Thursday, October 13, 2016

Measuring how bad Twitter is

My last blog post (exposing Twitter's excessive costs) prompted horror story emails on Twitter.

But the best thing sent to me was a financial history of Facebook. The first copy came from Twitter.

Here are the numbers.

Year Ended December 31,
(in millions, except per share data)
Consolidated Statements of Income Data:





Total costs and expenses(1)





Income from operations





Income before provision for income taxes





Net income





Net income attributable to Class A and Class B common stockholders





Earnings per share attributable to Class A and Class B common stockholders (2):










Total costs and expenses include $1.84 billion$906 million$1.57 billion, $217 million, and $20 million of share-based compensation for the years ended December 31, 2014201320122011, and 2010, respectively.
See Note 3 of the notes to our consolidated financial statements for a description of our computation of basic and diluted earnings per share attributable to Class A and Class B common stockholders. 

When Facebook had $1.974 billion of revenue it had $1.008 billion of income before taxes.

Twitter is kind of different.

Year Ended December 31,






(In thousands, except per share data)

Consolidated Statement of Operations Data:







Costs and expenses(1)

Cost of revenue






Research and development






Sales and marketing






General and administrative






Total costs and expenses






Loss from operations





Interest expense





Other income (expense), net





Loss before income taxes





Provision (benefit) for income taxes





Net loss






When Twitter had $450 million of operating losses and $533 million of losses before tax.

There was about $1.5 in difference in costs.

Facebook does more, had more growth runway and had much lower costs.

I received a lot of anecdotes and wild parties and profligate spending, and the plural of anecdote is data - but few things are as convincing as the raw numbers.

The conclusion is inescapable. Jack Dorsey - the Twitter CEO - should be fired.

This should happen regardless of whether Twitter is bought or not. He simply does not deserve the job.


PS. Twitter staff - I am not exaggerating. Look at the young man on your left and the young woman on your right. Only one of you three will keep your job.

Don't worry. It should be worse in the C-Suite.

Prepare resumes.

Tuesday, October 11, 2016

Some comment on the Twitter buyout rumours

Twitter is wildly addictive. This is well known and there are people who check twitter more obsessively than anyone checked email.

Twitter is also a chaotic world full of trolls, useless information, porn-spam and videos of kittens.

It is also - as anyone cares to notice - for sale.

The gossip - and I have no reason to doubt this - is that there are on the Twitter board two factions:

  • The CEO Jack Dorsey who wants to run the company and
  • The board who - sick of pointless losses and running out of money - wants to sell it.
This leads to probably the most leaky sales process I can ever remember - with almost daily rumours about who is interested and who is not interested. The current rumour mill says all the "strategic buyers" are not interested.

In this blog post though I just run through the numbers and try to delineate what as a regular user (but an outsider) should be done. But I will cut to the chase now. This company should be and probably will be bought by an aggressive financial buyer. And Jack will be fired. (And - I think - the world will be a better place for that.)

Just the numbers 

You can find time series quarterly P&Ls (standardised by Thomson Reuters) here. An annual series is below.

Period End Date31-Dec-2015 31-Dec-2014 31-Dec-2013 
Net Sales2,218.01,403.0664.9
Total Revenue2,218.01,403.0664.9
Cost of Revenue, Total729.3446.3266.7
Cost of Revenue729.3446.3266.7
Gross Profit1,488.8956.7398.2
Selling/General/Admin. Expenses, Total1,132.2804.0440.0
Selling/General/Administrative Expense892.3583.7270.5
Labor & Related Expense239.9220.3169.5
Research & Development806.6691.5594.0
Total Operating Expense2,668.11,941.91,300.7
Operating Income(450.0)(538.9)(635.8)
Interest Expense, Net Non-Operating(98.2)----
Interest Expense - Non-Operating(98.2)----
Interest Income(Exp), Net Non-Operating--(34.0)(6.9)
Interest Inc.(Exp.),Net-Non-Op., Total(98.2)(34.0)(6.9)
Other, Net14.9(5.5)(4.5)
Other Non-Operating Income (Expense)14.9(5.5)(4.5)
Net Income Before Taxes(533.3)(578.4)(647.1)

Here is what to notice. Revenue has gone up very nicely - from $664 million to $2.2 billion and is still increasing. And costs have gone up commensurately. Losses seem stubbornly stuck at half a billion per annum. That is real money - just burnt - and burnt by a business that is already established.

In other words costs have gone up by $1.5 billion give or take something. That is billion with a b.

Now if costs were rising that fast and the service were noticeably improving and engagemet growing then you could be tolerant. Making money is far less important in a growing tech company than increasing your relevance and the moat that surrounds your business. (Amazon is the leading example of a company which increases the moat every day.) The short-hand for that thinking is that revenue follows relevance.

But - as a pretty dedicated tweeter (with almost 20 thousand followers) - I have noticed almost no changes in twitter that improve my user experience. It is almost impossible to find out what they spend that $1.5 billion extra per annum on. I gather there are some improvements in the monetisation side but this is just a website - and it does roughly what it did in 2012 - and but spends well over a billion dollars more to do the same thing. [From my perspective the marginal improvement is that I am seeing fewer failed-to-load pages... but that is it.]

Twitter has become a parody of bad Silicon Valley management - the sort of management that existed in the dot-com boom where quite literally burning shareholder funds was considered a mark of innovation. 

The main difference between this and (say) Pets.Com is that underneath is a business that should be salvageable - and should make pot-loads of money. After all if they raised costs by $1.5 billion per annum without achieving jack-shit then costs should be able to be controlled. And if that is possible then Twitter as an LBO works on the back of an envelope at these prices.

Why a financial buyer not a "strategic buyer"

The news of the day is that almost all of the strategic buyers (other big tech companies) have pulled out of the bidding process. There is good reason why that should be the case.

If you run for instance your main agenda should be on growing your business in a disciplined fashion. They are still in the stage of building relevance. And that requires friendly well directed management willing to let staff have their little well-directed flights of fancy (rewarding of course those fancies that grow the business). 

But Twitter is past that. Somewhere near half a billion dollars of costs need to be taken out almost immediately. And that involves firing people and being a general tough-bastard. It's inevitable anyway - because Jack Dorsey burning half a billion dollar per year isn't a sustainable business. The cash eventually runs out. 

The problem is if you mix this with a or similar company it will be really hard to take costs out in a disciplined fashion without upsetting the culture of the home company. Instead this should be fixed (with extreme prejudice by a disinterested outsider) before it is sold again to a strategic buyer.

Or - in summary: the best bastards are from Wall Street. And this needs a Wall Street bastard. 

Carl Icahn - Twitter needs you. 


That said - there are things that need to be done that are not being done under the (seemingly incompetent and fashion obsessed) Jack Dorsey.

First troll detection has to be done much better.  There degree of incompetence in troll-hunting beggars belief. For example I have stereotypically attractive 20 year olds in bikinis who just want to do wicked things to me (and I am not even Donald Trump). I block them all and report them - but somehow Twitter has not managed to stop filling my time-line with porn spam. Blocking this is the sort of pattern recognition that computers should do - and if your spam-to-content ratio gets to high you eventually lose real users.

Also there is a lot of semi-commercial (even scam) spam here. Have a look at this twitter stream:

There are almost 10 thousand tweets - and they are all penny stock promotion mostly for the same penny stock. I think it is Russian but the location says Manchester. (Many scam promotion schemes look the same - and I do not think the penny stock promoters all live in Manchester.) The Tweets include a reference to some hot stock or controversial stock (Apple, Herbalife etc) and then links to a penny stock page. It is really obviously spam. But it has been around for months.

It also has 800 followers and not a single overlap with my followers. In other words almost all the other followers are spam bots too (because I seem to have overlap in followers with all serious financial tweeters). 

I could block five of these a day and there is still an endless supply. It makes searching for news about a stock almost pointless because the ratio of spam to real news is not good. 

I suspect the management incompetence goes further. If they actually fix the spam-bot problem then the truth about the active users numbers will out. It is weak (precisely for the reason above). But weak numbers mean they are all going to need to be fired. 


But lets play the numbers

Twitter revenue is still rising and is running about $2.5 billion per annum. It is a website that once ran extremely well on less than $250 million in costs. (No I am not joking.)

If you can't make this have a 40 percent operating margin then - frankly you are inadequately brutal. Personally I think 50 percent is possible.

At this market cap that works extremely well for a financial buyer. Its a no-brainer even.

So expect it to be bought. By some Wall Street bastard armed with a lot of debt. 

And that bastard will fire a lot of people. 

If I worked at Twitter I would be preparing my resume and providing a list of really quick things that can be done to improve the user experience - with the code all mapped out. That largely involves getting rid of spam bots and the like. But unless it radically improves the user experience or monetisation and you can convince the new owners you can implement then you are out. 

And the fashion-obsessed philosopher king. He is out too whether there is a buyer or not. That is necessary to save the company.


PS. Long for the takeout which I see as inevitable. 

Sunday, October 2, 2016

Some comments on the New York Times story about Donald Trump's tax returns

Decades ago - before I was a fund manager - I was the resident expert on tax avoidance working for the Australian Treasury. That was where I started to hone the accounting skills sometimes shown on this blog.

I very rarely do anything in tax - but now I think it is time.

The New York Times has published a story (including extracts) about Donald Trump's tax returns over two decades ago. The money-quote is this:

Donald J. Trump declared a $916 million loss on his 1995 income tax returns, a tax deduction so substantial it could have allowed him to legally avoid paying any federal income taxes for up to 18 years...

According to the New York Times the losses came
... through mismanagement of three Atlantic City casinos, his ill-fated foray into the airline business and his ill-timed purchase of the Plaza Hotel in Manhattan.
There is an issue here.

Donald Trump did not repay all the debt associated with those investments.


  • the loss is a real loss and the Donald was really was out of pocket by $916 million (in which case he has legitimate NOLs)
  • or the loss was passed on to someone else by The Donald defaulting on debt - in which case Donald Trump should be assessed for income from debt forgiveness.

After all if the debt is forgiven it is not Donald Trump's loss. The loss is borne by the person who lent Donald money and did not get it back.

That - clearly stated by example - is why most income tax systems assess debt forgiveness as income.


Okay - I do not know whether Donald Trump had the wherewithal in 1995 to bear $916 million of losses personally. But I doubt it. (If he did his financial career is different from what is popularly accepted.)

So the alternative is the debt was forgiven in some way. But then the story the New York Times is running is wrong - because the $916 million of losses would not have survived the debt forgiveness and hence would have wiped out his NOLs and thus he would not be allowed to shelter his income for the next 18 years.

Unless that is there is an avoidance scheme the New York Times has not worked out. Those schemes go by the name of "debt parking".

Debt parking

Here is how debt parking works. Suppose the debtor (in this case The Donald) is going to get his debt cancelled for (say) 1c in the dollar. When he gets the debt wiped out the debtor (ie The Donald) will have to report assessable income equal to the debt wiped out (in this case 99 percent of $916 million).

The alternative though is for the debtor to set up a dummy party. The dummy party might be his wife or children or some company or trust set up by them or more likely some completely opaque offshore trust.

And that dummy party goes and buys the debt for say 1.1 cents in the dollar. Then they just sit there.

They don't force the debtor (ie The Donald) to repay. They don't make a profit or loss on the debt. And because the debtor never has his debt forgiven he never gets the assessment on debt forgiveness and he gets to keep his NOLs even though the losses did not come out of his pocket.

Every tax system worth its salt has some rules on "effective debt forgiveness" to prevent debt parking. And - from my experience which is now over twenty years old - none of them work entirely.

Now if Donald really has all those tax losses its pretty clear that the debt must be parked somewhere.

There is a vehicle out there (say an offshore trust or other undisclosed related party effectively controlled by Donald Trump) - which owns over $900 million in debt and is not bothering to collect it.

I do not have the time or energy to find that vehicle. But it is there. Now that this blog has gone public journalists are going to look for it.

There is a Pulitzer prize for whoever finds it. Just give me a nod at the acceptance ceremony.


Monday, September 26, 2016

Comments on investment philosophy - part one of hopefully a few...

This is the first of several investment think pieces I have in my head dealing with investment philosophy, where markets are now and maybe even a stock or two... They are surprisingly hard to write so these posts might come slowly...


When I was starting out in the investment game I read Warren Buffett's letters from inception, Ben Graham, Phil Fisher, anything I could on Charlie Munger and the rest of the standard investing canon. 

One thing that had a profound effect on me was Warren Buffett's twenty punch card. (Quoted here...)

Buffett has often said, "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."

Buffett is right. That would be a really good way to run your private investments - you would, I think, be very rich by the time you were old. And indeed Charlie Munger has run his career close to that way (though I suspect he is closer to 100 investments by now...) 

Charlie Munger has quoted Blaise Pascal approvingly: "all of humanity's problems stem from man's inability to sit quietly in a room alone."

There are plenty of people out there who call themselves Buffett acolytes - and as far as I can see they are all phoneys. Every last one of them. 

Find any investor who models themselves off Warren Buffett and look at what they do.

And look at their investments against a twenty punch card test. 

They fail. They don't even come close. Several big-name so-called Buffett acolytes have made more than three to five large investments in the last three years and at prices that can't possibly meet the twenty punch card test. Most phoney Buffett acolytes have been turning stock over faster than that.

Warren Buffett's two juniors (Todd Combs and Ted Weschler) have turned over many stocks in the past few years too - and at prices that don't reconcile with any twenty-punch-card philosophy. They are phoneys too. Just a little less egregious than many other so-called Buffett acolytes.  

I used to profess myself a Buffett acolyte too. But somewhere along the line I realised I was a phoney too. I just wasn't close to that selective and when the situation was right I wasn't anywhere near willing enough to pull the trigger and go really large in a position

There are psychological feedback mechanisms that stop you meeting the twenty punch-card test. Firstly it is really hard to be that patient. I did not find a new stock that met that test this year. Or last year. Or the year before. Or the year before that. I found one in 2012. And prior to that I had not found a new one since the crisis (when there were many available most of which I missed). 

But I am incapable of sitting idle since 2012 (even though the local beach is very good) and so I do stuff. Inferior stuff. Stuff that may produce inferior results. 

And some of it (thankfully not much) did produce inferior results. [I was long Sun Edison for example.]

And when you are wrong like that it is scarring. It makes you less willing to pull the trigger in quantity when something does meet the twenty punch-card test. Indeed perhaps the main advantage of the twenty punch card test is the avoidance of mistakes so you can (both psychologically and from a risk-management perspective) take much bigger positions when they come along.

Phoney Buffett-style value-investing is dangerous

A twenty punch card investment portfolio is - by its nature - a concentrated investment portfolio. If I had run my portfolio like that I would have come out of the crisis with maybe six stocks, turfed one or two by now and added a single stock in 2012. 

The rest of the time I would have spent reading, talking to management of companies I was never going to invest in, and otherwise tried to work out how the world actually works. (And the world is always more complicated than you imagine so the work is endless even if the activity is muted.) 

Many so-called Buffett acolytes (phoneys, all of them) have imbibed that a concentrated portfolio is a good idea. And so they present as having five to twelve stock portfolios and are prepared to take 30 percent positions. 

But the stocks often don't meet the twenty punch-card test. And so these investors wind up with large positions in second rate investments. When one goes wrong it is deeply painful. When three go wrong simultaneously it is devastating. 

The lesson here is easily stated: "if you are going to fill your portfolio with crap, it better be diversified crap". 

Several of my favourite phoney Buffett acolytes have been posting catastrophic losses. It was due. The phoney Buffett acolytes still here are just waiting for their turn to have catastrophic losses. 

Real twenty-punch-card investing is impossible to sell to clients

Just imagine if I had run a twenty-punch-card style portfolio and sold it to clients. We would have made a bunch of decision in 2008 and 2009 and our numbers would have been stunning to 2012. (Our returns on our longs were very good in those years. Way ahead of market.)

We would have turfed one or two of these. (Some businesses just change, others go up seven fold and are just not worth holding.) 

I would have bought a single big position in 2012.  

And since about mid-way through 2013 my cash holdings would be going up and up. Partly from dividends, partly from asset sales. 

And I would be underperforming now. Quite badly, even though returns would be positive. Come to think of it, my longs mostly are underperforming now. So are the longs of many fund managers I admire.

But mostly I would have been just idle. So in the midst of underperformance a client might ask me what I did last year and I would say something like
a) I read 57 books
b) I read about 200 sets of financial accounts
c) I talked to about 70 management teams and 
d) I visited Italy, the UK, Germany, France, Japan, the USA and Canada 

but most importantly I did not buy a single share and I sold down a few positions I had.

And I underperformed an index fund.

That is kind of hard to justify. I don't have a clue how you would ever sell it to clients. I can't imagine any clients buying it.

And so to my knowledge there is absolutely nobody who is true to the formula and who really runs a concentrated 20 punch-card formula fund. 

They are all phoneys because (a) the truth is so difficult it hurts and (b) the clients can't handle the truth.

What I did when I realised I was a phoney Buffett acolyte

Somewhere along the line I realised that did not have the temperament to be a true 20 punch-card investor. So I did two things.

a). Rather than accumulate cash and just sit there for very long time periods (five to ten years) I tried to find shorts. The shorts have two benefits (i) they turn into cash when the market goes down and twenty-punch-card opportunities arise and (ii) they attempt to make some money on their own.

b) I run a portfolio that is more divesified than I desire. I desire to be 15 stocks in 15 industries and seven countries, though in reality my desire should be to be more concentrated than that. [I would/should be happy with five 20 percent positions as long as they all meet the 20 punch-card test.] Alas (justified) lack of conviction means my portfolio is about 45 long positions - many of which are for sale when a better idea comes along. In other words when I hold crap at least I diversify it.

This is not entirely satisfactory. I get some longs wrong and lose money on those. And the shorts can be difficult to make money on even when you are right. A stock that goes from 10 to zero might look like a great short but if it goes via 50 then you are likely to be forced to cover some on the way up and its unlikely you will ever recover your losses.

We have strategies to manage both those problems and the results have been and will remain satisfactory although they will not always glow. There can be sustained periods of dull performance. And whist this is not as hard to sell to clients (or yourself) as a true 20 punch-card portfolio after a couple of years dull performance can become exhausting. Clients who haven't lost any real money will leave - because there is always someone else who is making money - and the grass is always greener - and because clients see performance more than inherent risk in any portfolio - and low risk portfolios can be dull.

Portfolio managers I admire

I still admire Buffett's portfolio management more than I can say. He really is astonishingly good at what I have chosen to do for a living.

But I can't emulate Buffett and nor can anyone else I know. And if someone uses his name to describe their investment philosophy my (likely accurate) presumption is that they are a phoney.

There are other managers I admire. I still think Kerr Neilson at Platinum is a freak but it is awful hard to emulate him though in at least part of my portfolio I try. I worked for him for seven years and have some idea how he does it. [He is unbelievably good at cyclical stocks for instance - something Buffett professes no desire to do and which I lack some of the skills necessary to do.]

But almost every other portfolio manager I admire is a long-short manager who has come to an investing compromise like mine. They aspire to be world-class long investors but irregularly fill their portfolio with more diversified second-class stock picks. And they run short books.

And the short books hopefully make money on their own - but mostly make money at the right times - delivering their profits in down years like 2008, and stripping them of profits in super-strong markets.

The problem is that almost every one of these managers is having a dull patch at the moment. These are people I think are amongst the best in the world. And I think (without naming names) that they are having the dull patch the same way as I am. In particular it is devastatingly hard to find things that meet the 20 punch card test. [If you have one please email me. I am prepared to listen to almost anything.]

So instead they have been buying things which are "ownable" rather than "buyable". In other words things that are sort-of-okay in that if you owned them for a decade you would probably be happy enough but not thrilled with the result. And the results from doing this have - at least over the past year - been dull. [Exception: if you bought pure bond sensitives as an alternative to bonds you did really well - but alas I did not do that...]

And the good long-short managers have found it easy to find egregious crap to short. Stuff where the story has more resemblance to fantasy than reality. The typical tell is massive differences between "the story" and the GAAP accounts". 

Some of these fantasy stocks have blown up (Valeant, Concordia) but many are alive and well and when I describe them as fantasy stocks I just get back hostility. And as a rule long "ownable", short "fantasy" has not worked that well. Truth be told it has produced results that somewhere between 5% positive and 5% negative. It has been hard work to go nowhere. 

And there are fund managers who are doing better. Some of them have tricks I do not understand (I put David Tepper in this camp - I simply don't get how he does it and hence can't emulate it*). But the ones I do understand I don't like. Their chance of a plus 20 is clearly better than mine. And their chance of a minus 40 is alas even better than that, and that is something I find abhorrent even if the clients are seduced.

Its really hard out there. I don't think it is a time to be greedy, but low to negative yields make it a difficult time to be safe/fearful as well. 


*The Tepper trade that most impressed me this cycle was long the airlines. I had enough knowledge to know this cycle would be good if I put the pieces together. But I did not put the pieces together and my allergy to capital intensive competitive businesses overwhelmed common sense. Tepper made a great trade that almost any Buffett acolyte would have ignored.

Sunday, September 18, 2016

Fan blades - analysts adding value

I wrote a long post about fan blades the other day. In it I pointed out that fan blades on the front of turbofan jet engines (the ones on commercial jets) are really difficult to make. They spin fast (providing most the thrust for the plane). And they have to deal with bird strikes (which are surprisingly common). And finally they are not allowed to penetrate the engine casing if one were to fly off.

Fan blades have taken a surprising amount of material science to develop. They really are "cutting edge" stuff.

I talked a bit about Alcoa supplying the fan blades on the Pratt & Whitney geared turbofan (GTF) engine. Indeed I showed an Alcoa video of the project.

Well it turns out that these fan blades are the main reason for the GTF engine being slow to deliver.

The FT is running a story about how Pratt & Whitney are cutting engine production targets. It is not good news and they are blaming Alcoa.
Mr Hayes said front fan blades were among about five engine parts “that are causing us pain” by slowing deliveries. The company is continuing to build the engines, since fan blades go on at the end of assembly... 
The fan blade, developed with Alcoa, is made of aluminium-lithium alloy and tipped with titanium on the leading edge. Efforts to speed up blade manufacturing have taken longer than expected, leaving Pratt with fewer units than it expected by now, according to people familiar with the process. 
This year, we talked about delivering about 200 engines,” Mr Hayes told investors. “As I stand here today, I think that number is probably plus or minus 100 — more like 150 engines for the full year...
I encourage reading the article.

That said an analyst on the United Technologies conference call couldn't resist the chance to get in their question about 3D printing. 3D printing has uses - one is to make really complicated parts. But it is not much use in making really strong parts (like fan blades)* because there is in weaknesses where the product is added rather than made (say in a cast/forge process) as a whole piece from inception. 

Enjoy the question and the none-to-subtle put down:
Nigel Coe - Morgan Stanley - Analyst 
Obviously, GE is making a big play in additive manufacturing. Why couldn't you print out these fan blades -- what -- easy, right? It's simple. What is your play is additive? Is that a potential for Pratt? 
Greg Hayes - United Technologies Corp. - Chairman, CEO 
It's a potential for Pratt. It's probably a bigger potential maybe even with -- at the Aerospace Systems business. If you think about where additive really gives you the advantage, think about a fuel pump today, which is essentially a piece of aluminum or nickel that you hog out, you put all of these passages and cavities in, very, very difficult to machine. Where we see the opportunity there is through additive to be able to build these up 1/10,000 of a layer at a time, and build these cavities right in.


*I simplify a little here. Additive manufacturing (aka 3D printing) is of great use in making the moulds for casting. You can cheaply and easily print very complicated designs which you then use for making moulds. 3D printing has its place but nobody has yet come up with a way of actually printing the super-strong cast elements.

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The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.