Attacking The Drug Problem Globally

I saw on LinkedIn that Richard Branson spent all of last week in Geneva debating drug policy at the Global Commission on Drug Policy. He welcomed suggestions on a slogan in the comments, but it got me thinking about how to tackle the drug problem as a whole. Do we legalize drugs and regulate them? Do we impose stiffer penalties? What results would they manifest? My approach is a little different. I say, tackle the problem at its source: the economics of the industry.

Unfortunately, stiffer prison terms for dealers by itself will only be marginally effective because the payoff remains relatively the same. Legalizing drugs won't do much because a legal market with regulation cannot thrive when a healthier black market exists for the same commodity. Anybody who's ever read "Freakonomics" by Steven Levitt will recall the lengthy chapter on the bursting of the "crack" bubble in the early 1990's. So this got me thinking: perhaps the way to control the drug problem is to create an artificially induced market crash.

The approach would be a 4-prong approach, but in order to implement it, we need to look at the supply chain of drugs, their players, and their incentives:

According to Levitt, the 'crack' bubble burst in the early 1990's happened because when 'crack' hit the market, the market price of cocaine dropped as 'crack' was a cheaper alternative to cocaine. This lead to drug-dealers starting to undercut each other, which eventually caused the crash because the risks associated with dealing were not worth the low payoff (getting killed, shot, arrested, etc. vs. the earnings of the average crack dealer of $7/hour*). So the first step would be to get the drug dealers to start undercutting each other in price to unload their inventory. 

To do this though, a few more things are required. Getting dealers to price cut each other and the second step of the approach, requires making the wholesale price of drugs cheaper. Temporarily higher margins to the dealers will make the industry attractive to price-cutters. In any commodity-based industry where no one supplier has a competitive advantage, the return on investment becomes compressed downwards towards the cost of capital because the only thing participants can compete on is price. So where a 70% margin is attractive to one participant, other participants are perfectly willing to settle for a 60% margin, 50% margin, etc. etc.

So to make the wholesale price cheaper, we need to increase the inventory of the manufacturers, which leads to our third step, have local governments subsidize sourcers that reach a certain production quota (lots utilized and total yield) and penalize sourcers who do not reach this benchmark with a "Agricultural Inefficiency Tax." This will incentivize all sourcers to both keep their total yield high and require minimum order quantities from manufacturers to hit the subsidy benchmark. Manufacturers now being forced to take on excess inventory, will both require mininum distribution quotas from their dealers. Dealers will then become loaded with excess inventory and thus incentivizes them to lower their prices just to move their stuff in larger sized deals.

But we're not done there, the fourth and final step is to make prison sentences even higher for drug dealers. What this does is increase the risk profile to drug dealers. Because of this higher risk, the dealers will demand for higher reward in the form of pricing pressure on the manufacturers to expand their profit margins. So what ends up happening is the entire supply chain becomes pressurized from both ends, and the incentive to each player gets flips on its head:

In these conditions, the market becomes unstable and cannot self-sustain, which inevitably will cause conflict between all participants and cause the market to eventually crash.

At least, that's my theory...implementing it is another story.


*See the financial statement of the average crack dealer provided by Steven Levitt in "Freakonomics."

Zuoan Fashion Ltd (ZA): A No-Brainer For Big Returns

Just took a long position in Zuoan Fashion, Ltd. (NYSE: ZA), opportunities like this come few and far between. Not far from its IPO back 2011, Zuoan Fashion is a design-driven fashion menswear company in China that has taken a beating for no apparent reason.

The No-Brainer Aspect

The reason to me this is a no-brainer investment is because while the company is currently priced at $2.17/share, a quick look at their balance sheet in 2012 shows they have $5.96/share in net cash alone (cash minus debt). Furthermore, if we take all the current assets and pay off all outstanding debt, we're left with $11.79/share. What this means is that if the company liquidated everything tomorrow, that's how much shareholders would receive per share, which makes this a textbook Buffet/Graham/Klarman value play with a 82% margin of safety. Wow...

And the story gets better. The company has no long-term debt and no short interest whatsoever. Below is my analysis of the fundamentals versus the stock price over a 5-year period:

Zuoan Fashion Quality of Earnings Vs. Stock Price (2008-2013)

(click to enlarge)

So what we have is a company who's fundamentals are clearly growing stronger over time while the stock price is diverging to reflect the opposite. No financial shenanigans here either, their financial reports were signed off by Crowe Horwathe, one of the top 10 auditing firms in the United States. Zuoan is essentially like a straight-A student in a bad high school, the top institutions are overlooking her just because she's small and didn't go to Harvard Academy. Their loss...

Not only has their fundamentals improved, but their ability to self fund with cash is getting stronger too (defensive), which means they can weather any storm that may lie ahead because their industry is so competitive.

Industry Recognition

So what about the company? Well, the fashion industry is highly fragmented. While the company has no defensible competitive advantage against competition and its success is dependent upon its ability to recognize and create appealing fashion styles in the years to come, the company has received the #1 spot of fashion designers in China by Apparel Magazine two years in a row now, beating out major competitors such as True Religion, Ralph Lauren, Nike, Urban Outfitters, & lululemon, two times over. From the July 2013 issue of Apparel:

(click to enlarge)

And as apparel magazine mentions, they sponsor and are regularly featured on the Chinese equivalent of Project Runway, "Hello Gorgeous." What better marketing avenue could a fashion company ask for? As China's middle class grows, Zuoan's affordable fashion line stands to benefit which makes this not only a value opportunity, but a growth one as well.

Valuation

Baseline valuation is $9.08/share (assuming a 50% write-off of Accounts Receivable in a liquidation event), but if the trend continues I may hold on until $12-14, making this one a potential 6 or 7-bagger. Estimated time to value realization, 2 years, maybe even sooner.

A Great Value Play: Lihua International, Inc. (LIWA)

Just took a position in Lihua International (NASDAQ: LIWA) and I usually like to do some sort of writeup so I can remember in the future why I took particular positions. Lihua International is a Chinese reverse-merger company that is in the copper wiring/electrical arena. They're currently trading at about $5.07 per share ($158M market capitalization).

Asset Valuation

First thing that jumped out to me about this company is that while the market is valuing them at $158M, they have $144M in cash equivalents alone in the bank. Ignoring the $854M in revenue in 2012, this at first glance seemed to be a complete misvaluation by the market because if you divided up the cash alone, each share outstanding would receive about $4.80. In fact if you look back to 2011, if all assets were liquidated and debt paid off, net current assets per share alone are worth $11.69, and that was over two years ago:

Lihua's Net Current Asset Value/Share (2011)

(click to enlarge)

Attractive Margins

Another thing worth noting is Lihua's supply chain management. Unlike its competitors, Lihua isn't making its wiring from virgin copper, but instead scrap copper. The benefit of this is that its margins are not compressed like it's competition's because its costs are not as high, so its management of scrap copper suppliers has given it a competitive advantage:

Chinese Copper Suppliers

(click to enlarge)

Product Mix

Besides it's supply chain management, Lihua also has the benefit of focusing on one of its core product innovations, copper-clad aluminum wiring (CCA). Their high-quality pure copper wiring alternative is priced much cheaper than pure copper wiring (almost 1/3) which provides significant cost advantages in larger projects from the lower commodity price of aluminum.

Copper-Clad Aluminum (CCA) Wiring Structure

Why is this important? Because the PRC government just approved $240B to be invested in the development of China's Smart Grid infrastructure over the next five years so all of its citizens are able to receive affordable power. Along with this comes miles and miles of necessary wiring and cable running, and what better use of CCA wiring/cables than for large projects over thousands of miles. Why is Lihua set up best to benefit from this? Because they currently are the only company that has the proper license in place to import scrap copper to China from places like the United States, which makes them the only company currently able to even approach filling such large orders. Besides CCA wiring, its product mix does still include pure copper wiring, in addition to copper anodes, rods, and magnetic wiring.

In addition to China's investment in its infrastructure, China is the number one consumer and importer of copper:

Copper Demand By Region

(click to enlarge)

The trend is in no way slowing down either, current predictions are that given the trend, China's consumption and utilization of copper could soon exceed world supply, which means scrap copper suppliers are going to become vital, and Lihua is already in position to benefit from this. As far as copper commodity fluctuations go, even though copper pricing is expected to remain stable with the growing demand, Lihua's products are all priced on a cost-plus basis, which means any movement of commodity prices would not erode its profit margins.

Risk

So why does this price of $5.07/share seem too good to be true? Well, its China, which means shady business practices, and its a Chinese reverse-merger, which means potentially even shadier accounting practices. However, due to the fate of its fellow reverse-merger companies such as China MediaExpress Holdings (CCME), all Chinese reverse-mergers are being painted with the same brush by institutional investors.

In 2011, Absaroka Capital, who had taken a short position on Lihua, released a study it commissioned on Lihua trashing the company's practices and accounting methods. Among things claimed in the study included doubt regarding Lihua's financial statements, its executives' backgrounds, supplier relations, and its auditor's track record. In response to this allegations, Lihua's CFO directly addressed all claims (seen here) made by Absaroka, which in my opinion rendered them moot. In addition to that, Lihua has made strides over the past year to be as transparent as possible to the market regarding its accounting methods, even going so far as to having forensic accounting firms such as John Lees Associates do a full investigative confirmation of its cash balances. Besides this, its auditor is Crowe Horwath. While technically using Crowe Horwath's Hong Kong division, Crowe Horwath has a reputation here as one of the top ten auditing firms in the US.

Also, since these allegations were made two years ago in 2011, I'd presume Absaroka has already left its short position by now after the stock tumbled 22% from its study. In other words, they made their money, and now with Lihua's transparency of accounting practices, there's little more to gain for Absaroka or any other institution with a short interest.

Conclusion

Taking a long position in LIWA, committed half my capital allocated to this position for now in case of a dip in the price, this will allow me to average down a bit for a bigger return later. My estimated fair value of the stock is about $15, with a hedge of at least $11.69 from a net asset valuation. Expected time for value manifestation is about 2-3 years, with a option for future review of fundamentals at the $12/share mark.

Abandoning Your Presets

This is something I decided this morning I'm going to dedicate myself to. I've found myself all too often using pre-determined frameworks to guide my action, whether it be in business or personal. While frameworks and guidelines are important, there comes a point in any development, professional or personal, in which you must abandon your presets.

Bruce Lee described this as being formless, but only now am I really understanding the depth of it. So often I've found myself consciously determining action, "they said this, now I will counter with this because..." or "I will do this to elicit this response, which will allow me to...". It's too much thought and interrupts flow. That level of planning and thinking is important but it can also hinder creativity and true expression.

I used to see this a lot when I was practicing judo, you learn a new throw and then you look for every opportunity to use it in competition. While mastery of technique and recognition of opportunity for proper application is important, that narrow focus will cloud the recognition of other opportunities that will achieve the same desired result. Maybe instead of waiting for your opponent to be in position to apply that throw, he's already in position for osoto-gari, but you don't see it because you're sitting there waiting for tai-otoshi to show up and thus miss it.

I also used to see it in jazz improvisation a lot, you learn a new lick (maybe some cliche diminished scale lick like at the 2:06 mark here), you can't wait to use it and you look for every opportunity during improvisation, maybe forcing it in there as if to say "look what I learned!" Compare to this to the approach of someone like Michael Brecker, who once said in an interview that when he practices a lick or line, it might be months before the line comes out naturally in his improvisation, and even then it might come out in a completely different form.

Instinct with true expression, versus consciously and arbitrarily forcing a framework. That's the essence of formlessness.

Your Body's Chemistry: Pyruvate

I'm a big proponent of understanding how things work first before I take action to achieve a desired result from it, but if you were like me you were falling asleep in high school biology class...and you flat out just did awful (I got a C). However, maybe if some of that chemistry was applied to everyday life, I actually would've paid attention.

One of the most important things we learn about without realizing it is the Krebs Cycle. This is the cycle that our body's cells use to make energy. Its part of the reason we get hangovers after drinking and also the reason for weight loss in exercise. I want to share a diagram of the cycle to highlight a huge part of it when it comes to weight loss.

Basically, one of the most important things about energy systems is that if you want to increase your output, you need to increase your input. The Kreb Cycle essentially begins with a substance called pyruvate, that through a series of reactions converts into ATP, which is the molecule cells use for energy. So using this basic assumption about energy systems, if you increase your input (pyruvate) you increase your output (energy). This is big because in order to do these reactions in the cycle, your body has to use energy in the form of calories. So if we increase the amount of pyruvate our cells are getting, we thus increase the amount of ATP created and increase the number of calories burned to make it. Calories burned equals weight loss.

There was a study conducted at the University of Pittsburgh School of Medicine that confirmed this principle, however its important to note that subjects were not given a standard dosage of 500mg found in most supplements, the were given a much higher dosage around 6-8g. So with a little digging on the internet, I found this stuff:

http://www.maxbodysupplements.com/product/GF1.html

One of the side effects of upping your pyruvate intake is your sweatpoint happens a lot sooner. Your sweatpoint is the point at which during a workout your body starts to pour with sweat. My experience from taking this stuff so far is that sweatpoint happens a lot sooner. I also feel like I have more energy to get through double and even triple workout sessions if I want. No jitters or energy crash either like from caffeine, and no facial blood rush like you get with nitrogen-based pre-workout supplements. Great stuff, will definitely be buying more. 

The Fame Equation

I like reality TV stars. I don't watch a whole lot of reality TV, however I think it says a lot about human beings socially. As long as time as stretched, people have always associated fame with talent: if you're the best at something then you'll probably be famous. And rightfully so, how many examples can you think of where someone's fame is a result of their talent? Probably thousands, just look at any major singer or movie star.

However, watching reality TV and the resultant stars from it makes you realize that this correlation between talent and fame is not so strong, in fact its flat-out weak. If Fame = Talent, then that expression would explain people like Tom Cruise, Lebron James, or Christina Aguilera, but what about Pauly D, Kim Kardashian, or Paris Hilton? Surely whatever explanation that explains Lebron James's claim to fame should equally be able to explain Kim Kardashian's, because in terms of fame they're pretty much equal. Yet one has a clear monetizeable talent while the other is seemingly just famous for being famous. What gives?

So let's take the Fame = Talent equation and throw it out because it isn't explaining much. We need an equation that not only explains the Tom Cruises and Angelina Jolies, but one that explains the Kim Kardashians, Paris Hiltons, and regrettably, even the John Wilkes Booths and Dzhokhar Tsarnaevs. We need an equation that objectively expresses fame, whether good or bad, in clear simple terms with talent not being an integral part of the equation. So without further ado, I give to you, the Fame Equation:

Simple, yet all encompassing, this equation explains fame ranging from movie stars to dictators, from Real Housewives to real psychopaths. It explains why criminals and killers can achieve levels of fame as high or even higher than a TV star and can potentially help us prevent the frequencies of atrocities such as school shootings. So let's take a look at each component so we can better understand what fame is really comprised of.

Novelty is often thought of in terms of something that is good (i.e. "what a novel idea!," novelty stores, etc.) however in this equation novelty simply means something that diverges from the norm. This can be an specific event, a personality, a talent, an achievement...anything that for one reason or another cannot be classified as "status quo."

Gossip is the resultant talk or word of mouth regarding that particular novelty, this includes the identity of the person as well as the novelty about them, so in essence Gossip really can be broken down into even simpler terms, Gossip = Person's Identity + Novelty.

Bandwidth is quite simply the speed and spread at which something travels. Bandwidth in this equation is affected by things such as media channels, influential people, and communication methods. Gossip is magnified exponentially by the bandwidth in which it travels. Case in point, if gossip were to make a major headline in news outlets, the magnitude of that gossip will have been increased dramatically than it otherwise would have been if it were just to travel from person to person. So in short, a person's fame can be expressed by the magnitude at which something novel about them is talked about.

Understanding this equation can not only help us become potentially more successful in our everyday lives, but also understand how to take preventative measures when it comes to bad fame. To quote Shakespeare, nothing in this world is good or bad, but thinking makes it so. The same goes for fame in this equation: fame is objective, its nothing more than a metric. Its how we interpret that fame that determines whether its good or bad fame. So when we look at something that we'd consider to have "bad fame" such as the notoriety of a shooter or terrorist, we can take action as a society to reduce its power.

Let's take the example of a school shooting. One of the reasons school shootings happen so frequently now is because of the instant fame that is given to the shooter. The appeal of doing such an atrocity is that its quite simply "easy fame" with a simple thought process behind it: do something atrocious, then everybody will know me, then everybody will finally listen.

So if we look at a school shooting through the lens of the fame equation, we can see how this works:

Expressed in the fame equation, the killer becomes famous when he does something atrocious and the resultant discussion of his doing is magnified by it making every major news outlet and talk show.

So how do we mitigate this? Humans nature is to talk to each other, especially when it comes to things of novelty or interest. We are social animals. Do we really need to change our nature just to prevent awful occurrences like school shootings from happening?

The good news is we do not, only the specific content that we talk about. Let's assign some arbitrary values to this particular "famous killer" example and put them into the Fame Equation:

So here we have assigned an arbitrary value of 500,000 to denote a killer's fame after committing an atrocious event, where Novelty of the event equals 5, Gossip equals 10, and Bandwith equals 5. Now that we know the factors that contributed to the killer's fame, can we erase his fame by just not talking about it? It theory yes, because if the Gossip equals 0, zero to power of anything is zero, multiplied by anything is still zero, which means resultant Fame is, well...zero! However, we know that in practice, that would never happen because people will talk regardless.

So if we can't eliminate Fame, perhaps we can make it less significant. Let's remember again that gossip is comprised of a person's identity as well as whatever is novel about them (Gossip = Person's Identity + Novelty). We can't erase the Novelty itself especially if its an event that already occurred, but what if we don't know the person's name? What if we remove their identity from the equation and make them anonymous?

For example purposes, we'll say the Gossip is made up of about half what the person does or did (Novelty), half about the person themselves, such as their background, why they did it, etc. (Person's Identity). So where gossip equaled 10, we'll say the Person's Identity equaled 5 and the Novelty of the event still equals 5. Let's see what happens with a little substitution and when we eliminate the Person's Identity (Person's Identity now equals 0):

Pretty amazing, huh? So just by anonymizing the identity of the person, we cut the fame factor and thus the appeal to commit the atrocity itself by almost 100,000%! This is huge when it comes to taking preventative measures of such atrocities. If law enforcement made it a policy to anonymize the identity of the person who committed the crime, they'd effectively mitigate the exponential power of the media and thus the appeal to even commit such a horrible act in the first place. Could it be done in every case? Probably not, especially if the person is already well-known, however not confirming the identity would still reduce the identity factor and the resulting fame factor by a huge amount.

So good or bad, the fame equation explains a lot about the famous figures in our society. Fame is nothing but a metric, a metric that can be interpreted as either good or bad, significant or insignificant. It's how we use that metric that matters most.