Jan. 31, 2022

The Theranos Bubble

Today we look back Elizabeth Holmes and Theranos. Was this a unique case of "faking it until you make it" or this what everyone in tech does?

Today we look back Elizabeth Holmes and Theranos. Was this a unique case of "faking it until you make it" or this what everyone in tech does?


Will Page: Welcome back to Bubble Trouble, conversations between the economist and author Will Page, that's myself, and the independent analyst, Richard Kramer, who we'll now call the King K. And this is where we're gonna lay out some inconvenient truths about how the financial markets really work. Today we're picking up pieces from the bubble that has long since burst, Theranos. Ms. Holmes has got 20 years ahead of her to think about what happened. Is she guilty of faking it until she made it or is that kind of being innocent? 'Cause it's what everyone else in tech does. Only she got caught big time. More in a moment. Richard, welcome back to Bubble Trouble, sir.

Richard Kramer: Lovely to see you Will.

Will Page: Nice one. Now we're gonna refer to you as a King K throughout this podcast. You've been christened again.

Richard Kramer: I'm not sure I like that.

Will Page: [laughs]. Okay. Well, we'll tone it down. This time we're talking about Elizabeth Holmes. We have to do things differently on the podcast otherwise [laughs] there's no point doing this podcast. And I don't wanna do the shouting fighter thing of, you know, laughing at or a pity. I wanna really tackle this deeper debate about, is there a crime to fake it until you make it? If it is, what does that mean for tech in 2022? So let's get to the crossroads. The first thing I wanna tackle Richard is the verdict. Firstly, how closely have you been following this case, past and present?

Richard Kramer: I've followed it reasonably closely. I am no expert in med tech, but certainly it got so much attention, mostly because of Elizabeth Holmes herself, and her presentation skills or looks or simply the, the rarity of being a female entrepreneur, chief executive innovator, visionary as she would style herself in Silicon Valley. So it was kind of impossible to miss. In preparing for this podcast, I wanna say I really enjoyed listening to John Carreyrou, the Wall Street Journal author of Bad Blood and his three series podcast on the trial and the ins and outs of it. It really opened my eyes to the way in which Elizabeth Holmes is still managing her image ahead of this trial and how there's still a fascinating trial to come of her former partner and co CEO of Theranos, Sunny. I've listened to quite a bit of the podcast that have come out about, uh, Theranos, and there were some incredible sycophantic moments and you'll know that word from previous podcasts.

Will Page: [laughs]. And this is gonna be like a greatest hits of all of our podcasts, right here, right now in this one [laughs].

Richard Kramer: Well, there's certainly the sycophantic moments listening to the likes of Jim Krammer, no relations, spelt differently.

Will Page: [laughs].

Richard Kramer: Uh, phoned over Elizabeth Holmes after some very damaging revelations had come out and sympathizing with her about how difficult it was to be an entrepreneur and a visionary, and to be like, uh, Steve Jobs of her era, when it turned out that a lot of what she was saying was complete smoke and mirrors.

Will Page: So let's get context on your recollections before we get into this incredible verdict that came out last week. You were aware of Theranos before the Wall Street Journal broke its story. Give me your recollections, what you thought about this company then. Were you buying into it or were you smelling bubble trouble? If we, we use the name of our own podcast.

Richard Kramer: I wasn't either of those, because again, I don't have the context to judge med tech. Uh, how difficult, what they're speaking about might be to create this incredibly simple blood test, which is so much cheaper and more accurate and can be done with so much less hassle. I had no context, but it was impossible to miss this blonde Stanford graduate, Steve Jobs styled lookalike, that had promise to revolutionize an area, certainly in the U.S., which is fraught with issues. Which is medical testing. And I know that it's become an industry precisely because of the liabilities and the legal niceties of the U.S., uh, medical system, oblige doctors to prescribe test after test, after test.

Will Page: Mm-hmm [affirmative].

Richard Kramer: And it becomes an incredible burden to people.

Will Page: Yeah.

Richard Kramer: And equally because of the, the fear factor, the visceral reaction people have to the needle getting stuck in their arms so that they can draw blood to find out what, what's in it.

Will Page: And that's an important context for this podcast and for listeners who wanna go deeper in the subject, thoroughly recommend watching the Alex Gibney documentary, Out for Blood in Silicon Valley.

Richard Kramer: Mm-hmm [affirmative].

Will Page: But even though you're not an expert in med tech, you're drawn into the story through the personality as were many others. Now let's go from before Christ to after Christ, the Wall Street Journal article lens, you are for me a professor of bubble trouble. When you read that Wall Street Journal article and you've read what's happened since, was it deja vu? Was it I've seen this story too many times or is it different this time?

Richard Kramer: I thought it was a classic example of an entrepreneur making a potentially inflated but incredibly compelling sounding claim for their invention. And we've had this time and time again, that entrepreneurs will suggest that the invention that they've come up with is going to change the world, has revolutionary potential. And because of that, ought to be valued at a billion or many more, uh, dollars. And that's why there has been this incredible fixation on unicorns, on, on companies that, that sport a billion dollar valuation, wholly without reference to the underlying business that justifies that billion dollar evaluation.

Because there are plenty of other companies that they can meet on the way down that previously were valued at tens of billions, but now are heading to zero, and they, they probably meet in the middle at the billion level on the way down. So this cult of the entrepreneur, this veneration of the visionary who breaks the mold and disrupts an existing industry, largely without thought for the people whose livings rely on the industry that's being disrupted or the consequences of disrupting those industries. I think that is well entrenched in our culture now. We all want to believe that there are, there is the clever teenager living next door who is gonna come up with an invention that changes, hopefully for the better, the way we are all live.

Will Page: You're on a role Richard. Last week you came up with FOFO, Fear of Finding Out. Now you've got the ventilation of the visionaries. [laughs]. You could almost turn this to Volvo or something, but yeah, it's a nice term. Now, the decision's interesting for me, because we could see, you know, Theranos was a bubble at burst. She got caught, she's going to jail, but it's not that straightforward because she was found guilty on four of the eight counts. I'm not a lawyer. I'm presuming that you are not a lawyer, but what's your interpretation of only being found guilty on half of the counts that she was charged against?

Richard Kramer: Well, look, there's a very high burden of proof, and having listened to the John Carreyrou podcasts about the trial, clearly there are some inflated claims that investors may choose to believe. And if they put their money where their mouth is, it's buyer be beware, it's caveat mTOR. At the same time, this crossed a very important Rubicon, because we're not talking about software or some consumer gadget where you fake the demo and it looks like it improving your life, we're talking about medical technology on which people make literally life or death decisions. So when you cross that Rubicon into measuring the clinical efficacy of medical technology, there is a lot more at stake than whether your software works or makes your computer crash or that new gadget that we bought is gonna end up in the box of all those gadgets we bought that didn't work out the way we planned.

Will Page: The stakes are a lot higher this time, I guess.

Richard Kramer: Yes. And there are many examples. I think currently the wearables market is full of examples of products that people, our listeners probably have sitting in a shoebox or in the closet somewhere or in a drawer that we thought they were gonna be something we'd wear all the time and would really help us in our lives, and turned out to be something that well, didn't really work as planned.

Will Page: And one last thing which bugs my basement about the judge's ruling or the way the U.S. legal system works is, she spends 20 years in jail whether she gets caught on one of the eight charges or all eight of the charges. There's no proportionate nature of the sentence, which I find fascinating. But let me move into another trade off that you've already touched on, which is promise and deception. You can promise so much, but at what point does that become deception to your investors?

Richard Kramer: Well, certainly there are many examples of entrepreneurs making misleading statements if for no other reason than to buy time for themselves. And perhaps the many employees that rely on them to keep the plate spinning and their business prospects still in play. And in many cases, those entrepreneurs will go to great lengths to play out the string, to see if their invention could work, to see if they can raise that extra capital that will get the extra development staff or sales people that will make their invention a reality. And I think Elizabeth Holmes dug herself in the ditch and the only tool she had to hand was the shovel to keep digging deeper. And that's why she kept raising more money even though the private communications coming out showed time and again that there was serious challenges with the technology they were purporting to offer.

Will Page: Now I wanna make you cough up your coffee here because in the Financial Times, one of her early investors who still keeps the faith in her promise of Theranos and what it can offer med tech said, "The spirit of entrepreneurship is in jeopardy." Now, when somebody says that after the Theranos story is played out in the core, what does Richard Kramer say?

Richard Kramer: Nonsense.

Will Page: [laughs].

Richard Kramer: Utter nonsense. There should be no contradiction with outlining the potential or prospects of an invention or any new technology with making statements that are demonstrably justifiable or backed up by some modeling or projections or market research, or what have you. I'm sure Elizabeth Holmes identified a large addressable market for blood testing, but to then make a promise about the technology that had no backing in science was clearly at the heart of the wire fraud trial.

Will Page: Now, before we go to the break, I wanna draw on that lifelong lesson from Abraham Wald, the statistician in World War II, who taught us that when we study the bullet holes in airplanes that come back from battle, we're drawing a wrong conclusion.

Richard Kramer: Mm-hmm [affirmative].

Will Page: We should be thinking about the bullet holes which prevented those other planes from coming back. Those that were downed. He taught us to think about what we might be missing when we read the headlines. So what about all those startups that faked it and actually made it? You know, did they commit a crime even though they got across the finish line and popped their IPO and got their valuation and cashed out at the casino? There's a lot of people faking it, some of them make it. I wanna hear your take on that.

Richard Kramer: There are lots of other cases of bad deals gone wrong. And certainly there's a lengthy court case playing out right now between Hewlett Packard and a software company they bought in the UK called Autonomy.

Will Page: Mm-hmm [affirmative].

Richard Kramer: Which they bought for close to $10 billion.

Will Page: Wow.

Richard Kramer: And it turned out that Autonomy had massively inflated the real revenue that it was getting from customers and done a lot of barter transactions and so forth. And the reality is that the courts move extremely slowly and the money disappears very fast. So there may be lots of companies where they faked it and got bought. They made it, in that sense. There will be lots of companies who faked it and made it by getting themselves bought. But I wanna introduce a new term here to finish off our first half. We've talked in bubble trouble about FOMO, Fear of Missing Out.

You don't wanna be of those, that, one of those VCs that misses out on the next big thing. We've talked about FOFO, Fear of Finding Out, of realizing that something that you might have bought or done wasn't what it was cracked up to be. And I wanna introduce a new one. It doesn't quite trickle off the tongue in the same way, but it's FoE, Fear of Exposure. And for all those companies that made acquisitions that turned out to be dogs, they are afraid of exposure. They don't want investors asking, "Well, what did you do with acquisition?" For all those funds that invest in dozens and dozens of startups knowing the vast majority of them will fail, they don't want the exposure of someone asking, "Well, why did you place so much money into something that turned out to be a fraud?" They'd rather bury it under the carpet.

And it's interesting in this case that one of the lead witnesses for the prosecution was actually a fund that put a bunch of money in Theranos and then took detailed notes of their meetings and did the due diligence, and turned up the fact that a lot of what Theranos was saying was not backed up by reality. They weren't negotiating a great contract with the FDA or they weren't about to launch this new blood testing machine for Ebola. All of the things that they said were found out to be untrue. And this fund, to its credit, didn't have FoE, they didn't have Fear of Exposure. They were willing to honestly look themselves in the eye and say, we made a mistake and we'd like to know why. And I think that is at the heart of this case, that all of these wealthy people you heard about putting money into Theranos, they didn't complain. They were quiet because they had FoE, they had Fear of Exposure.

Will Page: Let me triangulate it before you break up here. So you can pop your startup for billions of dollars through the Fear of Missing Out [inaudible 00:14:39]. Now, with Theranos hitting the skids, you might have a Fear of Finding Out that what you popped wasn't worth that much. But you don't need to worry that much because of FoE, because a person who's bought you is got Fear of Exposure. You have a kind of happy equilibrium between that as well. Fascinating conversation. We're gonna be back to continue this trial, just like the trial is gonna be continued in the courts, more in a moment.

Richard Kramer: Welcome back to Bubble Trouble. So Will, you were grilling me in the first half about the implications of Theranos and what it says about the investors and the due diligence that they did, and what it says about the legal system in the states. But tell me as an economist, how do you think about the bets that are being placed into new technologies like Theranos, that are gonna be inevitably speculative? How would you guard against future Theranoses, Therani? I don't know what the Greek, uh, plural of that would be.

Will Page: [laughs].

Richard Kramer: But how would you, how would you address the fact that tech is inherently risky and a lot of bets fail?

Will Page: The, the thing that gets to me here is, we think about our original title for this podcast and the strap line for the whole scenario, fake it until you make it, it's the word until. It's the fact that today's tech companies are staying private for longer, a lot longer. And I'm wondering, is there a type of solution that exists which could potentially call time on the bet to make sure that we're gonna see a return on this investment, as opposed to staying private where you can keep on faking it? I mean, I'm thinking about the children's story of the boy who cried wolf here. Do you have a kind of a view about just this tendency to stay private for longer and what that means with regards to future Theranoses?

Richard Kramer: Well, certainly the SCC is starting to ask for more real disclosure on these unicorns. They're saying companies that have a certain size, even though they were able to file amended or limited S1 registration statements, they're now flipping that on its head and saying, there shouldn't be as much hiding as private companies. And maybe when they get to a certain size they should be forced to have the same sort of disclosures that public companies do.

Now, if you are someone who has the resources, there are lots of ways to find out bits and pieces about private companies in the same way, as you can do that on public companies, but it takes a lot of work and you don't have the stocks as an investment vehicle to express your value of the time that you put into them in the same way. So if I spend a lot of time and effort researching a public company, I can then potentially choose to a invest or not, or short the stock if I think I've found something untoward. Uh, we don't have the same way to express the value of putting that investment into due diligence in private companies.

Will Page: Now that's almost like regulating for good behavior. I see the incentive structure there, encouraging more transparency earlier, preventing you faking it until you make it for longer, but it can go the other way. How about regulating for bad behavior? We've heard presidents in the past say were gonna reign in fraud, and I'd like to ask about how would you advise against reigning in fraud? What can you do for the bad behavior aspect? And before we get to that, let's just pull up that favorite crime stats analogy I have, which is when crime stats to go up, three things can happen. One, crime is on an increase and that's bad. Two, we're getting better at catching criminals. That's good. Or three, we change the definition of crime. Now as a policy wonk, how would you go about reigning in fraud when the best fraudsters are the ones you can't see?

Richard Kramer: We could come at that question from many different angles. One angle is simply the way in which disclosure has been constrained or denuded over the past years. By that, I mean, you have large companies that can report a single business segment that comprises $200 billion of revenue and offer no material details into the composition of that segment. You have some of the largest companies in the market that report balance sheets with everything consolidated into eight lines.

Will Page: [laughs].

Richard Kramer: So they're giving you the absolute bare minimum.

Will Page: Three years for granularity.

Richard Kramer: And absolutely companies realize that secrecy doesn't hurt them, it hurts their competitors. It may harm investors, but investors may not be bothered by it as long as you're delivering the results. And better to disclose the least possible than to disclose the most possible. So certainly a first step would be requiring greater disclosure. And I think the lesson in a Theranos and one we all forget in rising markets, is to be mindful of the downside risks. So what you had here and why the story attracted so much attention compared to how many other failed entrepreneurs and billion dollar startups didn't make it through the Rubicon, was that you had a very high profile, self promotional, attractive female CEO.

And she hoodwinked a lot of what were supposed to be the smartest VCs that pride themselves on their rigorous due diligence. And obviously they weren't as selective and rigorous as they thought they should be. So I think it's incumbent to sort of push it back to the buyer beware, but let's face it in a rising market, in a world where it's a wash with money and everybody's searching for a home for that investment, it's something where FOMO takes over and common sense goes out the window.

Will Page: I, I'm inclined to agree with you, but we're padding and that we need balance here. I wanna stress test this. You seem to be calling for more compliance earlier in the startups lifecycle. Now, could there be pushback there where I'm in a startup, I've got 30 people in a warehouse, we're gonna make the world a better place, 'cause that's what startups do, they make the world a better place. They all do by the way. And then you say to me, 'You've got all this compliance to do." And I'm like, "I've barely hired a business development team. And now I have to hire compliance officers. That's gonna stifle my entrepreneurship." Is there a risk that it could like, you know, pure bubbles before they can even get bubbling?

Richard Kramer: Okay. So let's draw a continuum here, because a startup with 30 people in a warehouse without business development or without a legal team or outsourcing everything to their VCs, which I've already discussed as oftentimes a pimp prostitute type business relationship.

Will Page: [laughs].

Richard Kramer: Where the, the VC would like to provide a lot of those services for the new company such that the new company is highly dependent on them and they can take a greater stake.

Will Page: I got a lawyer who can solve that problem for you. He's not cheap, but I got that lawyer.

Richard Kramer: I'm sure you do. But those sort of companies are not looking to raise billions of dollars. And I think, again, the Rubicon that gets crossed here is not that a bunch of incredibly wealthy older men were hoodwinked by the charm of Elizabeth Holmes, it's more that when you look at VC funds, some of which are invested in by the pension funds that you and I rely on for future income, that those funds should be doing more due diligence. And when you reach a certain level of funding or a certain imputed valuation, whether you wanna call that threshold half a billion or a billion or more, then there should be some compliance requirement. There should be some reporting. There should be some material auditing of these sorts of companies and not just existing results, which may be zero revenue, but a lot of costs, but stress testing their business plans. And I think where we get into trouble and where you see bubbles forming is where that stress test never takes place.

Will Page: Right.

Richard Kramer: Because you take it on faith or back to FOFO. The investor is afraid of laying bear their own ignorance by saying, "We really don't understand what this clever young guy is doing, but it sounds very impressive."

Will Page: And that's what I wanted to take it right there. [laughs]. I'm gonna ask you to get dusty fingers and flick through your old recollection here, because we've done a lot of podcasts and a lot of them come into a second when you discuss the Theranos. So the most fascinating claim I saw in the research I did for this podcast was a lot of investors were erased, resting their claims on that of the previous round, to your point, not during due diligence.

Richard Kramer: Proactive.

Will Page: But believing on the previous round to be true, to believe in that trajectory, those themes and dreams, those sick of offense and Thenographers. You can see these podcasts coming back to life. Uh, could you just go through the old record collection and pull out some of the anecdotes we started, discussed in the past and how it applies to trusting the previous round as opposed to doing the research in your round?

Richard Kramer: Well, look, I think there is a herd mentality in the markets. And that is certainly true among a very concentrated Silicon Valley VC community. And this has been discussed at length. They accept the way in which many of them will only invest in deals if all of their peers invest in deals, or many of them will view the investment of one or another as a stamp of approval to say, "Well, since so and so invested, we should go in as well, because they must have done their due diligence. That means we don't have to." In a way it's a form of burden sharing, which can and be quite effective, and it could be a form of collectivism, but it also begs the question, what value are they really adding for all the fat fees that they take on top of the investments that they make?

Will Page: If I turn that into a different direction here, [laughs] in the case for Elizabeth Holmes, almost, she was trying to do a good thing. I mean, obviously it go very messy and it's all ended up in a terrible mess and she's staring at 20 years in the clink. But she was trying to do a good thing in response to a really bad thing, which is the system of U.S. healthcare. Is there a case for the defense here and that what she was trying to do was overcome the hurdles of the incumbent, the regulation that favored the incumbent over the new entrance, and that leads you to faking until you make it? Do you see startups in that situation where I get it, you cooked your books, you're a bad boy, the judge is gonna deal with that? But what you are trying to do is solve a problem, which is being protected by the incumbent, the old guard. And that involves playing a little dirty from time to being.

Richard Kramer: To the extent Elizabeth Holmes was trying to solve the problem of U.S. healthcare, pretending to have technical competence is not going to cut it in a field like med tech. And a lot of the problems of U.S. healthcare are endemic or structural to the way in which it's set up as a commercial system, to the role of the insurance companies, to the, the salaries that doctors in America get compared to everywhere else in the world, to the malpractice industry. When anything goes wrong, which says, we ought to order loads of tests that we probably don't need, but we're covering our in terms of liability in case we don't order them and, and we fail to pick something up. So I don't see that Elizabeth Holmes was necessarily in an altruistic way trying to address all that. Frankly, the astonishing thing was that there was no there, there in terms of the technology that she promised and how it would work. And that no one seemed to recognize that her methods as promised was simply breaking the laws of physics.

Will Page: You very eloquently thrown a case from the defense, not just out the window, but across the river to ends as far as I can see it. Um, let's bring this one to a wrap by stressing that Theranos story hasn't finished, and in many ways it's only just begun. The bubble trouble story hasn't finished, in many ways it too is only just begun. Think about this, firstly, her co-founder goes on the stand next month. Secondly, she's got to appeal and we know that's gonna be time consuming. And thirdly, you got TV rights being sold to dramatize the whole episode.

But it gets worse, if we think about WeWork, Richard, the founder of WeWork, he's back in the ring, he's doing his landlord thing right now. And we think about Enron [laughs], the godfather of bubble troubles, Jeff Skilling, guess what he's doing? He's back in spec. So this is definitely not the end of the story, it's been a beginning. But I want to thank Richard Kramer, AKA the King K. It's been a fantastic episode of Bubble Trouble. I hope you've enjoyed the conversation. Move back in next week. Guess what? With more bubbles and even more troubles.

Richard Kramer: If you're new to Bubble Trouble, we hope you'll follow the show wherever you listen to podcasts. Bubble Trouble is produced by Eric Newsom, Jesse Baker and Julia Nat at Magnificent Noise. You can learn more at bubbletroublepodcast.com. Will Page and I will see you next time.