Even Billionaires Can Fall for Bull (Expletive Deleted) Artists

Posted On Oct 7, 2016 By Dave Gonigam

  • “A chemistry is performed”… and other signs a hot startup isn’t all as advertised
  • The disaster at Theranos — a product of Harvard Business School mentality?
  • A Silicon Valley meltdown and the lesson everyone’s overlooking
  • Mediocre job numbers and a currency “flash crash”
  • The final chapter of the MF Global fiasco
  • Hurricane Matthew and the War on Cash

The memo read like the usual mumbo jumbo when a corporate executive decides to cashier a sizeable chunk of the firm’s workforce.

“After many months spent assessing our strengths and addressing our weaknesses, we have moved to structure our company around the model best aligned with our core values and mission,” said Elizabeth Holmes, CEO of a fallen-from-grace Silicon Valley sensation called Theranos.

And with that, 340 people got kicked to curb at the close of business on Wednesday.

Maybe you saw the news in your online feeds early yesterday; as we say, the company was a sensation. We bring it up this morning to illustrate an important investing lesson. Ignore it and you stand to lose your shirt. Heed it and you can dramatically improve your chances of making a fortune.

The lesson is this: Even Silicon Valley’s best and brightest are capable of casting aside their skepticism and falling for a slick song-and-dance.

And none was slicker than that of Elizabeth Holmes, as she sought to raise capital for her fledgling firm. With “a preternaturally good story” — to borrow the phrase of Vanity Fair writer Nick Bilton — Holmes reeled in renowned venture capitalists like Tim Draper and Steve Jurvetson. Marc Andreessen (of Netscape-in-the-’90s fame) called her the next Steve Jobs.

Hmmm… Maybe that’s because Holmes’ schtick entailed a conscious emulation of Jobs — right down to the black turtlenecks and the veganism. No, nothing suspect about that at all…

Elizabeth Holmes in 2014: Consummate bull**** artist
[Photo by Flickr user Max Morse for TechCrunch, posted at Wikimedia Commons]

But with a mantra about how she was going to “change the world,” Holmes “had indeed mastered the Silicon Valley game,” Bilton writes.

Holmes claimed her firm was developing a machine that could take a mere finger-prick drop of your blood and test it for hundreds of diseases at an incredibly low cost.

How did it work, exactly? She seemed to struggle when describing it to The New Yorker. “A chemistry is performed so that a chemical reaction occurs and generates a signal from the chemical interaction with the sample, which is translated into a result, which is then reviewed by certified laboratory personnel.”

Alrighty then…

But having mastered the Silicon Valley game, she went on to master the media game — getting onto magazine covers. And she mastered the deal-making game, striking a distribution agreement with the giant drugstore chain Walgreens. At the peak of the sensation, Holmes amassed a personal net worth of $4 billion.

Then The Wall Street Journal started sniffing around. Long story short, it found many holes in the company’s story, and ample evidence the machine was less accurate than claimed. Then the SEC started investigating. Then Walgreens bailed on the deal. Thus, the restructuring announced this week.

Which still leaves the question hanging: Did Holmes seek to mislead her investors and business partners? Or did she sincerely believe everything she was saying?

We’ll offer a third possibility: We suspect Holmes drank deep from the Harvard Business School’s approach to “leadership training.”

True, Holmes is a Stanford dropout… but over the years, the HBS approach has permeated American business culture — something we pointed out in The 5 2½ years ago. Author Susan Cain sat in on a HBS information session, where students learned how to be a good class participant: “Speak with conviction,” said the session leader. “Even if you believe something only 55%, say it as if you believe it 100%.”

Huh?

“Our society once routinely called people ‘bull**** artists,’” commented psychologist Bruce Levine, “if they spoke with total certainty without any basis for such certainty so as to persuade others and get attention for themselves.

“Nowadays, bull**** training is called ‘leadership training’ and unashamedly taught at ‘elite institutions’ and at expensive leadership seminars.”

But despite the legions of smart people who were taken in by Holmes, “the postmortem on Theranos reveals that certain venture capitalists did it right,” says our small-cap specialist Louis Basenese.

Louis is the newest addition to the Agora Financial team. He steered more than $1 billion of institutional capital at Morgan Stanley. Then he moved from Wall Street to Silicon Valley. Now he’s one of the world’s premier venture capital analysts. He fills a critical void for us — vetting up-and-coming companies before and after they go public. He separates the wheat that can make you fortunes from the chaff like Theranos. (Thank goodness Theranos never went public.) He already has legions of satisfied readers who call him a “miracle worker” and who appreciate turning an $18,000 investment into $39,000 in only three months.

About the venture-capital guys who didn’t bite when Holmes came calling: “They took the time to verify the technology by asking for third-party validation,” says Louis. “When they couldn’t get it, they passed on investing in the company.”

In an Overtime briefing today (scroll down), Louis reveals more of the shocking history behind Theranos’ rise and fall. He also reveals an even more outrageous example of seemingly smart Silicon Valley types falling for a “good story.” Then Louis shows you how other venture capitalists sidestepped the carnage — using the same due-diligence techniques he applies when screening companies for his readers. Along the way, you’ll get to know our newest editor and what makes him tick. It’s all under the “Overtime” banner at the end of today’s episode.

To the markets, which are all about the monthly job numbers and the British pound.

At last check, the Dow had shed 100 points, resting at 18,176. The 10-year Treasury yield has bumped up to 1.75%. Gold has surrendered the $1,250 level — $1,246 as we write — and that’s despite a bit of dollar weakness. Crude is back below $50.

The job numbers were thoroughly mediocre. The wonks at the Bureau of Labor Statistics conjured 156,000 new jobs for September.

That’s less than the “expert consensus” was counting on and barely enough to keep up with population growth. On the other hand, there was a small bump in the number of people who’d given up looking for work who’ve started looking again. Thus, the unemployment rate ticked up to 5.0%. And there was a modest increase in wages.

Anymore, Wall Street looks at the job numbers not through the prism of whether the nation has a robust workforce… but what they mean for Federal Reserve policy. Today, traders are concluding there’s no chance of an interest rate increase in November (as if the Fed would do that just before Election Day) but a strong chance in December (as Jim Rickards forecast earlier this week).

The real-world unemployment rate from Shadow Government Statistics is unchanged at 23.0% — more or less where it’s sat for more than four years.

Meanwhile, there’s been another “flash crash.”

The term came into vogue in May 2010 — the day after the Dow industrials collapsed 999 points and then recovered most of that loss, all within 36 minutes. Something similar happened two years ago with the 10-year Treasury rate.

In Asian trading overnight, it happened to the British pound — which tumbled 6% within moments and then bounced back, though not all the way…

Now, as before, easy explanations are elusive. A “fat-finger” trade? Automated trading systems reacting to online news stories about the British exit from the European Union? An alarming drop in the NFL’s TV ratings?

Around here, it’s one more reason we figure the forex markets are for pros only. For retail investors, we’re far more partial to the IMPACT system Jim Rickards uses to help readers profit from longer-term moves in the global currency wars.

It’s official. Jon Corzine skates.

Five years to the month after his brokerage MF Global collapsed in a heap, Corzine is close to a deal in which he’ll fork over $5 million to make the Commodity Futures Trading Commission back off from a civil case. Or so says this morning’s Wall Street Journal.

To briefly reprise the sorry story, Corzine — ex-Goldman Sachs CEO, ex-senator and governor from New Jersey — took over a storied firm known for its conservative portfolio approach and turned it into an exciting go-for-the-gusto outfit. In the firm’s trading account, he made huge bets on European bonds that started going sour. To meet the margin calls, he raided customer accounts.

“It’s kind of considered the third rail of the brokerage industry,” we quoted Stanford business professor Darrell Duffie at the time, “that when you’re holding your customers’ funds in their names, you don’t touch them — even in an emergency situation when you’re running short of cash.”

But it’s not enough to earn you any time in Club Fed, evidently. The feds poked around a bit to see if they could bring a criminal case… but filed no charges. Meanwhile, it took more than two years for MF Global customers to be made whole.

The only question now appears to be whether Corzine can tap MF Global’s insurers to pay the $5 million settlement. It’s a tough life.

[Ed. note: Elsewhere we see this morning that yet another ex-Goldman Sachs exec named Phil Murphy has muscled aside all competition in next year’s Democratic primary for Corzine’s old gig as New Jersey governor. Whiskey tango foxtrot?]

With Hurricane Matthew lashing Florida today, we pass along a reader’s cautionary tale in the War on Cash.

“Living in the Charleston, South Carolina, area,” he writes, “we have been in ‘evacuation mode’ since midweek.

“My bank closed TUESDAY evening, a full four days before Matthew’s expected arrival in our area. I understand and appreciate the need to allow employees the time to evacuate safely, but all area branch ATMs were shut down as well with absolutely no warning.

“I’m glad to have saved a small cash reserve fund. If not, we would be out of luck if the power were off for an extended time and credit/debit cards weren’t working. Will be interesting to see if the bank will have an adequate supply on Monday after the storm, if power is available.

“An eerie prequel to a ‘bank holiday’ sometime soon? Just a fair warning that banks will shut down ASAP when given the opportunity!

“Love The 5!

The 5: We thank the reader for the note… and we extend our best wishes to everyone in the storm’s path. It’s a little personal for us at Agora Financial; in addition to our sprawling Baltimore headquarters, we have an office in Delray Beach, Florida — midway between Fort Lauderdale and West Palm Beach.

Everyone there is OK; turns out the storm brushed south Florida and took aim further north…

The status of Waffle House locations actually matters to federal disaster planners. “The Waffle House Index,” according to Wikipedia, “is an informal metric used by the Federal Emergency Management Agency (FEMA) to determine the impact of a storm and the likely scale of assistance required for disaster recovery. The measure is based on the reputation of the Waffle House restaurant chain for staying open during extreme weather and for reopening quickly, albeit sometimes with a limited menu, after very severe weather events such as tornadoes or hurricanes.”

Said FEMA’s administrator five years ago, “If you get there and the Waffle House is closed? That’s really bad. That’s where you go to work.”

Hmmm… As government numbers go, it strikes us as at least somewhat more reliable than the unemployment report.

Have a good weekend,

Dave Gonigam
The 5 Min. Forecast

overtime

Someone else who was taken in by Elizabeth Holmes’ too-good-to-be true story — Mark Cuban.

For real.

Below, Agora Financial’s small-cap guru Louis Basenese reveals more of the seamy story behind Theranos… and the critical investing lesson that could make all the difference to your retirement.

I Trust Her…” and the Three Words Mark Cuban Should Have Said Instead

by Louis Basenese

Trust, but verify.

Any investor that violates those three simple words can bank on losing their shirt. Even in Silicon Valley.

If you need proof, look no further than Theranos, which is back in the headlines this week.

For those unaware, the embattled blood diagnostics company supposedly developed a “revolutionary pinprick blood test” that promised to perform a litany of tests from a single drop of blood, instead of the vials required by current protocols.

By doing so, Theranos was going to be able to disrupt and dominate the diagnostic lab testing market, which generates over $75 billion per year in revenue.

The company’s CEO, Elizabeth Holmes, was a Stanford dropout and quickly became a Silicon Valley phenomenon. So much so that media outlets dubbed her the “next Elon Musk.”

One thing Holmes certainly shares in common with Musk is the ability to sell a vision.

She managed to raise a whopping $686.3 million from investors, which sent the company’s valuation skyrocketing. In 2014, Theranos was worth an estimated $9 billion.

As it turns out, though, vision was the only thing Holmes was selling.

Theranos’ “revolutionary” technology turned out to be nothing more than snake oil. That’s right. It didn’t work. And management knew it.

The fraud all started unraveling last fall, when a series of investigative articles in The Wall Street Journal raised doubts about the company’s methods.

Then a federal report found serious deficiencies in Theranos’ quality controls, which led to Holmes being banned from owning or operating a medical laboratory. (That’s kind of a big deal when you’re supposed to be a blood diagnostic company.)

An SEC investigation also ensued.

Finally, this week, the company announced it was letting go more than 40% of its workforce.

It doesn’t take a genius to figure out the end is certainly nigh!

Instead of billions in profits, Holmes and investors are belly-up.

I’m not here to celebrate this failure, though. Rather, I’m here to drive home the importance of trusting, but verifying when we evaluate any investment.

You see, the postmortem on Theranos reveals that certain venture capitalists did it right. That is, they took the time to verify the technology by asking for third-party validation. When they couldn’t get it, they passed on investing in the company.

Take, Google Ventures (GV), for instance. As The New York Times’ Randall Stross reports, “Theranos approached GV twice and was turned down twice because of what one partner called ‘so much hand-waving.’”

Theranos wouldn’t provide any data and simply refused to respond to GV’s requests.

“Eventually, Google Ventures sent a venture capitalist to a Theranos Walgreens Wellness Center to take the revolutionary pinprick blood test,” writes Vanity Fair’s Nick Bilton. “As the VC sat in a chair and had several large vials of blood drawn from his arm, far more than a pinprick, it became apparent that something was amiss with Theranos’ promise.”

Indeed.

Other venture capitalists also sensed “something was amiss” when Theranos wouldn’t publish data on their technology in peer-reviewed journals — the gold standard for validating a technology. So they passed, too.

Lest you think Theranos is an isolated incident and we don’t have to worry about making the same mistake, think again. It happens more frequently than you might suspect. Even in Silicon Valley.

Look no further than wireless charging startup uBeam. It quickly raised $13.2 million from Silicon Valley elites, including Marc Andreessen, Marissa Mayer, Shawn Fanning and Tony Hsieh, among others, with little more than an idea.

Billionaire Mark Cuban even took the bait. By his own admission, he invested without ever seeing a prototype.

As he told Fortune, “I trust her enough that I haven’t gone out and said, ‘Show it to me.’ She’s shown it to enough people that I trust what’s going on.”

Yikes!

And wouldn’t you know it? In May, serious questions were raised by former employees about uBeam’s technology being nothing more than vaporware. Time will tell if that’s the case. It certainly doesn’t look good, though.

A fact even uBeam investor and venture capitalist Mark Suster acknowledges: “We haven’t yet shipped product or shown the public our prototypes. The product isn’t yet where we want it to be — like most startup products, it is a work in progress.”

At the end of the day, simply trusting a company (or trusting that earlier investors did their homework) is a terrible investment strategy. It’s lazy and destined to lead to losses.

That’s why before I recommend any investments, I take the time to verify the technology with independent third parties and, if possible, demo it myself.

By doing so, I’ve built a track record of providing my subscribers with countless triple-digit winners. More importantly, though, I’ve saved them from investing in seemingly revolutionary but ultimately worthless technologies like Theranos and uBeam.

Ahead of the tape,

Louis Basenese
for The 5 Min. Forecast


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