Complexity Investing & Semiconductors (with NZS Capital)

0:00 Okay. Excitement. Fun. Brevity.

0:08 I love it. For brevity is the soul of wit. Who got the truth? Is it you, is it you, is it you Who we got the truth now? Is it you, is it you, is it you?

0:24 Me down, say it straight Another story 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. And I'm David Rosenthal, and I'm an angel investor. Based in San Francisco.

0:49 And we are your hosts. On our TSMC episode, one of the 65 sources that we used was an episode of The Knowledge Project with Brenton Johns and John Bathgate. Brenton and John are public equities at a hedge fund called NZS Capital. And they spend a lot of their time researching semis.

1:10 It was packed so full of great content. That I actually watched it twice to make sure that I understood everything. It was so good. Is awesome. And then in a wild coincidence, the very next week, even before we shipped the TSMC episode, David and I were at Capitol Camp great event organized by Patrick O'Shaughnessy and Brent Bishore.

1:29 And we ran into Brinton in person and I was like, I recognize that guy. What do I recognize him for? Very, very much so. So after like nerding out the whole rest of the event on TSM C, geopolitics, semis We decided to have Brenton and John on Acquired and on this episode. We actually didn't even get into semiconductors for the first hour since it was so fascinating to hear about their investment principles at NZS. And I've said this many times on the show, but yet again

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4:25 And just tell'em that Ben and David sent you. Now as always, this is not investment advice. We almost certainly hold stocks that we talk about on this episode. So do your own research, make your own decisions, but love the frameworks that we dive into with Brenton and John. So Without further ado, onto our conversation.

4:45 All right, well, listeners, we want to introduce you to NCS Capital, their investing philosophy. And Partially because we think they're a fascinating firm similar to Honam of Altos or Hamilton Helmer of Strategy Capital. But also the deeper David and I have

5:01 dove down the rabbit hole the last week of reading all the papers they published, we feel like we've gotten a lot smarter. And so We basically just wanna expose the world to uh More and more of that. So Brenton and John Welcome. Thanks.

5:14 Thanks for having us. Well First. Let's start with complexity theory, which is uh concept that your whole firm is based on and you've published a

5:24 forty seven page paper on that is just A full of fun little graphic, but B I think probably has Five to eight. kind of mind blowing concepts in them. And the first one is You come right out and admit that you don't know the future. What's going on with that?

5:40 You would be bad marketers as VCs. No, I mean, look, the whole investing philosophy comes out of a lot of pain, right? So we were investors for a long time. We are wrong a lot. Like all investors are wrong a lot. On a consistent basis. And we're just looking for a better way to think about things. Somebody suggested

6:02 This book to me called The Origin of Wealth by Eric Beinhacker. And sort of serendipitously at around the same time, someone suggested complexity by Mitch Waldrop to Brad. And we both Read those books and

6:15 Origin of wealth was a slog. I think it took me six months to really get through it. And then swap books and started thinking about sort of a different philosophy. I'd heard a little bit about it Complexity theory and the Santa Fe Institute, which I want to get into. I think Bill Gurley talks about this fairly frequently and uh Michael Malvison and That's how I kinda originally got turned onto it. But tell us a little bit more about

6:37 What is it?'Cause you know it's It's not at all about investing. It's about the world. That's right. Yeah, in fact I think it was Bill Gurley that recommended complexity to Brad. Complex adaptive systems are all around us, right? That's what governs the world. That's how the world works. We don't know how the future is going to unfold because these system is interacting together and it creates what's called

6:59 Emergent behavior and emergent behavior makes predicting useless in most cases. And we can have guidelines and heuristics and those are all helpful. But As far as exact outcomes and what's gonna happen in the future. Those are a lot more difficult. Santa Fe Institute started with a group of scientists from the Los Angeles National

7:17 labs and they came together and they were mostly physicists and they started talking to economists. It was sort of hard sciences and soft sciences. And the physicists were like, Hey, economist guys You guys seem really smart. But you know your theories. They don't work. Like your all your math doesn't work. So what's up with that? Like, you know, with our math, it's extremely precise. In fact, you know, when the math is off just a little bit, Einstein's like, Oh, your math is off. The Pluto should really be here and comes up with a theory of relativity, right? We it's like we we literally made the atomic bomb, like it works. Yeah, it works.

7:47 And so they started coming together around this idea of complexity. What is complexity? How do we define complexity? Where does it sit? And because we are living in this complex adaptive system. How do we think about The future. How do we think about life? How do we think about going forward? And for us

8:04 This sparked an interest in Biological systems and we found this sort of biology vein. Much more interesting than the traditional economics variant. And much more applicable to investing than the traditional economics bank.

8:16 Oh, that's so cool. And am I right that Yeah, actually When to the Santa Fe Institute and took courses there? Like how deep did you go in this? We did.

8:25 Like a lot of rabbit holes we go down very deep. We quickly became members of the Santa Fe Institute. They call it the action. group. It's this group of non scientists that are allowed to sit in on a lot of the the science and and so then we took this complexity course over A weekend Brad and I did at Stanford. And that was just a ton of fun, actually. John and Joe, the two other investors on our teams, they took a longer course. They actually had to do real work.

8:48 Bride and I didn't have to do homework. But we just learned so much. And I remember sitting outside of this cafe at Palo Alto with Brad and we just sort of been at this course with Deborah Moore, this lady that teaches at Stanford, who studies ants. And I thought Man, this concept of resilience is really fascinating.

9:06 You know, it's really more about resilience than it is about predicting the future and and it's about adaptability. Biology doesn't really care that much about the future. They care about adapting to this wide range of futures. My bees don't really care if it's gonna snow tomorrow. They can adapt to snow. They've learned how to do that over millions of years. And what if we looked at companies like that?

9:26 And so then, you know, of course. We kept reading, we kept writing. This is probably Twenty eleven, twenty twelve, and then in twenty thirteen we published this long paper that you referenced. Which is super geeky, but it's got a lot of pictures. Because that's the way we think.

9:38 You've got the back to the future DeLorean in there. It's got the DeLorean. Like what more could you want, right? We really are hoping for a DeLorean for the office. That's our dream office furniture. On the Known of Ants, this is probably the first and best example of an extreme version of resilience in an organization. Can you share the insight you had there? Yeah. We attended this class by Debora Gordon and she has been studying this group of ants for thirty years in New Mexico. They obsess over this group of ants, right? And they know what every ant is doing at all times.

10:10 And what they found was really fascinating, they found that about half the ants in the colony weren't doing anything. They were just sort of sitting around and then they had half the ants doing these defined jobs. And that's very counterintuitive. We think of ants as sort of the ultimate productivity machines. But it turns out ants aren't optimized around productivity. They're optimized around longevity. They're optimized around resilience, around living as long as possible. Let's say it that way.

10:33 So that was really insightful for us. We thought, man, all these companies are optimized around productivity and Wall Street only makes it worse because we're obsessed over quarterly earnings. And so what if companies were really optimized around this long term thinking? Of course, we see that with lots of companies. Most of them tend to be run by founders, because founders have a lot of skin in the game and they think long term. But There are CEOs that think that way also.

10:57 We know that the average tenure of a CEO in S P five hundred is less than five years. So they're not optimized like ants are. They're trying to get uh a lot of return really quickly. But companies that take this long term view are so much more interesting. When I read that in your paper the thing that hit me over the head I was like oh This is Warren and Charlie's, you know, laziness bordering on sloth. That's exactly it. The goal is not productivity. The goal is

11:22 Long term steady returns and resilience. I think Warren's trying like rock this very early, and you know, there's a lot of science behind it and math, but they don't need that. They're so good with Folksy Wisdom. So then the thing that hit me, of course, I'm like, Well a company's not gonna have half their employees sitting around doing nothing. But just as a fun thought experiment, what if a company only was growing at half the growth rate of a high growth company? But, you know, it's a marathon out of sprint. They could do that over forty, fifty years instead of thinking in these five and ten year time horizons.

11:54 Do you have any good anecdotes on uh I know you have this firm belief that uh hypergrowth is bad and actually slow, very long term compounding growth is the real holy grail. Yeah, I mean I think what we're generally looking for is we kinda use group on as an example, whether that's fair or unfair, of like we're not looking for the next company to hit X revenue run rate in the shortest period of time or whatever it is. Like we're really looking for this

12:18 durable, resilient growth. And I think the the way you framed it, Ben, that If the company does have employees. That aren't driving the I guess level of growth that Yeah, we'd be seeing it a hypergrowth firm. That's okay, as long as it's hyper durable. And so you could look at

12:31 I mean like a Danaher are kinda like some of the classic iconic growth companies that have compounded for decades. And that's generally where you see the compounding. It says obviously you compound it ten to twelve percent a year, or in the teens, but you can do it for 10, 20, 30, 40 years, you can just get tremendous value creation. So I guess some companies in the portfolio we admire. That do that. Maybe someone like Texas Instruments where they have a really decentralized culture and they actually push responsibility and decision making down into the deeper parts of the organization. And so the CEO is not really a manager. He's a capital allocator. He almost has to think more like an investor and a portfolio manager than, you know, an operator. And so I think that's what we really look for.

13:09 is companies that can provide this durable growth. Again, it's very buffet like we're hopefully finding companies where you can just set it and forget it and they're gonna put up moderate to healthy growth for ten, twenty, thirty years and in our framework, which we can talk about around Resilience and optionality, that's what we're looking for in the resilient bucket of the portfolio is these companies that can really compound it a at a healthy rate for for a very long time. Yeah, so You guys have these

13:32 Two concepts and then one kind of super concept that combines both of them of resilience and optionality that you look for in investing and Neither of those are terms that most investors are familiar with. Can you define what you mean? Bye.

13:48 Both of them and maybe give a few examples of companies. Sure, on the resilient half of the portfolio. We kinda say, You know it when you see it, which I think is kind of an unsatisfying answer. But John, what we're looking for are companies that are further along, kind of in their S curve and their growth trajectory. And so this would be companies we own and the head of the portfolio would be someone like a Microsoft or a TSM C, where we're not looking for value stocks or kind of like cheap companies. We're looking for companies that are healthy growers that we think can durably grow for the next twenty or

14:14 thirty years and our turnover in this half of our portfolio is around ten percent. So this is Hopefully it's I didn't forget it part of the portfolio. And so they know a few characteristics we tend to see in that part of the portfolio. Or ignition criticality and switching costs, which I know you guys cover well. And some of the deep dives you've done.

14:30 I mean just scale, like T S M C we can talk about in in more detail, just like a classic scale company where we talk about power laws in our investing framework and pockets of industries where one company can take ninety to ninety five percent of the profits in a given industry and TSM C is a great example of that. And then you exactly the way you guys laid it out so well. on your episode on TSM C is you really get the flywheel going, right? Where the more scale you have, the more you can reinvest, the more you can impact your customers, and it just becomes this beautiful compounding machine. the last bucket we probably would see in the resilient part of our portfolio is just network of effects based competitive advantages, where you see companies that really hit their inflection point. And again, especially in digital markets, you'll tend to see a handful of companies or potentially one or two companies take most of the economics in a given market, like digital advertising or

15:13 smartphones or there are just so many markets where there's, you know, one or two players that have eighty to ninety five percent of the profits. And so we tend to see those in the Resilient part of the portfolio. Well and one thing. I think was really counterintuitive.

15:26 About how you guys think is You're actually not looking for moats. the companies you just described and I think a lot of investors think about like oh wow well like they've got really deep motes and so of course you want those as your, you know, long term compounding holds, but You guys have a little different perspective on this, right? Yeah, we have a little bit of a different take, and so I don't wanna offend anyone that uses the term mo because I think it's a great term and it's a great part of anyone's kind of investing toolkit.

15:50 But I I guess one of the things that we're careful about is like looking for companies where part of their moat is inserting themselves into the value chain or into their customers' share of wallet, basically. Where they put themselves in a position to extract as much economics as possible. And so I think that can be viewed as especially in kind of a uh more of like an industrial age view of how competitive advantage has evolved is is that something that that we try to avoid. We're not trying to look for a company where

16:15 They feel like they have customer lock in and then all of a sudden they can raise price three to five percent for the next ten years. part of our framework and the reason we name the firm NZS Capital is we're looking for non zero sumness. So looking for a win win outcome for all constituencies across kind of the value chain that includes a company's Employees and their customers and also kinda society and the environment. at large. And so we're just careful looking for companies where all of a sudden if I have this moat, then I can screw my customers over the next ten years, right? I think that's what we're careful about. I noticed

16:44 I don't think you guys hold Apple, right? But you do Some of the other large tech companies. And this feels like a perfect example to me of like, oh, Apple, like incredible modes. They're getting pretty good at value capture over there. Yeah. Yes, that's a very nice polite way of putting it. Y you obviously see it with Spotify in the U and Epic here in the US and

17:03 Being in the news flow constantly. I I just think When you get to a point where you're taking so much economics for your business, which already has the largest market cap. in the world that your key partners on your platform are taking you to court or Taking you up to various regulatory bodies or writing white papers on how you're screwing your customers. That's just what we're trying to avoid. And who knows? It might work out perfectly for Apple over the next ten years. It makes you less resilient. Yes, exactly.

17:26 Is that the idea that if there's consumer surplus money left on the table for consumers where they're not getting every dollar extracted that they could by the company, that that company is more resilient over time, even if they're not making every profit dollar and growing as quickly as they could today? I agree with that. I mean if you really have a management team that's thinking really long term, I don't know why you wouldn't give up a little bit of extra economics for your key partners, whether that's suppliers or developers. on your platform or your customers. To really solidify your trajectory over the next 10 to 20 years versus I don't want to pick on Apple too much, but like what's the gross profit impact if they cut their app store.

18:02 Take rate from thirty percent to fifteen percent. across the board, what is that, like five percent of gross profits? It's meaningless to them and it would create so much value. There's obviously knock on effects of that. But anyway, I think that's what we're looking for is as companies that are paying it forward. Like again back to the T S M C example,'cause you guys covered it so well. CSMC has lower gross margins than most of their customers. And so at any point, they could probably take their margins from fifty percent to sixty percent and say, Hey, I'm obviously have a monopoly in this market. But the way you know Morris Chang architected the culture there

18:29 is on you know long term value creation and really creating a platform for their customers to create massive You know, amazing businesses. And so I think that's the way we think about it. Yeah, and just for listeners to put some numbers behind this concept, which I think is just great from this NZS white paper. 15% growth over 10 years would deliver more than a 300% return. Not bad. But fifteen percent growth over fifteen years would almost double the ten year return.

18:55 If we could populate our top twenty positions with these types of resilient companies, we'd only trim and add around periods of volatility. All the the real absolute dollar value of compounding shows up in the out years. So you just want to make sure that you're still compounding in the out years. That's right. And it's sort of where we take issue with Porter. This is of course Michael Porter competitive strategy, Porter's five forces. Thank you. Yes. Um if we take a cynical view of Porter

19:21 A lot of people have interpreted uh hey, build a mode around your business and then stick it to your customers on price, right? I'm not saying that's what he said, I'm just saying that's the way it's interpreted. And that's a terrible way to build a business because eventually someone will undercut that and offer actually a better value problem. to the customers and because all of this value are in the out years. It was really not a value maximizing way to run the business either. So we think this concept of creating more value than you take is really important. And and Porter agrees. He actually revised his

19:51 thinking and in in twenty nineteen. wrote a paper at Institutional Vester called Where E S G fails, where he talked about this concept of shared value. And that's not him trying to say that purely because it's good for the world to care about all your constituencies.

20:07 you know, not just your shareholders, but also your customers and partners. He's literally making an economic argument for shareholders that that's the long term value maximizing thing to do, right? I think that's right. And you know, he was a consultant for Intel. back when ARM processors were starting to come out and actually dominate the mobile space and they came out with this sort of Dumped down processor.

20:27 The Addam? Yeah, exactly. But even before that they came out with a cheaper version of it. But in reality, that's not what they should have done. They should have actually embraced a totally different business model like Armdead, where they were just selling IP and and enabling a whole ecosystem. Instead of trying to take all the profits for themselves.

20:44 Okay, so that's the Resilience. Side of N C S thinking and the portfolio. Then you also marry that with

20:53 Something very different. Tell us a little bit about optionality and how you think about that. Yeah, really we're thinking about the future. We're just thinking about How broad and safe is the prediction we're making? So we can make these very broad, safe predictions like we think electronics are gonna push deeper into the world, right? I think In nine out of ten copies of the multiverse, that's happening.

21:12 But There are other predictions, like we think E Vs are gonna dominate the world and Tesla's gonna be the power law winner inside of E Vs. That may only happen in two out of ten copies of the multiverse. No, it's certainly not ten out of ten.

21:25 So these predictions are much narrower. And the range of outcomes is much broader. It's so That doesn't mean we can't invest there. Because it's incredibly asymmetric if we end up being in that copy of the multiverse.

21:37 But if we're not and it's a zero, it also doesn't torpedo the portfolio. So I feel like actually you guys could give the master class here since you're such great Venture capital investors. But that's really what we're trying to expose ourselves to and these earlier stage public equity companies.

21:52 And so how do you actually then apply both of these very different principles inside the same portfolio? Are you picking some stocks Because You're maximizing for Resilience and you say that look, this is a great

22:08 compounding slow growth but durable company. And then there's other companies that you're investing in because you say, Oh my gosh, if this thing's right, it's gonna be really right. Like venture capital asymmetric upside right, or is it blended in some of the same companies? Yeah, you're right. It tends to be these two portfolios in one. So we concentrate resilient, that's about fifteen names and then just over half the portfolio.

22:32 And then we distribute optionality. So that's about forty names. Also just under half the portfolio. Max position size one and a half. And in the middle it's between one and a half, two and a half, one and a half, three. We don't own anything. And that's percent of the portfolio. Thank you very much. Percent of the portfolio. I say this stuff so much, sometimes I don't complete the sentences.

22:52 And then sometimes we find these very resilient companies that are actually layering on optionality to the business. So they have both. They have this resilient base, but then they have optionality on top of that. And you call those companies. Rootmoes. Yeah. We're such geeks. It's so bad. Uh for resilience with out of the money optionality. It's just a shortcut on the team that we use.

23:13 And those are the companies that you bump up to Seven, eight percent of the portfolio, right? Yeah. What are some examples of those? Well, I mean, sort of there's a couple, right? The classic example would be Amazon in ninety seven when they went public, you know, I think around a billion dollar valuation, nobody could have foreseen AWS, right? That wasn't anybody's DCF. Oh yeah, they're gonna also create infrastructure that everybody in the world's gonna use create businesses. Sounds so silly, right? But another one that we had in the portfolio years back was eBay.

23:42 I don't know if you guys remember the marketplace business was struggling. They brought in a new CEO, John Donahoe. they had PayPal and really you weren't paying for any of PayPal if the marketplace business would recover that more than cover. the cost of entry. Course. Marketplaces did recover. Paypal ended up being great. John Donahoe's an amazing leader.

24:01 And that was a classic rootmost stock. So in that situation, you've got a fairly resilient business, or the hope is that the marketplace is a resilient business, and then PayPal is the out of money option that you sort of have that's being valued at zero, but clearly is a a very valuable business. That's exactly right. Well I think what's cool about this yeah, right, this makes a lot of sense in investing. This also makes a lot of sense in how you should run your company. Yeah. And that the best CEOs

24:30 Think this way. as a how do I create resiliency. And my core business, but then what are the options that I'm investing in for the future on top of it? To my mind, there's no better example than Amazon. I've just

24:42 This is the whole operating philosophy of the company, right? So we love this concept because we think it's true in the universe. And so therefore the narrow slice of investing that we're using it for, we're pretty sure is also true. But it works really for everything. I mean It works for parenting. Parents don't know what we're doing. Like I have four kids, I have no idea what I'm doing. So I'm just trying new things all the time. Well, that didn't work. Okay, well it's uh you know, so there's a l optionality evolved too. And then sometimes your optionality becomes resilient. That's what you're hoping for. But you just try a lot of new things. So I don't know, for us it's a life philosophy. Fantasy football is another area where I can like you can apply resilient and optionality very well, actually.

25:18 You can't get out of your head once you start kind of practicing this. Which is so funny. All right, I'm gonna take us in a totally different direction. I want to talk about the difference between normal distributions and power law distributions. And listeners of the show who are in venture capital or in startups and have tried to raise venture capital or successfully raised venture capital will know You know, they get this answer from VCs all the time that our portfolio construction is really a power law.

25:42 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 gonna ten, fifty, hundred X that sort of gets us a great return regardless of what else, you know, happens in the portfolio. You guys, interestingly, are sort of applying that thinking at much later stage companies, hopefully ones that aren't going to zero, you know, the way that a frail 10 million dollar valuation startup could.

26:10 How does that work and what was the insight that made you realize Hey, the world is not normally distributed. Actually in certain scenarios, it's very power law distributed. Right. 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.

26:32 Then Of course. those complex adaptive systems tend to be governed by power laws. So it's sort of a natural follow on. But the insight here is

26:41 All risk models are based on these Gaussian these normal distributions, right? But in fact the world doesn't work that way. And so there's a really fascinating economist named Ole Peters. Who's done a lot of work here and said Wait a second. Uh, your wrist models are sort of like airbags that go off at stop signs, but not when you get in a crash.

26:59 Right. This has always been my beef, you know, when I was in business school with economics as applied to like business and investing in the real world is you study this stuff and you're like, wait a minute, I actually work in the industry and this is not how it works. Right, exactly. And and being venture capital investors, you see this all the time. With public companies, it's also true. There are a few big power law winners. We see them in the market today. They're driving the entire market, right? This is our reality.

27:27 There's a great study that you guys reference in the Paper that I'm wondering if you could Just talk a little bit more about it. The toy example of a coin flip. A coin flipping contest.

27:37 Where Let's say you win fifty dollars or whatever, when you lose, you lose forty. That sounds like investing to me, like there's an expected return of ten percent. What actually happens when you run that contest?

27:51 Wait, real quick before you answer. Is it that is it win fifty dollars, lose forty, or is it fifty percent. Oh, it's percent. Oh, okay. Yep. So if it's a hundred dollars then yeah, you're right, David. It's fifty down forty percent.

28:04 Got it. Okay. Yeah. The concept it gets to the heart of modern portfolio theory and expected utility theory. And the flaws of that. So back to the multiverse. The way this works is if you had a hundred people flipping coins and they did it for enough time, you would actually see a nice, steady positive return.

28:20 And that looks like on average the experience of the Chrisman is winning. But that's not really true. What you get is a lot of people going bankrupt and a few massive winners, sort of the buppets and the soroses of the investing world. Right. So the average is not average. And in one portfolio theory you're taking an ensemble of all these, but that doesn't really make sense because I don't really care

28:41 About Your outcome, David or Ben, your outcome. I care about my outcome. And I I only get to live in this one universe. I don't get to live in yours. You know, I don't get to live in the multiverse. So my outcome on average is that of loss. It's that of bankruptcy. So when the time average

28:56 Does not equal the ensemble average. That is called a non ergotic system. And you guys can put in the show notes Olay Peters works on this. It's super geeky but really fascinating. Oh it's so cool. Well this is so counterintuitive. You would think if you presented that game to me, I would be like, Oh, for sure I want to play that game. The odds are stacked in my favor. But most people who play that game will lose and then a few will win really, really, really big.

29:21 That just blew my mind reading that. Yeah, the distribution set is not normally distributed. It's power law distributed. And so that changes everything. And that's why all these risk models are like airbags that go off at stop signs, right? It's because It turns out the world doesn't work that way, so You know, we hear on a regular basis, Oh, this was a three standard deviation event, you know. Which if you understand the math of three standard deviation events, you expect, Oh wow, I'm so lucky to have seen one of these in my lifetime. But we see them a lot, according to the media. And so that's sort of ridiculous.

29:50 Ninety nine point seven three percent of all events should fall within three center deviations. This is the way the math works. Meanwhile, I mean, I've been in this business for thirteen years and already been through two recessions that are way outside of three center deviations. Britain has as well. And so it is just kind of a funny kind of common sense thing that when you're practicing this stuff that the normal distribution Doesn't really make that much sense. Brittany mentioned I took this course at the Santa Fe Institute. It was actually around this time. Last year and like I mean his power laws are just like so cool. It's amazing. I mean one of one of the examples we use in the white paper.

30:21 is um if you plot like earthquakes by frequency and intensity that just like in nature naturally forms a power law which actually makes a lot of sense. You're gonna get, you know, one or two or three. Heavy magnitude earthquakes a year and then a lot of small ones. But also if you plot the frequency of every word in the book Moby Dick That actually also forms a power loss. The is mentioned fifteen thousand times, and then the next word is an, and that's like seven thousand times. And then there's like this super long tail of words that are only You know, used you know, a handful of times. Again, it's one of these things, once you see it, and it's amazing for studying companies, obviously, like we mentioned, especially in kind of digital markets, because

30:54 The world is going towards more markets where a winner can take all and you know becomes much more of a power law dynamic. And so that's why we just always have our kind of antennas up for these power law dynamics. That's honestly a big part of When we're looking for optionality, that's what we think about is like is this a company that is relatively earlier stage in public markets that has the opportunity to power law, you know, a large market? Which is why of course you're making forty Diversified. optionality bets here because

31:18 It's funny to think about this, but The statement of Let's go back to the stop sign example. Yeah, the vast majority of the time the fact that these airbags don't work is totally not an issue. But it's a massive issue the moment that you need them the most.

31:31 Very similarly, all of the gigantic outsized economic value is created from the three, four, five, six, seven sigma events in the world. And so It's kinda ludicrous to be like, Well, the vast majority of the time this investment philosophy is very sound.

31:48 And you're like Yeah, but we're not really trying to index on how many days out of the year it sound. We're trying to index on how much value can get created at the end of the portfolio 50 years from now. And that's going to be driven by the outliers. So we have to be prepared and fulmize Around the outliers, not Close our eyes to the few days that they might exist.

32:10 That's such a good point. I'm really glad you brought it up'cause what we're really playing for are now finality, half the portfolio. It's asymmetry and and really it's not about batting average. Like it's okay if we're only right thirty percent of the time, which is not intuitive at all for public markets investors. I think. I think everyone wants to be right fifty five percent of the time, sixty, whatever, it doesn't have to be that high to have. good long term returns, but you know, we're playing for slugging percentage where even if only one out of three work, but you know, those are multibackers and can really create a lot of value over a long period of time. And that's like the beauty in that half the portfolio. And we've seen it. We've been doing this for years now. And it is amazing how you see these companies emerge as as value creators and and generate a lot of value for the portfolio out of relatively small starting position sizes.

32:48 It gets back to this whole idea of you don't know what's gonna happen. If you set everything up with the idea that you don't know I think in a lot of ways. Most Venture capitalists.

33:00 Grok this idea and set up their portfolios in this way. But I think lots of people, myself included in the past. Didn't fully understand this. You say in the paper I think you use nicer language than this, but I'll use my own language. This is my quote. That conviction, this idea of conviction that so many people in Venture talk about and entrepreneurs and like I've conviction, I'm convicted that which Convicted means you're convicted of a crime, but anyway. I'm I have conviction that in this company I'm gonna lead this investment.

33:29 Conviction is kinda stupid. Conviction is saying I think My view of the future is gonna be right. And really what you want is optionality and like you need people to have conviction'cause otherwise there would be no entrepreneurs, right? That example of the coin flipping contest, that is exactly

33:45 The dynamics of becoming an entrepreneur. The expected value is positive. And yet the vast majority of people who start down that path Go bankrupt. And then a few people win really, really, really big. But when you're constructing a portfolio, what you actually want is a lot of those bets. You guys have, you know, thirty, forty optionality names in your portfolio as a venture fund. You want thirty, forty quote unquote names in your portfolio. Venture portfolios with five or ten.

34:12 Are very non resilient. Yeah, that's right. I mean we use conviction as a synonym for overconfidence. I think that's what Really Is the right way to think about it.

34:23 Conviction for us means Hey, I've done a ton of work, so I've got a lot of stunt cost, which means I've got bias. And I think that my view of the future is better than yours. That is literally what you're saying when you say that. Yeah, right. So who knows, right? What we're trying to do with the tail of the portfolio, and I think what you guys are trying to do in venture capital investing

34:43 is maximize the probability that we get lucky. I just ripped that off for Balbison. He's very good. at calling it what it is. And we're just trying to maximize the probability that we get lucky. I also think I mean. Just changing your mind is the hardest thing to do as an investor when you're wrong. And I think if you kind of stand in a row and say, This is my highest conviction idea, it just makes it that much harder to Brent's point on just like introducing bias into the equation.

35:06 And so and I I also think if you kind of invert it. I think it's fine to have an optionality position that you actually don't have that high of conviction on. Like to Brent's example on Tesla, like I don't think that we have Super high conviction that Tesla's going to power law the E V market, but is there some probability where they do that and it's you know worth Yeah, multiples of what it is today. Sure. That's the way. That we kind of think about conviction and again

35:26 I don't wanna piss anyone off that uses the word conviction, similar to boats, like it's fine, everyone has their own process and we're not trying to like push what we do on anyone else. This is just what has worked for us over time and so thing we're very careful about is just introducing bias into our process and luckily we all Everyone on our team knows each other well and can call each other out, but I do want to be a little careful. Well I have two points to make that this cultural one I think is the second, but let me start first with

35:48 At the end of the day, this is a buffet concept. This idea that it's better to be approximately right than exactly wrong. That's another way to describe this optionality phenomenon here where It doesn't sound nearly as strong to stand up in front of an investment partnership and say I have very little conviction in this, but it could totally work. And if it does, it'll be really big. That's about the best I can tell you right now. That does not get everyone around the table excited, but in a very buffet sense,

36:16 If it works. It's gonna be so freaking successful that this is a great price to own it at. And like, do I know if this is the right price to own it at? Not at all. How many versions of the multiverse do we have railroads? Like all of them, right? And they're important. And where can we how can we recreate that? We can't. It's impossible.

36:35 And so I think you're right, Buffett and Munger say this so easily, so naturally, and we're just saying it in a much more complicated way. That's the second point I'm curious about is what are some guardrails that you have in the internal culture? to reward Non conviction. to reward like, yeah, I don't know, but it could work. And if it does, it could be really big. And here's why it could be really big.

36:56 Well, the funny thing is, um, the way we view team, so we think investing is inherently a team sport. It's a terrible solo sport for the most part. And the way we view team is our role is calling out bias in each other. Now these are uncomfortable conversations because nobody likes to get their bias called out, but we all know that bias is really easy to identify in other people and really difficult to identify in yourself. And so by opening yourself up to having being called out. Then

37:22 Your probabilities go up as an investor. So it feels unnatural to us at this point to say I have super huge conviction that this Microcap stock is gonna rule the world one day, right? It's like that would feel really odd. Everybody was like, Are you okay? Feeling all right. I think the way we've also

37:39 set it up with our our framework is we just inherently expect failure, I think, more than other public markets investors might. Like if we Put something in the optionality tail of the portfolio, and by the way, that half the portfolio turns over a lot more quickly than the resilient part of the portfolio, which makes sense. Like we are going to be wrong. a lot. And luckily there's smaller positions and so you're not going to torpedo the portfolio as long as The most important thing to do is just admit you're wrong and move on. And so I think Building that into the culture where

38:03 You know, it's okay to be wrong and move on and fail quickly versus like string ourselves along on a three year journey on a tough position. And so that's one cultural way that we've architected the way that the team works together that has really helped. It basically gives yourself a license to take some risk that maybe you otherwise wouldn't Take if you were sitting on a different team or within a different organization. And do you try and document here's the reasons why I'm making this optionality bet so you know you can decide to rotate it out of the portfolio if those reasons are no longer true. Yes. Everything's written down and actually Brad

38:35 Which is an investor on the team is amazing at pulling the stuff back up and saying, You said blah, blah, blah. He must be really popular on the team. Oh yeah, he's great. We love Brad. He's just very good at like remembering and then pulling the source data and saying, Hey, look, you've drifted. To your guys' points too like it's not Is their operating margin exactly? twenty two percent this year or like as a revenue exactly if this renovate with autobiography is like are we approximately right on the thesis, right? It's not like we

39:01 But you can certainly have checkpoints along the way. We call those usually with any stock there, I think there's usually three or four things that really move the stock, as we call th those key leverage points on any position. And so you can generally check in on those and make sure that We're on track. questions are things that didn't quite make sense to me.

39:19 in reading your paper. Can you talk about what you do? with your Optionality. part of the portfolio as things evolve.

39:29 Exactly. And how you Start an optionality position. There are two copies of the multiverse where this works. And then X amount of time passes and

39:40 You start to have more of a view of which copies uh you know, two out of ten, and now, you know, maybe it's like two out of five or two out of three or like, you know, a as it evolves, what do you do? Exactly. There's like kinda two scenarios that you can really see this happening. is be on Peloton before the pandemic. You know, and the stock obviously went parabolic. They were a huge beneficiary of

40:00 work from home, but it's also just a really dynamic company, you know, that's early in its life cycle building a brand and a platform. And so with a company like that. Yeah, I think it's still early days to call that business resilient for many reasons, both just like the context of the company of where going through a digestion after the twenty twenty kind of a record year for them and off the charts year, I should say. So for a position like that, we'll just trim it and you know we have this cap of how big in the portfolio we allow optionality positions to get. it's generally pretty clear, like, how much of this is something that's a really durable inflection in the business. And sometimes I guess it is both. Like I think Peloton is definitely a different company in this version of the universe versus the non Covid version of the metaverse, right? But I I think we can't cross it over. Well, this is so different that you trim it. You know the canonical V C wisdom is

40:43 Ride your winners as long as possible. You know, the things that are working are likely to continue to work, so don't sell. But that's not the approach you guys take. Yeah, it's a really good question. We talk about it a lot,'cause you're certainly, in some cases, leaving money on the table, I think, if we're not letting our compounders really express themselves over time. And so There are stocks we will let them we'll own them earlier in their life cycle and let them cross over in the resilient head of the portfolio. And so we'll do that. a few times a year. And I think it does kinda force us to average up if the company Yeah, and actually buy more stock, potentially at multiples higher than our initial purchase. Oh, it's so hard to do. It's so hard to do but I think it's actually I've thought about this a lot. This is actually

41:19 kind of part of our process where we're kind of forced to do it, which is really helpful because otherwise it's harder to just look at the stock and buy more, but we're saying We're making this explicit decision that we're gonna take this from a hundred and fifty basis point position to two hundred fifty basis points. And so we're gonna add capital because this business has structurally changed and actually belongs in the resilient bucket of the portfolio. And so there are companies where we've done that where they're honestly just more mature or they're becoming like more of a platform. You can actually see like the network effect starting to hit. And honestly Some of that is a valuation conversation also, that there are plenty of platform like companies we might want to own in the resilient part of the portfolio, but in the current market environment they're trading it. Valuations that we would not consider resilient. And so that's another reason we would own them as optional positions. But it's a really good question. And I think

41:59 What we try to do is not make sure that an optional position ends up in the head of the portfolio because that's something we've just learned. The hard way that, you know, if you have a stock that can have a fifty but seventy percent drawdown, you know, and it's the starting point is a five percent position. Not only does it crush your performance, but then you're also probably hamstrung where you've got a stock that's still a really big position and you don't really want to add to it, and then you just kind of have to have to take your licking. And so that's something that we've learned through experience. Yeah. Well I'm wondering if

42:24 even just thinking about this past two year COVID cycle. You've kinda seen this happen. The stocks that were huge multiverse winners in the beginning, the Pelotons, the Zoom, CDO, and the like. I'm thinking Zoom. You know, Zoom went from I don't know what, seventy, eighty dollars a share to six hundred dollars a share, and then back down to, you know, the I think it's at like two eighty right now. So you've kinda seen this happen, right? The optionality.

42:50 Played out, that was correct. But then Returns pulled back. We're always looking at like what's happening to the range of outcomes. Is it widening? Is it getting broader? Is the prediction becoming safer? Or is it remaining narrow? So with a company like Zoom.

43:05 It looks a lot to us like a feature. So now the question is can it become a product and eventually maybe a platform? Can it develop an ecosystem around it? We don't know. But to take your example, let's say in the middle of the pandemic, it was just sort of a cool feature. It was better than everything else out on the market. Still is. And then this big ecosystem came around it and it became a full blown platform.

43:24 Well then the range of outcomes. would narrow and the prediction would get safer. Right. And so then that would warrant that becoming a bigger portion of the portfolio. Valuation is a key piece, and this is the piece that we get every day as public investors. And valuations, expensive valuations, force predictions.

43:41 I have to believe a lot more at ten times sales than I do at ten times earnings. So we're seeing okay What is the prediction of the company and what is prediction the market is forcing us into? And are we comfortable with that? So we are in an unprecedented investment climate where everything on a you know whatever basis you wanna revenue multiples, earnings multiples, unprecedented highs. Any asset you could invest in, be it

44:04 Stocks or Farms or crypto. is forcing you to make predictions. And What I've heard this whole podcast so far is you actively avoid trying to make predictions. So how do you respond

44:17 in an environment where there's very little resilience in your ability to invest without making a prediction and have a margin of safety there. You just insert yourself into the weekly NZS meeting, investment meeting, then I think with that question. This is most of our dial us in any time. Yeah, part of this is interest rates, right? We never had negative interest rates and then stimulus and so those effects on all assets, which which are unprecedented. We think about this a lot. We don't know the answer exactly. But

44:46 You know, this could get us into our top of uh semiconductors because there's a few building blocks of the information age. And we are in an epic shift. We're still early days. From the industrial age to the information age. And semiconductors are the new oxygen in this environment. And so we look at some of these companies, we think the valuations are actually quite reasonable.

45:05 And we choose to sort of bring the portfolio more towards resilience and these are one of the ways we do it. We do it multiple ways. Yeah. Like you used the railroad example, there are ten out of ten copies of the multiverse in the future going forward where railroads are important. Right. There are probably also ten out of ten copies of the multiverse where semiconductors are important. Exactly.

45:26 Well That's a amazing way to transition to semiconductors. I mean, I was looking for the right hook and you know, Brenton, I think you bring that up. I was prepared to make some joke like, Wait, you guys know something about semiconductors? I think TSMC is like a top three position for you guys. I think your other top positions Amazon, Microsoft, they use a lot of semiconductors. And I think Salesforce is probably up there too. And T I is one of your top positions, right? Yes, that's right.

45:50 Maybe even before getting into some of the nerdier semiconductor topics, let's stick with an investment one. What semiconductor companies Do you own right now? In the name of resilience and which in the name of optionality. Let's start with the two different versions of the semiconductors, right? So there's a lot of

46:08 semiconnector makers that are on the digital space on the leading edge, right? They're making three nanometers and on, and these are the high compute functions. And there's other semiconductor makers that aren't really dependent on that leading edge. They're more dependent on having the breadth of a catalogue. That would be like a Texas instruments that has a hundred thousand parts. Or a microchip.

46:29 And so in our top positions we're more heavily weighted towards the catalog names, these names that The lifetime of a part is thirty or forty years. The margins are high, the growth is pretty good. There's clear NZS in the business, they're definitely creating more value than they take. And they're very hard to replicate. Not because what they're doing is so technically hard, it's hard, but it's because the breadth of what they have would take you decades to recreate.

46:52 I've always kind of hoped that Buffett would buy a catalog semiconductor business. I just feel like those are like just classic Buffett businesses where they're they're probably not gonna look honestly that different in twenty years than they do now. They'll have higher margins and be bigger and they'll be selling into, you know, cool electronics that we don't even know about, but they're also still selling into like water meters and coffee makers and just everything in your household or or in a factory or You know, anywhere you look, it just has these cheap but high margin chips in them. So and I I guess to Ant your question a little bit just on the semiconductor impact on the portfolio.

47:21 We have about a third of the portfolio in semis, and that goes across the whole value chain, like to Brittans point. We invest in kind of like the catalog analog microcontroller companies. We'll invest in a digital company like NVIDIA that's actually in the optionality tail of the portfolio right now, just because for valuation and context reasons, we're big investors in semiconductor capital equipment and those actually are head of the portfolio. We do those as resilient, TSMC is a resilient position, and then um kind of the broader ecosystem like Cadence design systems, which you guys Brought up in the T S and C episode that's kind of the key, one of the two key kind of cat software platforms for designing a chip is also position and so They're kind of more

47:57 less household name type positions we own as optional positions, like a company like Cree, which is early and silicon carbide, which is an alternative technology to silicon that's used in electric vehicles, including the Tesla model three. And so that's a classic example where There is some version of the metaverse where it's a massive platform and Silicon Car Bide, the market goes from being a one billion dollar market to a thirty billion dollar market. But it you know, I don't know if there's a fifty percent chance of happening or twenty or that kind of thing. It's like a little bit of a walk around.

48:23 The portfolio in terms of uh of semis. That silicon carbide thing is the first time sort of hearing of it. Is that changing the substrate? Of the wafer. That's exactly right. Yeah, instead of using a silicon like a bulk silicon wafer used a silicon carbide wafer, which is actually the wafer itself is much more expensive and it's very hard. It's one of these classic semiconductor processes where there's some black magic that goes into it.

48:44 Um and honestly most of the people that know how to do this are all in like the research triangle in in North Carolina. Korea is the one company that has two thirds of the market for the substrate itself, and then they will sell The chips. They're the ASML of silicon carbon. So potentially then that's like classic optionality, right? We honestly don't know, but there's 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 that no one else in the world can do. And so that that is kind of classic optionality for us. But it does it make electric vehicles and charging and also like renewable energy and really high voltage applications much more efficient. And so it's like really one of these companies where they're

49:21 Core competency has just like all of a sudden the market really needs what they can offer. And so the market is growing extremely quickly. You're seeing a lot of activity around from other companies trying to get into the market as well. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta. AI has scrambled the whole security picture. It used to be that you proved that you were secure once a year on audit or a static PDF, then everyone would nod and you're done. But in an AI first world, that doesn't hold up anymore.

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51:25 The N C S process. So You mentioned, John, that you own cadence as a Resilient. position in the portfolio, having just done our TSMC episode and got deep dive on the whole semi-industry infrastructure. You know, you mentioned they also have

51:40 a competitor synopsis and the two of them, it's like a duopoly in the EDA. Space. How did you decide to own Cadence? And I'm assuming not. Synopsis.

51:51 Or do you hold both? We've talked a lot about both of them over the years. We've owned Cadence for nine or ten years back to our our days at our previous Yeah, employer. I think on Cadence it's a few things. I mean it's actually kind of a cool story of just kinda like how we even

52:05 kind of got into the idea of investing in an EDA as part of our kind of process for finding new ideas and just kind of being up to speed on what's going on in the industries we follow is going to like industry trade shows instead of investor conferences. Like we don't generally go to a lot of like big Investor conferences and so and early last decade I used to go to all these chip conferences and like every presentation it was like someone from T SM C and someone from ARM and then someone from either Cadence or Synopsis. And at the time Cadence and Synopsis were viewed as these sleepy crappy companies and We love TSM C and we love arms. Let's, like, let's do some work on Cadence, you know? And then we the more work we did, I mean, both companies are amazing, like they deserve a lot of credit, I think what steered us towards Cadence. One is the management team. So Lipu Tan at the time was the CEO. He's actually moving into the executive chair role this year.

52:47 He just is like one of the iconic leaders in the CEB industry over the last eleven years. He was actually a a V C previous to being um the CEO of Cadence, and he was just on the board and had to come in and basically turn around the company. But he was just so focused on the culture of the company. I mean he don't he told us what we wanted to hear, you know, which helped. But 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 like re architecting the product positioning of the company, and he's so customer centric. That was how we kind of first got involved with Cadence. We do think they're taking market share, especially in digital markets like where they would be selling to an Intel or an Apple or an NVIDIA. Uh we think they're the share gainer, but both companies it's like an extremely high quality duopoly, and so y I think you've you've been fine either way.

53:29 And do you end up doing one on one meetings with The CEO at the level of capital that you're deploying. Yeah, so this was back to our previous firm where we were there was more than a hundred billion dollars of AUM to deploy and technology was a decent chunk of that. And so like I've Caden's is a great example. We were actually their biggest shareholder for multiple years. And so at that point we had really strong dialogue with them and I honestly would just bump into the CEO and airports and a conference desk of everyone. Some of these aren't that big of a universe. Everyone's kinda going to the same things, you know? And he's very tall.

53:58 He's very tall too, so it's easy to spot. Yeah, yeah, you're not gonna miss him. And he's honestly just like such a good person too. Like we would talk about life and kids and A lot more than just our investment in their company. And so it's actually something we think about a lot as NZS is a younger company with you know less AUM behind us. And we have a lot of relationships from you know being in the industry for a long time, but it's an open question of how often do you really need to talk to Do I need to talk to the CEO of a company four times a year? Probably not, or six times a year, ten times a year, like the way we're investing, especially with a resilient company, realistically. maybe a check in every year or two, or if there's something obviously that's really critical to the thesis, we can check in. But that was kind of the way we grew up investing is a lot of management interfacing.

54:36 I'm always curious with public market. investors. Like how do you think about that in Sounds like you do find it very useful to have conversations with management. Versus All the information's out there, you know. I would imagine on the one hand, it's like, well, of course I wanna know, like I could glean so much more information and like subtle signals from talking to somebody in person.

54:55 On the other hand, I kinda think, Well, I really care about what you do, not what you say, and I can just see what you do in your filings. How do y'all think about that? This has changed a lot over the past decade because of course seeing uh management team talk is easier than it's ever been, right? It's publicly available. There are some times when it's helpful, there's some times when it's harmful. You know, it probably nets out to be net helpful.

55:17 But I'm just thinking of one interaction that we had with Rich Templeton, the CEO of of Tech Sin early February two thousand nine, right? It's a terrible time. Everybody's unhappy. It's really rough. And Rich walks in the room. Big smile on his face. How's it going, boys? You know?

55:32 A recession is a terrible thing to waste. And you're like, what's going on? I love it. And so he clearly had a different mentality of, hey, this is where we make all of our returns over the next decade. We're gonna go buy equipment for pennies on the dollar, we're gonna sort of systematically lower our capex to sales. ratio and we're gonna go get customers and sign'em up because we're running our fabs full out still and other people aren't. And He's just one of these amazing leaders, you know, we when he took the company over

56:01 They have forty percent of the business geared towards wireless and Nokia. was a massive customer, the largest customer, and he bled that down to zero. So Clearly this embodiment of a company that's built around adaptability.

56:13 Instead of these point predictions. And so People like that are helpful to interface with. But honestly, we probably could get everything we need at this point. without meeting with them as well. David and I were explaining our research process to some friends the other day.

56:27 And you know, one of the things that I I think that Is chronically underviewed on YouTube is presentations by executives at industry conferences. And that's a thing that we've relied on really heavily. Everyone goes and watches

56:42 Elon Musk give his talk at the recode conference. About three hundred and fifty eight people watched the YouTube video of Gwen Shotwell presenting at an aerospace industry event. There's a lot of really interesting information about the company, probably more so than the big shiny public facing stuff. That's exactly right. It amazes me. I don't remember the last time I watched the computer history interview, it was between Chen Senna and Morris Chang. Oh so good. It was under three thousand views, something like that. I was like, how does this not have three million views? You're like, Am I watching the wrong feed? Or how can there not be more views of this? You know? It's like this makes no sense. There should be a million views. It's so funny. We send stuff like that around all the time. I couldn't agree more. Britain and I were sending some stuff back and forth earlier this week.

57:25 That's mostly free too, and from industry trade organizations and It's a huge resource. And you also do get a little bit of a different flavor if you see a management team at a investor conference or if there's even on a road show and coming through town, but you're the fifth investor, they've seen That day it's like you kinda are getting the company line, right? Versus hearing what they're really pitching to their broader stakeholders at an industry conference is is such a good resource. Yeah. When we're doing an episode just us. Two, three, three plus hour deep dive on a company. We almost never talk to people actually at the company. Maybe we should, but

57:55 We get all the insights we need from Obscure YouTube videos, books, presentations, you know, white papers. To Britton's point, there's so much material out on these companies and stuff by management teams these days. And we do it in our, you know, basements. I think you guys are onto something with this acquire thing. We'll we'll see. Okay, so I'm gonna take us into the more technical side of semis now. Brenton, you sent an email when we were batting around topics and you said, Well, what if we start by talking about the UFO crash that happened in Roswell in nineteen forty seven, where we got the first semiconductor technology and then began to reverse engineer it at Bell Labs. Winky face. It was the first tech transfer. That's exactly right. I mean we know exactly when semiconductors came to planet Earth. It was July seventh, nineteen forty seven. And then you needed a backstory, you know, when they were they took the UFO over to Area fifty one, they're like, How do we like get this in the world without people knowing?

58:48 And you know, of course inter William Chocolate. Fresh from the war, doing research on radar and submarine warfare, and he's already got top secret clearance. We're like, okay, where could this come out of? Bell lab, chocolate. Oh yeah, that's it. That's the backstory. We'll give it to Bell Labs. That's the whole backstory in semiconductors. I think we're done.

59:06 There you go. Ha ha. Was shockly I actually don't know the history. I know he was like super involved in uh World War Two, right? He was, yeah. There's this great book, by the way, called uh The idea factory. It's the history of our labs.

59:22 So d if anyone's interested in the history of the semiconductor, you should definitely check it out. Not only the semies, but information theory from Claude Channel, which came around the same time. Also from Bell Labs, right? Also from Bell Labs, yeah. And so yeah, in the forties he took a leap of absence from Bell Labs and did work actually with the Secretary of War on radar and submarine warfare. Okay, and so Just to keep pushing on this.

59:45 The reason that This is a a plausible story. that we got these from UFOs is because The magic behind how a semiconductor works is so mind blowing and unfathomable that you could just sort of experiment your way to finding this, right? That's sort of what you're going for here.

1:00:02 Yeah, I think that's right. It really was this This is overuse, but quantumly it They had vacuum tubes. That's what the switches were made out of, right? It was one of the few places where there was still pure science being done at Bell Labs and they said we need the switch that doesn't break'cause We send a lot of people out in the middle of nowhere to replace these vacuum tubes.

1:00:20 This could go on very long, but there were some key insights around doping Germania. You're on the acquired podcast, so it's okay, present. Indulge yourself. Right. There are these few key insights, and it wasn't just Shockley, it was two other guys, Bertane and Bartine as well. And so the three of them together came up with these insights in just right after the war. Some of it was during But uh most of it was just after and they figured out, Oh, you can dope this substrate germanium. With different

1:00:48 Sort of. N type and P type is what they're called. And when you run a current through it, it changes. So it actually does the switching in solid state. And this idea of solid state switching Which of course came about because of the transistor and then later on was made to integrated circuit by Kilpia TI.

1:01:04 is what sort of enabled the foundation for all modern electronic devices. Over the last decade I've read the Wikipedia pages for semiconductor for transistor for I remember the first time trying to look up like how does a flash drive work? Like I've got this cool USB drive and I put it in my computer and I read the whole Wikipedia page and afterwards I was sort of just blinking like Yeah, I still don't understand. This actually was not helpful. And it is one of these things where most of the time, especially having like a computer science education, I feel like I can connect

1:01:35 every building block to the next layer of abstraction building block on top of it. Where eventually at some point after a few years of studying computers, you're like Wow, cool. I pretty much get how we go from physic to like operating a operating system on a monitor. I understand all the building blocks in between, but somehow like there really is something right around this layer where like I never quite can jump from the physics to like how it actually works and then how it manifests.

1:02:03 in information and bits on a computer. I think I just need to go read a few more books, but it is one of these things where When you sent the alien joke, I was like, you know, you're right that I've just taken it at face value that this works, but like I don't really understand how it works. Yeah, I told my daughter that this morning and she was like, Wait a second, Dad, that's really the way it happened, right? And I was like I think I was yeah. Let's let's back up. Uh parenting.

1:02:29 Okay, well getting uh tactical here. So on our episode, I think we did a little bit of a high gloss shine on the story and the current state of the market, especially with TSM C and Samsung. We basically equivocated them and said they're basically doing the same stuff. TSMC is one to two years ahead. Obviously, Samsung has the whole consumer electronics division as well. Okay, that's TSM C and Samsung. And that was probably too simplistic. So one thing I was hoping from you guys today is helping us better understand who's good at what between those two companies. Yeah, well, Samsung is is an amazing company. Probably not. Super well understood, maybe like TSM C and people know them for consumer electronics and phones, obviously, but they have fifty percent of the market share in T RAM and about a third of the market share in NAT.

1:03:12 So of course as we do compute, we need more memory. We need a lot more D RAM, which is the fast memory on your phone or device or whatever, that cues stuff up. It's like a funnel, right? If you think of the funnel. Got. Solid state or stuff sitting there and Nan Flash. moves into D RAM, then actually goes onto the chip with S RAM which is really fast funnel and then it goes into logic to get processed.

1:03:33 So Samsung is very good at making memory and like I said, they have over half of the markets here at D RAM, which is incredible. There's really only three major companies in the world that make D RAM, two are in Korea, and one's Uh Micron in the US. And then in Flash they're big. They also have a decent foundry business. It's about seventeen percent of the total Foundry Pi. So not as big.

1:03:51 But D RAM and NAND are easier to make than logic. And are these branded Samsung products or are they manufacturing them as a contract manufacturer? the D Ram and is all branded Samsung, but of course everybody uses Samsung, so It'd be next to impossible for Apple to get all the memory they needed without having a massive relationship with Samsung.

1:04:10 So they're frenemies. So the four or eight gigabytes of memory in your iPhone. That's coming from Samsung. That's coming from Samsung, yeah. Exactly. And so these are easier to make, they have fewer steps.

1:04:24 But still they're very hard. So D RAM takes around four hundred steps and over a month in the Fab working twenty-four seven to make and Nand has A little bit fewer steps than that, but actually Nanda's getting more difficult because they're stacking it into three D. So as you get more layers, it's actually Getting more complex. But logic is still the hardest stuff to make. These The system on chips that T SMT makes and of course. It's just imagine um, you know, making one thing over and over versus making like a menu of what if you had to be a restaurant that made every kind of food on the planet, right? It'd be really hard to be good at all this food. So that's what T SMC is doing. So that's

1:04:57 Some of the different Samsung is also doing logic, but they have a different business model, right? They compete with their customers. So it's harder for their customers to trust them. Whereas CSMT doesn't have that conflict. What do you think makes for a more resilient company playing at multiple spots in the value chain such that you compete with your customers and have optionality? Or being super pure play so that you have no strategy conflicts.

1:05:22 I mean, I think it depends I mean if you're talking about something in in semiconductors and I mean like Intel's the classic example of this where they're More virtually integrated. I mean the hard thing about doing that is you have to fight battles on multiple fronts. Intel has to fight T SM C on process technology, which In itself is one of the hardest things, you know, any technology company's had to do over the last twenty years, and that's why Intel has been surpassed by T SM C, right? Then they also have to fight

1:05:45 AMD in their core kind of like chip design market where AMD enabled by TSM C is innovating faster than they have in the last twenty years and and like really delighting customers and and taking share from Intel. kind of real time or you know NVIDIA where they're trying to just basically marginalize the CPU and make the CPU less relevant, so Intel's less relevant. So I think That's the hard thing about being vertically integrated in semis versus being more of just like a horizontal Pure play is the needs of Moore's Law are just so difficult. It's hard enough to just do one of these things well and doing multiple of them well and makes it harder. So I generally I think

1:06:19 Britain's point on just like the business model difference between Samsung and T SMC is so spot on because I mean TSM C is like the neutral party that will never ever compete with their customers. And if you think about the amount of trust that the company has to put in TSM C because they're betting their entire company on TSM C's ability. to make this chip for them and to have capacity for them when they need it. Just like the amount of trust and this has kind of been worse, you know, Chang's Hallmark since he founded T S M C

1:06:44 That that's just something that Samsung can't quite offer because they just have a different business model and they're not willing to not that they're not willing, they just don't have the capacity to build kind of a massive foundry. They can't change, right? Like Then I could have shut down two thirds of the company. Yes, exactly. How do y'all think about especially since T SMC is such a large Position in the portfolio.

1:07:02 Yeah, how do you think about the geopolitical risk? 'Cause we did this whole big long episode and the conclusion I think we came to was this company's amazing. There's like no fault we can find in this Except that You know, China might want to like, you know, take over the land that they sit on. Company ending risk. Yeah. I'm just like, what a world we live in that like that's an open question that an analyst can ask about an earnings call. Like, what do you think about China invading your country? So Britt and I are not like geopolitical experts at all. I think we spent a lot of time thinking about just the importance of T SMC.

1:07:35 to the world. And I do think TSMC is top five most important technology platforms to the world. Like I think TSM C is more important than Apple. Like if Apple Disappeared off the face of the earth. I actually think it would be painful for everyone that, you know, loves My message and FaceTime, but like it really would not be as big of a deal versus if for some reason China moved to seiz Taiwan or or however you know it went into play. And all of a sudden T SMC's fabs were shut down.

1:07:59 Then the Western world will be set back. at least five years, if not ten, just in terms of like technology progress. And by the way, technology progress is driving most of GDP right now. And so you do read about What's happening with the auto sector and shortages. It's like you see nothing. If you think shortages kind of from the way the auto guys manage their inventory And kinda just like the classic post recession semi connector storages you always get.

1:08:21 You go from there to Yeah, what would happen if T SM C if Taiwan sovereignty wasn't questioned in T SM C that stopped making way for us for some period of time. I just think the impact on the global economy would be Extremely painful, so then that brings you to the logical conclusion of

1:08:34 you know, hopefully the US and the West would move to protect T some C at all costs, or at least get the people out of there. We were g I mean I guess I I shouldn't joke about it, but it wouldn't be totally dissimilar to what's happening in Afghanistan where I think you would just airlift as many T SMC folks out of there as possible in a short period of time, but then you have no fabs. there to produce I mean T some C fabs a quarter of the digital chips made in the world right now and so it would be a lag of multiple years between you know, you can get those people out and when you can actually start making wafers again. So it's a very

1:09:02 Complex topic. I think another way to think about this is just an ecosystem perspective. So like T SM C as a company is very valuable, but it's not Super valuable without ASML and LAM and A Mat and K L A, right? So When you think about the ecosystem of semiconductors and ASML of course is not valuable at all without T S M C and Samsung.

1:09:20 There are this handful of companies call it fifteen ish, maybe more. That's If you think of them as one super company, which is kind of what they are, it's like a super organism, right? Kind of like my bees are a super organism. It's like an ecosystem, you mean maybe like a complex adaptive system. It's like a complex yeah. So predicting the future is really hard. So anyway, yeah, if you think of it as a superorganism, this is probably the most important superorganism on the planet. If it's not, it's certainly One of the top.

1:09:45 Most important. So Could you recreate that elsewhere in the world? You absolutely could. If you had access to the rest of these pieces, which in the West

1:09:55 We do. It would just take to John's point a long time. And that's why people are sort of saying Maybe we should take some risk out of this place and And um you know ASML calls this semiconductor sovereignty.

1:10:06 Uh we're building this fab, of course, and Arizona, this five nanometer T S M C fab. But it wouldn't be a stretch to think that they will be built again in in Europe. This happened before. But of course. When technology reaches a fairly stable state

1:10:21 You wanna optimize around efficiency. So you get these horizontal. type models, right? I remember when Apple bought Semiconnector, I was on record going, Oh, this is the stupidest thing ever. Qualcommes these really good semiconductors. Broadcom makes some TI makes a great application processor. And this is the origin of you deciding that you don't know the future and so you should what I said was the dumbest thing ever, that's for sure. But when technology changes, I just didn't have a concept for the smartphone. So technology was about to change quite a bit. And In that change you really want to be vertically integrated'cause you're not

1:10:54 Pushing. Uh efficiency you're pushing sort of Product technical ability. You know, we see this with Tesla as well, that vertically integrated. So, you know, can you imagine Ford having an AI day?

1:11:04 Like that's just kinda funny, right? Well, they could have something then they would call it an AI day. Yeah. Oh man, MKBHD just did this awesome thousand mile road trip with a Tesla A Ford Maki Mustang and a gas car. And It was just amazing. They're like look, the Mustang like it's a good car.

1:11:24 It's really good. But we couldn't complete the road trip'cause we went to a charger, you know, it directed us to this charger. The charger was broken. Then we went to another charger. Well, that was like you know, it charged at a rate of like a mile every five minutes or whatever. So then we like got stranded and me the Tesla's like

1:11:42 Yeah, we were half an hour shorter on the trip than the gas car. You know directed us to the charging networks, it told us which stall to go to, you know, all this stuff. So I guess like the full circle question or answer to your question on like how we even incorporate the geopolitical risk on TSM C Is I mean I guess it'll never be our like

1:11:59 a 10% position for that reason, as there is always this risk. But I also I think it's important, I mean the my like kind of cheeky answer that's probably not fair as if If there is enough conflict between China and Taiwan at T C M C that they're like kind of you know, business sovereignty or are is under concern or people are worried about them being nationalized by China or something. the whole US market is going down. It's not just TSM C. I mean, I think they would be kind of like the epicenter, but it's not like this is going to happen in isolation. And so at that point, and who knows if there could be, you know, more of a more World War Three type global conflict coming from that. And so I kinda say like at that point the performance of our TSM C common stock is probably not my biggest concern that day, you know? Okay, so let's say TSMC is a resilience position. Let's say there is a Black Swan event, which the fact that we're all forecasting it and so is everyone else means it probably isn't that Black Swan y if their sovereignty gets challenged.

1:12:47 So the point of optionality positions is to benefit from these black swan events. Do you guys have any ideas on If the whole US market went down. in this situation, what could you hold that would hedge it?

1:13:02 The obvious hedge would be like defense stocks, but we probably wouldn't own them because of uh I just don't think those are very high N Z businesses, but honestly that would be the one pocket of the market that probably would fare. Okay. But Britton I didn't mean to interrupt you when we're gonna do it. I was just gonna say if you've got to rebuild all these tabs somewhere, you're gonna need a lot of equipment. And so You're leaving. twenty years of equipment in the ground somewhere. And you've got to recreate that. That would probably be pretty defensive against that outcome.

1:13:26 There's also I guess owning China tech companies. I mean'cause it's questionable like if all this is really going down, like uh I don't think China's probably gonna stop. Mm. Do you have any China Tech possession? You know, Tenton or others or We don't. We've owned China Tech for a long time, but when we put this portfolio together at the end of twenty nineteen, it just looked Sketchy to us, honestly. I don't know with for lack of a better word.

1:13:56 And so we we own zero China tech. Um we just thought we don't have to be there. There's other places that are very interesting. And it's a question of ownership. We're not really sure who owns these companies. And through the ADR structure and the VIE structure, we know we don't own them. So we just set out. Yeah, it makes sense.

1:14:12 Well I wanna come back to some more technical questions. Another thing that I think we kinda glazed over in our TSM C episode is the current state of More's Law. from a literal perspective, but then probably more interesting. the current state of the spirit of Moore's Law. And I was wondering

1:14:30 Maybe John, let's go to you. Could you give us a little bit of a download on like Does Morris Law still work at least spiritually? Yeah, I'm glad the way you framed it that way,'cause it is kinda like a religious debate, and people much smarter than me in the semi industry are on like both sides of is like the true Gordon Moore Moore's Law still. holding up but I think for the spirit of Moore's Law we still have we have visibility probably for the next Ten to fifteen years. And to be honest, that's like

1:14:54 The industry never has more than ten to fifteen years of visibility. I think obviously the death of Morse Law has been pronounced for a very long time, but I think that's one thing to keep in mind is there are a lot of things out there that's gonna keep us driving down Moore's Law and so One thing that you guys covered well in the T SMC episode is the implementation of EUV systems. from ASML and they actually are allow allowing us to shrink the transistor, kind of the fundamental building block, you know, two dimensionally. So actually put more transistors into a chip. And so ASML is kind of on record saying they think that

1:15:21 that E V will last about fifteen years. In terms of they'll allow us to keep doubling the number of transistors on a chip every eighteen months for fifteen years, or just it will be an effective way of getting any performance. Yeah, I think 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. But I think the the broader point you hear from the industry a lot is this concept of of more than more Which is kind of you know a cheeky pun, but uh yeah, there you go. The semi guys they're real real hoot. Exactly. So geeky. But so the broader point around you know where where Moore's Law is going now is it's not just about the transistor, it's really about

1:16:07 the package and so you're seeing a lot more Innovation, not just in like can we put like more transistors onto one gigantic chip to drive more performance? You can actually split up. you know, chips into multiple chips called chiplets, which AMD is doing, and this is a big part of Intel's future strategy, actually. Also, and so having like you know, one gigantic like GPU that you would buy for NVIDIA, you can have four

1:16:28 smaller chips, um, and you can kinda like stitch them together to drive more performance. And so that's Another way that we're gonna get a lot of benefit from Moore's Law. And then actually one thing I skipped over on the transistor side is we are moving to a new transistor architecture, um, either a two nanometer or three nanometer, depending on which company you're talking about, to a gate all around architecture. Previously we were on FinFet, which has been around since I guess for the last seven or eight years, I don't know the exact numbers. Uh maybe ten. There's line of sight into from here.

1:16:55 more gate architectures, different materials, and then when we get to like the mid twenty thirties, we'll kind of see how it goes, but it's just it is amazing. I was actually at a virtual chip design conference this week, earlier in the week. And there's so much focus, not just I guess, on this like packaging idea, but even like if you have to extract that. one more layer from that, it's about system level performance. And if you look at what

1:17:14 NVIDIA or AMD and kinda like the leading digital companies they're talking about. It's can you make more processors and actually like stitch them together into a cluster with some sort of proprietary interconnect. They're really thinking more like computing companies than just like chip companies now. And so that's a big change. But all of these transistor level innovation, package level innovation, and then system level innovation, I think we've got pretty good line of sight into the spirit of Moore's Law continuing at least through kind of the mid twenty thirties. And so it seems like with the sort of creation of the system on a chip.

1:17:42 That At least let's just talk about the iPhone, because it's the one I understand the best. Apple became the aggregator. rather than the old days of I'm gonna go build my computer and I'm gonna go buy a motherboard and I'm gonna buy a GPU and I'm gonna slot it in the PCI slot and blah blah blah. Apple basically says uh

1:18:00 Well, we've designed this logic board and we've designed most of the chips, the important chips, and we've situated them together. TSMC manufactures it, they do all the packaging, so you have like the bare metal to bare metal. packaging of these things so we don't need to run it through these buses that have low bandwidth to get information from one piece to another. Let's keep playing that out a little bit based on everything you know. Where in the value chain do you think the point of aggregation shifts to over time where

1:18:28 Who gets to own Where do we put all this stuff together and I get to capture a lot of extra margin because I'm the one putting it all together. I think that's the interesting thing about the semiconductor ecosystem is actually there's a lot of people capturing margin and they're capturing really high margin. So This is the sign of a healthy ecosystem, right? It's not one company that's making all the money. Um, throughout the whole chain, we've seen margins come up and

1:18:51 You know, here's a good trivia question. Who has higher operating margins, Texas Instruments or Microsoft? Right. Because I ask it, you know the answer. It's it's T I. Wow. But you know, th it's not really appreciated how good these businesses are. That's shocking. Right? Yeah. Especially'cause T I Um

1:19:10 Court business is not the leading edge. digital processors that T SMC is doing. It's the commodity stuff, right? I think this was Richard's key insight, you know, he said, Okay, we're doing all this leading edge stuff, we're fabbing it, T S M C And what if we just trickle that business down to zero. They tried to sell it, no one wanted to buy it.

1:19:28 And boring is beautiful. And so, you know, you look at T I's in markets, two thirds of which are industrial and auto. And I guess it's a tech company. Yeah, they make chips, but Man, it seems a lot like an industrial company too, right?

1:19:41 Yeah, I think you can make the same point that you made on T I on NVIDIA, like the fabulous business model. really, I mean, it's like a software company. It's like NVIDIA's got close to seventy percent gross margins and like, you know, low forties operating margins. I really with very little cyclicality because TSM C offloaded all that cyclicality, right? So it is just like one of the best business models besides I would say enterprise software is one of the best business models in the world. And so T some C is the enabler of that. But I think Britain's point is spot on, you're gonna see it kind of in this future world. One of the things that's kind of cool is it takes the whole ecosystem to really drive kind of the future of Moore's Law. Like it used to be just about

1:20:13 ASML needed better litho tools and like Intel would use them and like shrink the transistors and we just kinda like brute force ourselves down Moore's Law and now All this advanced packaging needs litho advancement from ASML, but it also needs improvements from the other equipment guys like Lamb Research or Applied Materials or Tokyo Electron,'cause you need deposition and etch steps to build these advanced packaging and and you know, multi-dye packages for kind of the advanced packaging applications. You also have all this off the shelf IP they're getting from companies like ARM or from Cadence or Synopsis that I mean part of what Apple does to your point then is they're really just an aggregator. Like they buy you know IP bloc off the shelf. A lot of what designing a chip is about is just is just buying a lot of individual IP blocks and and aggregating them. And so

1:20:52 The great thing about it is like since Moore's Law is really frickin' hard, everyone in that ecosystem does really well. And then I think T SMC sitting in the middle of it will obviously do very well because they're driving a lot of the innovation also and and obviously are the key partner for a lot of this. Real quick on um T S M C I think we glossed over this on the episode'cause we weren't deep enough to understand it. My sense is that the open innovation platform that they've created is really important and is kinda the

1:21:15 What orchestrates all of the what you're talking about here that it really takes the village of the whole industry to push things forward now. Is that true? Like what is that and how of central is T S M C's open innovation platform to all this. That's exactly what I was gonna say. I think it's really true. And there is no GitHub to the semiconnector IP ecosystem, right?

1:21:35 The closest you get is kind of the TSM C open alliance. Um and there's pockets of it elsewhere. The EDA guys have a a ton of IP as well. And of course, as you make these chips you need to emulate them to see if they actually work. Uh, hopefully before you Put him in the fab because that's really expensive.

1:21:51 So All of these things really play together. And so when you think about how Intel was doing this for a long time, it was a closed system, it was Intel's way, Intel's process flow. And TSM C said, Oh wait, let's form an alliance with everyone. 'Cause this is really gonna take everyone to keep driving this forward. And this open architecture.

1:22:09 Or this open approach has really won over. One thing that's always hard for me to understand is how hard it is to do each layer of the stack. And by that I mean Wow, it seems like The ASML

1:22:23 Guys. create a pretty unbelievable machine. And they have a lot of services associated with that machine. Like they're even in the TSMC factory helping to assemble and operate these things. And then I sort of was scratching my head thinking

1:22:37 Well, could ASML just kind of like become TSM C? Could they just operate their own equipment? And then I dove down The other side of the slope and I was like, Well who makes the stuff that's important to the ASML machines? And I was like, what is this Trump company? And then of course you go on the Trump website Which let's just let the name lie for a moment here. And uh they make this unbelievable laser. And like they've got this crazy video on their website that shows off their laser and

1:23:07 I'm pretty sure what they're showing me is actually the magic of the A S M L. U V machine. And I'm like, well, shoot, why can't the Trump company just do what ASML does and then also do what TSMC does if they are the only ones in the world who can make this Unbelievable laser.

1:23:22 Can you guys shed any light on is that ever gonna happen? Could it ever like Vertically integrate. First of all, the videos of the the simulations of the laser in um an E V system on the Trump website are like so freaking cool. They're amazing. Yeah. Actually I hadn't seen them until recently and I've heard so many times that like fifty thousand pulses a second drops and multi tin the whole spiel from ASML, which Ben, by the way, you did a very good job on the uh on the T SMC episode. I was doing my best John Bathgate impression.

1:23:48 I could tell you were excited to do it, I think like multiple times. You're like I do the SML thing now. But anyway, we um a few things to to think about. One is there's so much innovation. So the laser itself actually Is ten tons, but an EV system is 180 tons. So there's a lot of other equipment in there that's not just a laser. And I actually I was trying to find this from a dollar value and I didn't track it down, but I'm sure that that number It's out there. ASML's partnership with Zeiss, the lens company, is also really special. And I guess Trump and Zeiss could

1:24:15 try to partner to I don't think they have any ambitions to do this, but they could try to partner together to kinda circumvent. ASML, but like, you know, the lenses that Zeiss is coming up with are literally the most uniform lenses designed, you know, in the history of the world, and some of the metrics that they throw out on that. And then I think One of the things that's unique about ASML is, you know, they shipped the first EUV tool in twenty ten to TSM C and U V didn't even really start high volume. And this was after a decade of R and D already. But then they didn't start high volume manufacturing on E V until twenty nineteen. So they had like

1:24:45 almost a decade of learnings in TSMC's fabs on like how to get these things to actually work, how to get the um you know the throughput to levels where the economics actually make sense. So there's actually like this really cool conference called S P I E every February where all of ASML's customers come together and basically give feedback on E V and And kinda give the updates on on where they're at. So A S ML lived through ten of those. with all the feedback not just from T SMC, but from all their ecosystem partners, right? And so I just feel like the learning cycle that ASML has been through, there's just so much more innovation in addition to the laser and the um

1:25:15 The lenses, but it is. I mean the lenses are a really critical component. I mean A S ML actually bought a laser company in twenty twelve called Simer. And I think they actually had like an internal laser bake off between Simer and Trump and I think Trump won for U V, which is also kind of a funny, you know, trivia question. Wow. Fascinating. Okay, so the answer is they all add a ton of value on top of uh

1:25:36 The previous stack. And like a lot of things in the tech ecosystems, there's fractals on fractals, right? It's like if you say, Okay, well, what's the most important part of this? A smell tool, right? There's a fractal down and then like, you know, you keep going. But it's really this ecosystem approach that makes sense. No one can do all of this. It's just way too hard. It really does take a village. All right listeners.

1:25:57 Now is a great time to thank our longtime friend of the show, ServiceNow. If you are running a large enterprise, AI agents are likely spread across every team, and deploying them is uh no longer the hard part. Yeah. The hard part is knowing what permissions they have, what employees are using them for, or what decisions AI is making. AI security for an enterprise at scale is not a small concern. Like the risk Are real.

1:26:23 Exactly. And the challenge with AI is governing it, securing it, measuring it, and making sure that it actually delivers value. That is why Service Now built the AI control tower. Yep, AI control tower gives enterprises a single place to see, manage, govern, and optimize AI across the entire business. And it works with Any AI, not just theirs. Every device on your network, every permission across every system. Every AI agent visible and secure in one place.

1:26:50 And ServiceNow can do this because they've spent more than twenty years building the operational backbone of the enterprise, the workflows, governance, approval, security controls, and institutional knowledge that power how work actually gets done across IT, HR, customer service, finance, and security. ServiceNow already runs more than a hundred billion workflows annually and trillions of transactions for more than eighty five percent of the Fortune five hundred. So when companies need a place to govern AI at enterprise scale, they're building on a platform at the center of how their business already operates. And in a future, that isn't going to be one AI, it's going to be thousands of AI agents working across every function of the company. But the question is Who's managing them all? So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely at scale, go check out service now.com slash acquired and tell them that Ben and David sent you. Great. Well, John, I know you have a uh ASML story that you want to share, so I'd love to hear it.

1:27:49 Yeah, I I I think this is a really cool story of like how ASML came to be. ASML and so strategic to the world is Yeah, they had one competitor, which is Nikon. in the lithography market. And then Lycon gave up on the market kind of coming out of the last decade.

1:28:03 And so I think TSM C and Samsung and Intel kind of looked around and realized like we're betting the future of Moore's Law on this one company, ASML, which at the time was like kind of a sleepy Dutch company that would have like a twenty billion dollar market cap, like no one really knew. who ASML was in twenty twelve and so it was so unique is the Intel and T S M C and Samsung partnered and actually bought 25% of ASML to inject capital into ASML to develop UV systems. And that started really like the iteration path of developing a UV to get a UV to where it needed to be for high volume manufacturing by the end of the decade. And so it's just such a cool story of like

1:28:36 The ecosystem coming together and everyone in the semi industry knew how important ASML was at the time, but the world didn't really understand that. And so getting A smell Where they needed to be. On a U V obviously is now enabling Moore's Law for the next at least ten years. And is it right that they've all largely divested at this point? They have, yes. Yeah. I mean they honestly should have just held on to it. I mean it would be not immaterial to especially like Intel's enterprise value. There's so many stories like that, like you guys covered, um the arm origins, like all these like major ecosystem players have all like had

1:29:04 you know, stakes from other companies at various times, which is is just kind of a funny way that the semi industry has has worked. I couldn't find in our research how much of T SM C does the Taiwanese government. currently own. 'Cause they started by owning fifty percent of it.

1:29:21 That's right. I looked for that too recently and I couldn't find it. I wanna say it's still in the twenties, but But I Could just be making that number up. I thought I actually was gonna say twenty off the top of my head, but maybe don't quote us on it,'cause I don't know if that's true or not. Wild.

1:29:34 Could you imagine if the US government owned twenty percent of Intel? I know, right? Or Apple or they owned a lot of Ford at one point. Yeah, and sometimes people ask, Well w why can't just another company buy T SMC? Well It's a national champion. The government owns a bunch of it. It's just impossible.

1:29:52 Right. Some things don't have a price at which they're uh for sale. Exactly. All right, John, you had one other uh trivia question for us. Yeah, well s we were talking about I kinda made the point that

1:30:04 fabulous chip companies are kind of the best business models in the world. I think one of the things that's so cool about T SMC is if you just look at all the value they created, like NVIDIA is a you know half a trillion dollar company and then add up their next few biggest customers like Qualcomm and Broadcom and AMD. That's like another half trillion and then I was trying to think of like their aggregate value creation and so I was trying to Think about I mean Apple's obviously the biggest customer. And so I think in an acquired episode about the top ten acquisitions of all time, you guys assigned a value

1:30:31 to PA semi and how much of kinda like Apple's differentiation is driven by semiconductors. And so if you guys know that off the top of your head, that'd be my guess for Kind of like Apple's contribution to the TSM C dial creation for the world, if that abstraction all make sense. Oh man, that was the most hand wavy part of that whole analysis. I kinda feel like we ascribed half of Apple to next.

1:30:54 And then like ten percent to PSMI or something like kinda arbitrary. We were literally carving up the apple. Here's the reason it's hard. It's because The notion of necessary but not sufficient is really hard to frame into a percentage. Apple would be worth zero if they didn't acquire next. But does that mean that Next is responsible for 100% of the value of Apple? Absolutely not.

1:31:19 So what percentage do you assign it? It's tricky. Yeah, that'll make sense. I actually don't know that the number you guys use. I thought it was twenty five percent off the top of my head. Which maybe that's a good rough number that you know Apple's contribution is you know, another half trillion dollar to the T sm C value creation story, but you get the broader point, right? It's just it's like trillions of dollars of market cap that T sm C is

1:31:37 created for their um partners, which I think is just so cool. Yeah, it's amazing. I mean, it truly, you know, meets the Bill Gates line of the definition of a platform that they've created way more value for their customers in their ecosystem than they've captured for themselves. Yeah, which is so cool'cause it's obviously not like a traditional Internet or e commerce platform the way like most of us are a SaaS platform, the way we think about platforms, right? It's just it's like a manufacturing platform, which is just so unique.

1:32:00 There's one point that you're getting at here that is part of the white paper and what we discussed earlier. Which is around sort of leaving money on the table for your customers and leaving money on the table for your partners. And It reminds me a lot of

1:32:14 when we did the Altos episode with Honom. And it's really this idea that If you as the management team, or if you as an investor who deeply understands the company, knows that. In a way that

1:32:29 other people outside the company can't underwrite. Then you can do a much more intelligent job. valuing the company. Then anybody could with a brute force. metrics such as

1:32:41 industry average earnings multiple. Because if you actually understand, well, our earnings could be this if we wanted it to. Or our growth rate could be this if we wanted it to, but you know, we're making strategic trade offs to not do that, then you actually have a unique ability to underwrite the company's value and thus actually more of a margin of safety or more of a willingness to pay up.

1:33:04 than anybody else. And so it's interesting being deeply studied about these companies where you do know that they're sort of leaving something on the table for other participants that you can be more comfortable making an investment than other people can. I think that's a really insightful point, Ben. And the thing it gets to for me is duration of the asset, duration of the growth. So when you leave money on the table, what you're doing is you're creating goodwill for your customers and you're buying

1:33:29 the company duration, which is Oftentimes the way to maximize Total value. Right. So when I think back about Ho talking about roadblocks He was effectively saying

1:33:41 we just really understood how big this ecosystem could become and we kept seeing the value of a crew and then it moved beyond our original investment case. And therefore we became more comfortable investing more money over time. And what people get wrong oftentimes is just duration,'cause duration, if you can go fifteen percent back to your earlier example, it's extremely nonlinear if you can keep that flat.

1:34:03 Right, all the value comes in the tail. And so um We just aren't very good at thinking like that. Our brains don't work in that nonlinear fashion. But when you create more value than you take And if that's your driving

1:34:15 Factor. And you want it. Take a lot of value. It's a hard task. Because you have to all the time think, Oh wow, we want to take a lot, but we need to create even more. How do we do that?

1:34:26 And then of course step by seration and with just a feedback loop. Sort of the happy feedback loop, if you want to think about it that way. I think Morris Chang got this very early on and and that's what created TSM C into such a great company. Oh, it's so good. You know, we touched on this a little earlier, but uh Just a double underline. One of the things about

1:34:44 You are on your ethos that What's kind of an aha moment for me is Flat growth versus hypergrowth. Flat growth extended over time will beat Short term hypergrowth. You mean the derivative being flat, right? That a company grows at the same rate every year. If you grow twenty percent a year.

1:35:00 For like fifty years like TSMC. You will destroy You know, every group on out there. So what you need for that is a negative feedback loop, right? So the negative feedback loop for TSM C is I'm gonna come in, I'm gonna take what used to be the special sauce of your business and you're gonna trust me to do that.

1:35:18 That's extremely hard to do, right? No one wants to do that. But then The more it happens, eventually there's a game theory to it. Everybody has to do that eventually because it works so much better. Right. So you're never gonna get a hundred percent growth. It's impossible. But you might get twenty.

1:35:32 for third years, which I think the number that you guys said in your podcast was seventeen point seven for thirty years or something like that, which is just incredible to me. And when you say negative feedback loop You basically mean a governor on the growth, like a natural force in that particular business that makes it so you can't have ludicrous Uber style hyper growth. And it ends up being long term good for the company to have that growth governor or that negative feedback loop.

1:35:57 That's exactly what I mean. So we when we think about ASML, right, they can ship everything they can make, but they just can't make anymore. It's impossible. Right. So there is a governor on the growth. Wow. Well that's a great place I think to leave especially the semi's discussion and most of this episode that It's so counterintuitive, but the way that you've sort of framed up Why it is.

1:36:18 Long term. good for an investor to want slow methodical governed growth. It's just very different than a lot of the things we talk about on this show. One of the things we think about sometimes is we're looking for companies that can double in five years and double again the five years after that. And all that means is we're looking for companies that can grow fifteen percent.

1:36:37 Over a decade. All sequel. Easier said than done. Easier said than done. Much easier said than done. I will just say one thing about our days.

1:36:46 You know, we get a lot of questions of, well, how do you do this at a small company versus a big company? And part of it goes back to what we were talking about earlier. It's easier to do research in these companies now than it's ever been. But the second piece of it is, yeah, there's more details we have to deal with at times. But how much extra time would you have in your regular job if you only had two meetings a week and you never had to worry about office politics? Yeah, my guess for most books is it's about twenty hours, right? And so then how would you use that? Well, we just use it for unstructured

1:37:15 Research time. And the way we think about it is we can wander around not knowing what we're doing and and waste ninety percent of that time and ten percent might be really useful and one percent might be absolutely watershed. And that's really all we're looking for. But you can't ever just get to the one percent and you have to wander around to find it. I mean so that's how we really structure our days. And Brenton, that's why you run for like twenty four plus hours straight. And that's why I run and that's why I keep peace. It's all the same thing. It's where your best investment ideas come from. That's right.

1:37:46 I do think this idea of like linear time versus nonlinear time is really Interesting. It's something Brit and I talk about a lot.'Cause like the linear time it's like it's probably very similar to you guys getting ready for your next episode. It's like you're going down the rabbit hole on one topic and then we do spend time doing that, obviously, but then we just have so much extra time to like Just be out there trying to connect odds and so you never know when you're gonna have that. Aha moment or that that insight, but having you know as much

1:38:08 opportunity for that as possible is kinda how we've intentionally tried to Structure our time. Oh, I love it. Well, we could spend another hour on how you structure your time. I'm w I was actually w wondering maybe um Maybe we can get uh one or both of you if you'd be up for it to join our next LP call and all chat about it. I'm sure folks would love to pepper you with questions and hear about how you spend your time. That'd be super fun. We always learn from those questions, so we'd love to do it.

1:38:32 Awesome. Well, Brent and John, where can folks find you on the internet? You can go to NCSCapital.com. We do try to write a lot. Um we put it all on the internet immediately. Um it is everything that we use internally, nothing's held back because we know when we put it out there. we're gonna get more value back. So this is our way of trying to create more value than we take.

1:38:53 Our partner Brad also writes a newsletter every week and so if you want to see how he spends his time You can sign up for the newsletter on NCSCapital.com. It's called Sit All Week. It's just Brad's process. of sitting all week and what he thinks about and Brad is Well, he's like a microprocessor. He's literally the smartest person I've ever met and

1:39:12 The way his brain works is incredible. And so if you'd like to Sign up for that. You can do that there as well. Great. And on Twitter, I think you both have Twitter handles. That's right. The whole team is on Twitter. N C S Capital uh has a a Twitter account. Um I'm B Johns Three. Brad is at Brad Sling.

1:39:28 And John is at J Bath. Great. We'll link to all those in the show notes. Thanks for having us, guys. Thank you.

1:39:37 All right listeners. Now is a great time to talk about one of our favorite companies, Statsig. Yes, there is a reason why the best product teams rely on Statsig, whether they are iterating on their core product features or shipping AI powered experiences at scale. Yep. In the

1:39:55 crazy speed of today's AI world. Shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next. This is where StatsIG comes in. It brings experimentation, feature flags, and product analytics into one unified system so teams can ship safely, test rigorously, and directly link what they changed. to how users actually behaved. So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, go to statsig.com slash acquired to get started.

1:40:38 All right, listeners. Hope you enjoyed our conversation with Brinton and John. If you found it to be frankly, as eye opening as I did, feel free to share it with a friend. If you learn something new about complexity investing or their barbell strategy or resilience and optionality, I'm sure you can think of someone uh that you'd want to share that with, so feel free to do so. If you are not already a member of the Acquired Slack, come join us, acquire.fm slash Slack, some of the best discussion you'll find on the internet about Lots of things that you care about. If you're not an LP, you should become one. It's a way to get closer to what David and I do here at Acquired. Uh we have these awesome LP calls.

1:41:16 Yeah, once every month or two. We uh have been on a tear recently with great LP exclusive content. We just dropped uh about a month ago now a great interview. with Ronal, the CEO of Audious, which is the largest so good. crypto application, web three application out there with over six million users. And then just before this episode, we dropped another sort of web three episode. Uh this time on web three marketplaces. Centered around brain trust.

1:41:45 Adam from Brain Trust. Wow, that one that one was a blast. Yeah. So if you're web three curious, or maybe you're you're Web three skeptical. These are fun episodes to listen to because they're super non DeFi, non sort of crypto use cases for Yeah, they're like Real world applications.

1:42:03 Yeah, which of course we wanted to dive in and tell those stories. You know what I'm curious about after this episode and and I feel like, you know, the universe in funny ways, right? Like I think everything sort of aligned that a bunch of stuff happened all at once. It's the Santa Fe Institute and complex like everything we talked about on this Episode it just seems like such an amazing place. I've always wanted to go to Santa Fe, period. I've never been there. But to go like take a class there, like we should do something. He's the chairman of the board there.

1:42:31 where uh kindergarten is actually investing in a company that the CEO is also a board member there. Just like there's too many stars aligning. We gotta go The universe is telling you something, David. I think it is. I think it is. But with that, we will see you next time. We'll see you next time. Who got the truth?

1:42:50 Is it you, is it you, is it you Who got the truth now

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