Blockchain, a way of implementing a distributed ledger (distributed record-keeping), is a novel technology with little real-world practicality. The original Bitcoin white paper published back in October 31, 2008 spurred little interest in distributed ledgers. The distributed ledger was ignored for years until Bitcoin started receiving mainstream attention and a few years had passed.
I simply couldn’t find much evidence that distributed ledgers are useful for any real-world applications (other than speculative asset bubbles). Once you understand that blockchains are bad at solving real-world problems, then you will understand why Bitcoin will fail. The blockchain imposes limitations that makes Bitcoin a bad version of something that has been tried in the past: e-gold (description here and Wired profile here).
A company’s stance on blockchain can also serve as a test of a company’s management. In my view, companies pushing blockchain technology (e.g. IBM, Microsoft, Intel, Oracle) are disconnected from customers’ actual needs and have mediocre management. Companies that don’t talk about blockchain (e.g. Facebook, Amazon, Google, Apple) are more likely to produce sensible technology that will work in the real world.
(This is not an actionable idea.)
From researching dollar stores, one of the things that struck me was that you can purchase a pregnancy test for a dollar. Amazon’s #1 best seller pregnancy test costs $12.33– a magnitude more expensive than dollar stores. Amazon is clearly not competing on price!!
By comparison, a more discounting-oriented online retailer like Newegg has razor-thin gross margins of between 8 to 11% (before overhead). Newegg sells computer parts online. Its financials are available via the S-1 filing on EDGAR due to Newegg’s aborted IPO.
Here’s what I do… I look at how the company handles depreciation and amortization of its assets. If management is trying to inflate earnings, it is highly likely that management will be aggressive in making aggressive estimated useful life assumptions behind D&A.
- It’s really obvious to the accountants that they can inflate earnings by making more aggressive assumptions here.
- Pulling this lever is perfectly legal since these assumptions are inherently uncertain and therefore subjective. No one will go to jail for pulling on this lever.
- All companies have to make assumptions on this accounting topic.
I think that proprietary ecosystems like Amazon Web Services will continue to grow. These ecosystems will be popular with small software developers because it saves a lot of time. Larger developers will see less benefit from proprietary software because their problems tend to be more specialized and difficult.
The main benefit of pooled infrastructure for larger developers is higher server utilization. Many of their workloads see fluctuating demand depending on the time of day, depending on the season, or depending on one-time events (e.g. ticketing companies will see a heavy server load when tickets for their most popular events first become available). They should see their costs drop by taking advantage of the elasticity made possible by pooled infrastructure.
One of the hot new growth areas in data centers is what I call “pooled infrastructure”. The data center is a pool of interchangeable servers that can be rented out on a moment’s notice. For example, a customer can rent out 30 servers during peak usage and 10 servers during off-peak usage. Allowing customers to share a pool of servers greatly increases hardware utilization.
Along with the push towards renting out server capacity, the infrastructure providers are bundling value-added software with their infrastructure to save time administering and setting up the infrastructure.
With traditional colocation, a data center will rent out space to many different customers. Each customer brings in their own server hardware. One of the trends among data centers is to have the data center purchase and manage all of the hardware. This creates various economies of scale and benefits such as:
- Standardization of hardware within a data center allows for elasticity and rapid provisioning of a server. This opens up a new market for customers who want to rent servers. Customers can have an operating serving within minutes or hours rather than weeks.
- Software can automate the process of setting up servers.
- Centralizing the purchasing and management of hardware reduces the inventory of spare parts that must be kept on site. It also allows for repairs to have a much faster turnaround time because clients do not need to physically go to the data center to repair their servers. These are very minor efficiencies.
- If clients do not need to actually visit their servers, certain efficiencies are possible. Vertical integration between data center design and server design allows for various capex and opex savings from power efficiency and cheaper servers.
- Some infrastructure providers offer managed IT services. They help customers to secure their servers, to maintain the server’s software, etc. etc.
In data centers, the most interesting areas currently are in:
- Software. In particular, Amazon has been a pioneer in creating value-added software that helps software companies quickly setup databases and servers and backup storage. Google, Microsoft, and IBM/SoftLayer are doing somewhat similar things. The problem is that the data center segments of these companies likely will not move the needle much.
- IT services. Rackspace in particular is doing very interesting things.
The least interesting areas are companies that are mainly involved in selling space in a building because that business is a commodity. Those companies will not make a lot of money and they will not lose a lot of money. While I think a lot of the data center REITs are overvalued and are suckering institutional investors into overpaying for their stock, they are not compelling shorts because they aren’t losing money quickly. As well, many (legitimate) data center companies have been taken over at large premiums by companies like Verizon and Cogeco Cable at valuations I would disagree with.
*Disclosure: No positions.