In this episode of "Acquired," hosts Ben Gilbert and David Rosenthal engage with public equities investors Brenton Johns and John Bathgate from NZS Capital. They delve into the intricacies of semiconductor technology and the investment principles that guide NZS Capital, emphasizing the importance of resilience and adaptability in both company operations and investment strategies. The conversation covers the dynamics of the semiconductor industry, highlighting TSMC's pivotal role and the geopolitical risks it faces. They also discuss the concept of "complexity investing," where understanding the ecosystem and the interplay of various players like ASML, Intel, and Samsung is crucial. The episode further explores the idea that long-term, steady growth often trumps short-term hypergrowth, with the discussion touching on the significance of creating more value than capturing it, and how this ethos underpins the investment philosophy at NZS Capital.
"Welcome to this special episode of acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert, and I'm the co founder and managing director of Seattle based Pioneer Square Labs and our venture fund, PSL Ventures."
This quote introduces the hosts and the theme of the podcast, which delves into the stories of technology companies.
"Brenton and John are public equities investors at a hedge fund called NZS Capital, and they spend a lot of their time researching semis."
The quote introduces Brenton and John as experts in public equities investment, particularly in the semiconductor sector, and highlights their association with NZS Capital.
"Complex adaptive systems are all around us, right? That's what governs the world. That's how the world works."
This quote explains the prevalence of complex adaptive systems in the world and their significance in understanding how the world operates, which is central to NZS Capital's investment philosophy.
"They're optimized around resilience, around living as long as possible. Let's say it that way."
This quote emphasizes the importance of optimizing for resilience in organizations for longevity and success, which is a guiding principle for NZS Capital's investment strategy.
"Pilot both sets up and operates your company's entire financial stack."
The quote highlights the comprehensive financial services provided by Pilot, which is a partner of the Acquired podcast.
"Now, as always, this is not investment advice. We almost certainly hold stocks that we talk about on this episode."
The quote serves as a disclaimer that the podcast content is not investment advice and encourages listeners to conduct their own research before making investment decisions.
"We're really looking for this durable, resilient growth."
This quote summarizes NZS Capital's focus on finding companies that exhibit durable and resilient growth for long-term investment.
"We concentrate resilience. That's about 15 names and just over half the portfolio. And then we distribute optionality."
This quote explains how NZS Capital structures their portfolio by concentrating on resilient companies and distributing investments in companies with high optionality.
"We love resilience with out of the money optionality."
The quote captures NZS Capital's enthusiasm for companies that combine resilience with potential for high growth, termed "Root Mo" stocks.
"We fully expect a third of the portfolio to go to zero, a third to return capital, and really only like one or two companies at the sort of head of the curve are going to be this hopefully ten, 5000 x."
This quote describes the power law distribution approach to portfolio construction, which NZS Capital adapts for their investment in more mature companies.
"Well, once you accept the fact that all of life is governed by complex adaptive systems and the markets are also governed by complex adaptive systems, which means emergent behavior, you can't predict the future. You focus on adaptability. Then of course those complex adaptive systems tend to be governed by power laws."
This quote explains the relevance of complex adaptive systems to understanding market behavior and the inadequacy of traditional risk models.
"This has always been my beef when I was in business school with economics as applied to business and investing in the real world is you studied this stuff and you're like, wait a minute, I actually work in the industry, and this is not how it works."
Ben Gilbert expresses his past frustration with the disconnect between academic economic models and the practical experiences in the industry.
"But that's not really true. What you get is a lot of people going bankrupt and a few massive winners... So the average is not average."
Brenton Johns describes how individual outcomes in a power law system can differ significantly from the average, resulting in a skewed distribution of winners and losers.
"Conviction for us means, hey, I've done a ton of work, so I've got a lot of sunk cost, which means I've got bias. And I think that my view of the future is better than yours."
Brenton Johns critiques the concept of conviction in investing, highlighting its association with bias and overconfidence.
"The way we view team is our role is calling out bias in each other... But we all know that bias is really easy to identify in other people and really difficult to identify in yourself."
John Bathgate emphasizes the importance of teamwork and the mutual responsibility to challenge biases within the investment team.
"It's okay to be wrong and move on and fail quickly, versus string ourselves along on a three year journey on a tough position."
John Bathgate discusses the team's approach to managing the optionality portion of the portfolio, emphasizing the importance of acknowledging failures and adapting quickly.
"We look at some of these companies, we think the valuations are actually quite reasonable, and we choose to sort of bring the portfolio more towards resilience."
Brenton Johns explains the rationale behind including semiconductor companies in the portfolio, emphasizing their role in the information age and the reasonable valuations they present.
"So potentially, then, that's like classic optionality, right? We honestly don't know, but has a chance where either this stuff isn't that hard to do, and they have a two year lead on their competitors, or it's incredibly hard to do, and they do become one of these companies where they're doing something that no one else in the world can do."
John Bathgate discusses the potential of silicon carbide technology and Cree's position in the market, illustrating the concept of optionality in the semiconductor space.
"So for anyone who's used notion's awesome generative AI features and watched how fast that product has evolved, all of that was managed with Statsig."
The quote explains that Notion's development and deployment of AI features have been efficiently managed using Statsig, highlighting the tool's efficacy in managing fast-evolving product features.
"I think what steered us towards Cadence one is the management team. So Lip-Bu Tan at the time was the CEO... He was just so focused on the culture of the company... in terms of turning around the culture and really taking a company that was in a very difficult position in the financial crisis and really re architecting the product positioning of the company, and he's so customer centric."
The quote discusses the reasons for NZS's investment in Cadence, emphasizing the impact of the CEO's focus on company culture and customer-centric approach.
"It's mostly free, too, and from industry trade organizations. And it's a huge resource."
The quote suggests that industry trade organizations offer valuable and often free resources that can provide deep insights into companies, which are beneficial for investors.
"Samsung is very good at making memory... They have over half of the market share in DRAM, which is incredible."
This quote highlights Samsung's dominance in the memory sector of the semiconductor industry, particularly in DRAM.
"I think TSMC is more important than Apple. If Apple disappeared off the face of the earth... it really would not be as big of a deal versus if for some reason China moved to seize Taiwan or however it went into play and all of a sudden TSMC sabs were shut down..."
The quote underscores TSMC's critical role in the global technology landscape and the potential consequences of geopolitical disruptions to its operations.
"ASML is kind of on record saying they think that EV will last about 15 years in terms of... It will be an effective way to drive performance and like drive shrink, basically, is the way the industry kind of frames it is you'll be shrinking the transistor to pack more performance into a chip."
The quote explains that ASML's EUV technology is anticipated to sustain the progress of Moore's Law by enabling further miniaturization and performance enhancement of semiconductor chips.
"Moore's law is going now is it's not just about the transistor, it's really about the package." "You can actually split up chips into multiple chips called chiplets, which AMD is doing." "We are moving to a new transistor architecture, either a two nanometer or three nanometer, depending on which company you're talking about, to a gate all around architecture."
These quotes highlight the advancements in semiconductor technology that go beyond traditional transistor scaling, emphasizing the importance of packaging and new transistor architectures in maintaining the pace of Moore's law.
"Apple basically says, well, we've designed this logic board and we've designed most of the important chips, and we've situated them together." "TSMC manufactures it. They do all the packaging."
These quotes explain Apple's approach to integrating multiple chips into a system on a chip, highlighting the role of TSMC in the manufacturing process and the trend towards greater integration in the semiconductor industry.
"Who has higher operating margins, Texas Instruments or Microsoft?" "TI's end markets, two thirds of which are industrial and auto." "Nvidia's got close to 70% gross margins and low 40s operating margins, really, with very little cyclicality."
These quotes discuss the profitability of different players in the semiconductor industry, comparing companies like Texas Instruments and Microsoft and highlighting the success of fabless models like Nvidia's.
"That's exactly what I was going to say. I think it's really true." "TSMC said, oh wait, let's form an alliance with everyone because this is really going to take everyone to keep driving this forward."
These quotes emphasize TSMC's strategic move to create an open innovation platform that fosters collaboration and has become instrumental in advancing semiconductor technology.
"ASML's partnership with Zeiss, the Lens company, is also really special." "No one can do all of this. It's just way too hard. It really does take a village."
These quotes illustrate the complexity of semiconductor manufacturing and the necessity of collaboration among specialized companies to drive technological progress.
"Crusoe's data centers are nothing but racks and racks of a." "Because Crusoe's cloud is purpose built for AI and run on wasted, stranded, or clean energy, they can provide significantly better performance per dollar than traditional cloud providers."
These quotes describe Crusoe's business model, focusing on the use of clean energy to power AI data centers, which sets it apart from conventional cloud service providers.
"ASML, which at the time was like kind of a sleepy dutch company that had like a $20 billion market cap." "They partnered and actually bought 25% of ASML to inject capital into ASML to develop uv systems."
These quotes recount the strategic moves by major semiconductor companies to support ASML's development of EUV lithography, highlighting the collective effort to sustain Moore's Law.
"I couldn't find in our research, how much of TSMC does the taiwanese government currently own?" "Some things don't have a price at which they are for sale."
These quotes touch on the challenges of determining the exact government ownership in TSMC and the implications of such ownership for the company's strategic autonomy and market position.
"If you grow 20% a year for, like 50 years, like TSMC, you will destroy every group on out there." "So what you need for that is a negative feedback loop, right. So the negative feedback loop for TSMC is, I'm going to come in, I'm going to take what used to be the special sauce of your business, and you're going to trust me to do that."
These quotes delve into the investment strategy that prioritizes consistent growth and the creation of long-term value, using TSMC as an example of a company that has successfully implemented this approach.