurance plans, self-insured employers), and not directly from patients/consumers. 

These clients pay TDOC recurring "subscription access fees", typically on a per-member-per-month basis.

Costs of revenue are essentially based on volume of visits:

Cost of revenue is driven primarily by the number of general medical visits, expert medical services and other specialty visits completed in each period. Many of the elements of the cost of revenue are relatively variable and semi-variable, and can be reduced in the near-term to offset any decline in our revenue

As far as value proposition and "jobs to be done", here's a line from TDOC's filings:

(Clients) purchase our solutions to reduce their healthcare spending, or to provide market differentiating services as either part of, or a complement to, their core set of consumer service offerings,

Cost savings is the most tangible benefit, and in my opinion the most important one, since telehealth itself will not be much of a differentiator for health plans given the proliferation of video technology. 

TDOC saves money for payers by "capitating" an otherwise fee-for-service cost. The typical health plan pays doctor each time patients visit. More visit means higher costs for the plan/insurer. But with TDOC, the insurer just pays TDOC a fixed fee regardless of how many times patients visits doctors in TDOC’s network.

Here's a very simplified diagram that illustrates how economics flow from payers to doctors through TDOC (right side of picture). Compare that to the world without Teladoc (left side of picture), note that TDOC basically injects another layer of physician network for the original insurer to outsource to, and turn a volume based variable cost into fixed cost.

Implications

TDOC’s business model has several implications:

1) This business model only makes sense in a non-integrated healthcare world where payers still pay doctors on fee-for-service basis. It makes no sense in a vertically integrated healthcare system like Kaiser, where doctors are salaried staff.

As mentioned earlier, in a typical non-integrated healthcare system (for example Blue Cross for example), the more you visit doctors, the higher the costs for Blue Cross. TDOC comes in and fixes that costs at some per-member-per-month, regardless of number of visits. But with Kaiser that cost is already fixed because doctors are employees, so TDOC can add little value there.

This implies an inherent limit to growth. But TDOC has a long way to go before it hits that limit since systems like Kaiser are relatively rare.

2) Ability to raise prices depends on how much payer clients are saving by using TDOC. That saving amount is based on telehealth utilization - and TDOC is incurring marketing costs to drive patient awareness and utilization.

That TDOC couldn’t pass that marketing cost along to payers, even as it directly benefit payers, shows the weak bargaining position that TDOC occupies in the value chain.

Unlike say, Uber, where both sides of the market place – drivers and riders – are both fragmented and politically weak, TDOC is a middleman between 2 powerful groups – payers and doctors.

This is why I would love to see TDOC go more of a direct-to-consumer route, like they’re already doing with behavioral health. Owning the customer relationship would give them more bargaining power vis-a-vis health plans.

3) Where will operating leverage come from in the future?

The problem with driving utilization higher to improve client ROI is that TDOC itself would have lower margins, since revenue is fixed based on number of members while costs goes up when visits are higher. 

TDOC can change its own costs structure though, by hiring doctors (which turns variable costs into fixed cost), or even use algorithms for simple prescriptions. They are in fact already exploring the former.

Having more of a fixed cost structure would further incentivize TDOC to continuously prove and improve ROI for payer clients. This would convince payers to offer Teladoc through more of their health plans (boosting membership), and allow TDOC to argue for higher access fees per member (boosting both revenue and margins)

4) Perhaps Teladoc can carve out a separate product for chronic care and using nurse practioners instead of doctors. This would be a more optimal use of resources from not just cost perspective, but also from coverage perspecdtive (more supply available to cover patients 24-7). It would also let Teladoc cleanly differentiate itself against your typical “health plan with video option”– important if TDOC wants to go direct-to-consumer and build that brand.

More on Video Games, from a Disruptive Innovation Perspective

I have been reading Christensen’s theories on disruption. Some key themes of disruption are: 1) making a technology cheaper and more accessible, and 2) solving a problem that’s previously under-treated, or addresses a slightly different audience. Competing against non-consumption is a key theme as well.

So disruption is about creating value and diffusing it throughout society. You want things to be both cheaper and available to more people.

This also echoes “Crossing the Chasm”, where a technology leaps across the exclusive purview of early adopters and visionaries, and into the mainstream.

Disruption typically requires three things that are internally consistent and reinforce each other:

• An enabling technology
• A new business model
• A new value network (value chain) of disruptive players. Creating this often requires one strong company to vertically integrate the value chain and force industry changes.

From an investment perspective, picking winners means spotting industry trend changes, understanding the technologies and new business models that enable these changes, and then investing in a company that is part of the new value network of disruptors.

For practice, I'm trying to think through the video game landscape and apply these concepts. 

Video games - changes I’m observing

Two changes come to mind immediately:

• First, the value proposition and target audience of video games is changing, from teenage and college dudes in the basement shooting strangers, to a more inclusive (both adults and children, male and female) social experience.
• Second, costs have gone down dramatically. The proliferation of simple, low cost mobile games means people are conditioned to only paying a few dollars for games, if at all.

These fit the themes of disruption – a broader audience, lower cost access, and address problems that were previously unsolved (social needs instead of pure adrenaline rush).

The next questions are "what's technologies and business models fit with these changes", and "who's part of the disrupting value chain?"

(Apologies - the next couple sections are a bit messy because it's a bit of brainstorming)

Enabling Technologies and New Business Models

1. Enabling technologies- 

Internet is an obvious enabler that allows players to go online and shoot at random strangers, or team up with friends and strategize. This increased the social component of video games.

Network technologies continue to evolve. First, with CDNs (Fortnite uses Akamai), and now with full streaming (Google Stadia).

Another one I can think of is Nvidia’s ray-tracing chips. This seems to me a complementary technology for CDNs, where the ray-tracing capability can be done not at huge data centers, not at consumer’s homes, but at more remote (“edge” if you will) locations within CDNs.

2. Business Models

Free to Play (F2P) a revenue model that’s here to stay. This could be F2P with advertising, or F2P with microtransactions (loot boxes, battle passes, skins…etc).

Distribution is another obvious one. We went from buying game at physical retail stores, to downloading games at home, to now full on streaming.

Fortnite is potentially pioneering a whole new business model. With unique in game events like concerts, Fortnite real value could be as a “gamified” online gathering place that monetizes by selling tickets to events.

Value Networks - who’s part of the disruptive chain?

Now it's time to find parts of the value chain that benefits from these enabling technologies and (relatively new) business models. 

Let’s go from upstream to downstream.

• Hardware.  As mentioned earlier NVDA’s ray tracing chips could be used to bring top quality to mass market.
• Consoles are being disrupted by F2P model as well as streaming, so makers like Nintendo, Sony, and Microsoft will have to rely on their game development skills.

• Game Developers and Publishers.  
• Developers that grew up with low cost mobile games will fit well with the F2P paradigm. Zynga and ATVI’s King are examples. 
• Publishers with strong experience in online multi-player games have advantage.

• Streaming networks like Twitch, communication apps like Discord, or even Reddit amplify the social value of playing video games.

How to invest – Tencent and ATVI

Unfortunately much of this is uninvestible. I'd love to invest in Epic Games, or Twitch, but they are owned by Tencent and Amazon, respectively. Both are so big that the impact of Fortnite/Twitch would be negligible. 

I do like Tencent itself though. The company is integrated along games, social, and payments. That’s three competencies that define the future video game world. No wonder they saw the potential of Fortnite before it happened! They also have a stake in Garena’s Free Fire.

Activision Blizzard (ATVI) is one that I have a small position in. Their games like Overwatch will be disrupted by F2P model, but they do have the resources to overcome disruption if management tread wisely.

Fending off disruption requires disrupting yourself, and separate the new business into an autonomous entity. ATVI (like EA) already does that. Activision is a different studio from Blizzard, which is separate from King. King is quite familiar with F2P model. So I do think ATVI has the skills to thrive in the new world. But we’ll see.

Video Games as Social Networks, and How EA Misses the Point

The market has been treating Electronic Arts (EA) and Activision Blizzard (ATVI) stocks rather harshly. A big part of it is the emergence of Fortnite, a free-to-play (F2P) battle royale game that’s taken the world by storm, and helped its creator generate $3bn in profit.

Investors who are long EA are counting on its new battle royale game, Apex Legends, to fend off this competitive threat.

Unfortunately, this type of thinking misses the point.

Fortnite is not about battle royale, nor is it about F2P. The disruptive part of Fortnite is turning traditional shoot-them-up games into a lively social experience, while broadening the audience beyond hardcore gamers.

All aspects of Fortnite’s designs, from graphics to game play to monetization model, fit together tightly to create that social experience.

Apex Legends on the other hand, merely copies Fortnite’s revenue model (free to play) and game mode (battle royale), without matching it to relevant product features.


Fortnite is more than a Battle Royale!

You don’t have to look very far to see that Fortnite is much more than a video game. It’s a social phenomenon:

• Athletes from basketball players to boxers have been celebrating with Fortnite dances
• Creatives like Carlton tried to sue Fortnite for its dances
• Carlos Santana had to smash a TV because his teammates were playing Fortnite during baseball games!

Why people play video games

Let’s take a step back and think about why people play video games. Common reasons include:

• Fill time
• For entertainment – this could be adrenaline rush or going through a story like in role playing games
• Get a sense of achievement - whether it’s solving puzzles or beating a stage boss
• Social needs – so they can interact with friends, or make friends through the game

The early generations of video games, say Super Mario, focuses more on the first three. There is a social component (kids talk about it in school or invite friends over to play), but in in general, game improvements are based on better graphics and fancier game play mechanics.

Then the internet came along, and we have multi-player online games such as Warcraft or Counterstrike, and all the sudden these games have more of a social component. Now you have to pick your teammates, strategize game plans, coordinate a time with your friends to storm some fortress. No one wants to let their team down, and the games are sticker because of that.

This is network effect in action. More players in the game means it’s more likely that my friends play, and the more my friends play, the more likely I’m going to play.

But a social network goes beyond simple interactions. In true social circles, people want ways to express their individualities, as well as build social status. Social circles also offer unique shared experiences that binds people together.


Fortnite as social network

This brings us to Fortnite. It has multiple elements of a social network - not just team play, but status signaling and shared experiences:

• Peer interactions 
• Play because your friends play - can’t let your teammates down!
• Or you can play with random strangers
• Shared experiences that people can talk about
• The Rocket launch in 2018
• Concert in Feb 2019
• But also ways to provide and signal social status 
• Game dominance = Bragging rights
• Your avatar can have its own unique attire (“skins”), including limited edition ones.
• Emotes/dances – these are great ways to express your individuality and sense of humour. Because earning these requires in-game achievements, they are bragging rights as well.

How Fortnite’s game features and monetization model both fit with this social function

Just saying “we want to build a social experience” won’t make it happen. Successful satisfaction of customer needs requires a suitable integration of product features and monetization schemes. And this is where Fortnite really shines. 

F2P totally makes sense given Fortnite’s “video game as social network” feel. To build a social network you want to minimize access barrier and maximize number of players. What’s more accessible than free?

To reinforce that accessibility, Fortnite’s cartoonish graphics broaden the audience to include kids and females. The game’s building mechanics also broaden the player base beyond just shooter fans. It drew in a class of gamers who likes solving puzzles.

In terms of monetization, Fortnite chose to monetize by selling skins/emotes/dances. These have no bearings on your competitiveness in the game itself, but are ways to express individuality and bragging rights.

Again, game features are fully consistent with monetization. The cartoonish graphics are aligned with silly dances, while 3rd person perspective (camera behind your character) means you can see the fancy clothes that you bought.


Now compare that to Apex Legends

Apex has copied two elements of Fortnite, the battle royale, and the F2P. But it fails to optimize game features to monetization while creating a social experience. As a result, this is just another game.

This article has a good comparison of Fortnite versus Apex Legend. Pay attention to various elements of the game (graphics, game play, perspective), and its implication.

• Perspective. Apex is also F2P and try to monetize by selling skins. But this is a first person shooter, so you only see the gun. This isn’t much incentive to dress up your avatars!
• Game play. Apex is more of a shooter, it doesn’t have the building mechanics, so gun skill is king. This limits access to a more niche group of players, and creates less of a diverse community.
• Graphics: Apex has more realistic renderings. While this is “better” graphics, it clearly caters to more of a mature audience, and will not work as well with humorous dances. This limits monetization through emotes.
• In-game events. So far I’m not aware of any.

Apex just put out its first Battle Pass (monetization). Not surprisingly, the feedbacks are disappointing across the board.


Conclusion

A disruptive business model has hit the video game industry, and it’s not about battle royale.

In Fortnite, Epic has found a way to do F2P to the tune of $3bn profit a year. That formula is to embrace the social network elements of a video game, complete with rare in-game events to encourage buzz, and with monetization tied to personal expressions.

Incumbents like ATVI and EA have to respond, but EA’s response via Apex Legends makes me wonder if they even “get it”. They seem stuck in the “let’s make the best shooter game we can and give it awesome graphics” mindset.

They better get it soon. Because Fortnite is here to stay.

What About Those Recessions? (From STOR's 4Q18 Call)

I bought STORE Capital back in mid-2017, right after news came out that Berkshire/Ted Weschler bought it. I remember reading the news at 10pm that night and got so excited that I jumped out of bed, stayed up all night researching, just in time to put in a buy order the next morning.

Since then STOR has provided good returns. More than that, I learned quite a bit about the real estate business by following a good management team.

The 4Q18 earning call was educational. You know one of these moments of mental clarity, when some one says something that (you thought) you knew all along, yet a light bulb just goes off in your head? It's one of those.

I had been thinking about cycles quite a bit, and STOR's CEO Chris Volk says this:

"So the first thing I would talk about is cycle, the notion of cycle, and this gets - a lot of analysts focus on the expansion cycle that this economy has been in for a long period of time and...somehow we must be getting near the end of the cycle..."

"...I think that this economy can grow at 2% to 3% at a margin, but inside of that 2%, 3% there's plenty of recession activity that's happening."

"...So if you were working for Sears Roebuck you might have thought you were in a recession, if you are working for Radio Shack you would have thought there was a recession.

Payless shoes I mean any one of the 9,000 retailers price closed toward and you would have felt pretty bad, right. A fewer in the oil industry, as oil prices plummeted in the Dakotas and elsewhere. And you are located in one of those states, you were thought there was a recession. 

So inside of that 2% to 3% growth there is a lot of kind of creative destruction that's happening that's buried in that."

Duh! Of course!

Instead of waiting/worrying about a big recession all the time, we're better off recognizing that mini "recessions" by sectors have always been with us. Its called creative destruction.

Sometimes real insight is simple and elegant, and right in front of you.

I'm not sure I can add much more without sounding banal. So I'll stop here.