In this week’s episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Aswath Damodaran’s – Revisiting he Big Market Delusion. Here’s an excerpt from the episode:
Tobias Carlisle: Let’s start with Aswath Damodaran.
Bill Brewster: Yeah.
Jake Taylor: Close. Yeah. Damodaran, something like that. Yeah. Late last year, he put out a, I don’t know if you call it a blog post or whatever, but… And yeah, I was… Revisiting The Big Market Delusion. So he’s worked on this before, talking about really trying to back into the idea of, you look at these companies and people start drawing straight lines up and to the right about revenue and income. And if you take all these companies and sort of sum them up, is there even enough revenue in the entire, kind of, economic universe for that to make any sense? And what he’s found is, and through multiple different scenarios that that typically, it doesn’t happen. And a lot of these… So he talks about the 1990s and e-commerce, and how rapidly that went up and then exploded.
Jake Taylor: You have online ad companies in 2010 to 2015 and then cannabis in 2018 and then maybe AI today. Who knows? But what was interesting about… So we’ll start with the eCommerce one. In 1999 60% of the IPOs were internet stocks. So you had just this absolute gold rush of people trying to raise money for internet stocks. And more than two thirds, a couple of years later, of Bloomberg’s internet index were bankrupt. So two thirds of the companies ended up being zeros. And granted there were some that survived obviously like Amazon, but even then, like there was a 90% haircut there. And there were question marks about if they would be able to get through difficult period. So it wasn’t… Amazon as we know it today seems like such an inevitable, but maybe it necessarily wasn’t.
Jake Taylor: So then online ad spending, 2015 Aswath came up that it would require a roughly $520 billion of online ad revenue to get any kind of a reasonable valuation for these companies by 2025. So he’s trying to project out in the future. Really what is the TAM in 2025? And at that time, the current ad spending for everything, was at 545 billion. So not that far off of it. And at that point the internet-
Bill Brewster: Just real quick.
Jake Taylor: Yeah.
Bill Brewster: Sorry, sorry, just real quick. When you say for all these companies, who is he summing up when he’s… I mean I assume Facebook and Google are in that, right?
Jake Taylor: Facebook, Google, Twitter.
Bill Brewster: Trade Desk? Roku? Like is all that thrown together, do you know?
Jake Taylor: I’m not sure. I think it was the more traditional online ad companies. I don’t think you include… I don’t think even like Amazon at that point yet. Or Snapchat wasn’t even around yet. So at the time 128 billion was the total revenue of the industry. So it basically had to grow to absorb the entire online ad industry for any of the valuations to make much sense. And today he did the similar calculation and it’s something like 570 billion needs to be online ad revenue by 2029. So that one is interesting because it hasn’t really popped like… It’s been more of a sort of slow balloon deflating, as expectations have come down a little bit. Maybe not so much for Google and Facebook, but definitely for Twitter it hasn’t been the best run for them the last five years.
Jake Taylor: Cannabis. So the numbers in cannabis are so insane, but… So you look at Tilray and when they went IPO it was a $13 billion market cap on $28 million of revenue.
Tobias Carlisle: That was almost-
Jake Taylor: And roughly-
Tobias Carlisle: Almost… Sorry, sorry, go ahea.
Jake Taylor: Yeah, roughly 25 million of losses also on top of that. So-
Bill Brewster: It’s just a bunch of stoned compounder bros being like, “No man, it’s on the come.”
Tobias Carlisle: It was a similar ratio for Beyond Meat when it was public.
Bill Brewster: Oh, it was? Yeah.
Tobias Carlisle: It was like a $13 billion market cap and I think it was like $23 million in revenue.
Bill Brewster: I had a friend that asked me about going long the Beyond IPO. And I said to him, I was like, “Look man, just paying this kind of multiple for sales and given the education that I think it’s going to take. It’s just not the game that I’m willing to play.” And then it goes up like seven X or something. I mean, what… I don’t even know what that thing did. It was crazy. It was just parabolic. And a couple of the guys that saw how restricted the float was going to be and worked out sort of what the demand was going to be. This one guy, Denny Crane on Twitter, he sort of had that thing completely pegged.
Bill Brewster: I just didn’t see the world that way. My mind wasn’t looking at it that way. And my friend was just texting me. He’s like, “Why’d you keep me out of this thing?”
Tobias Carlisle: And they added it to the value index as well.
Bill Brewster: Did they really?
Tobias Carlisle: Jake at EconomPic said they’re going to add it to the value index and he said it’s because when they don’t publish certain, or they don’t have certain metrics. They just impute them from the rest of the industry and it’s a food industry so they’re like, “Well it’s probably going to be a value stock.”
Bill Brewster: Oh that’s crazy.
Jake Taylor: Wow. So Tilray went up 10 X within a couple of weeks of the IPO and then totally blew up and I think it’s like off more than 80% from there. So-
Bill Brewster: Was that float driven too? I wonder.
Jake Taylor: Oh I think it’s just like magical pie in the sky ideas of what can happen here.
Bill Brewster: Cause [inaudible 00:08:02] owns a lot of that, right?
Tobias Carlisle: Nobody’s looking at the market cap relative to the size of the business. They’re just looking at the trajectory of the stock price and say “Well it’s been up. It’s going to keep on going up. I’ll buy some.” That’s what every marginal buyer is doing.
Bill Brewster: Momo baby.
Jake Taylor: It is.
Tobias Carlisle: Quite working.
Jake Taylor: But that Momo has to be fueled by something. And I think that’s what the interesting part of what Damodaran is talking about is that, so they have these four common elements in this. Number one is a big market story. So you have to have some big macro potential. We talk about TAM. Number two, there has to be blindness to competition. So you basically have to assume that growth is not going to be shared by anyone else. You’re going to be the only one that gets all of the growth. And completely, we like to joke, we call it a TES, which is total eventual supply, that you don’t hear anyone really talk about that much.
Jake Taylor: Number three was it’s all about growth. So you ignore profits and bad unit economics. That doesn’t matter. It’s just how quickly can you get this thing as big as possible. And then number four is disconnect from fundamentals. Which obviously, it’s usually there are negative earnings, so there’s nothing you can… You can’t do a P E on it. There’s usually a little asset. So there’s no price to book to really do. And they usually trade at just insane price to sales or revenue. So I found it to be an interesting paper because they share all these commonalities, but then the one difference they have is how they end. Some explode, some slowly deflate, but any time you get that far out over your skis, it’s usually pretty bad news for investors.
Tobias Carlisle: They’re impossible to trade, long or short. You can’t be long cause you eventually get dusted. You get what’s coming to you. And you can’t be short because before justice has done, you get your face ripped off. So there’s no easy way to trade that stuff. You just got to be away from it. Away from-
Jake Taylor: It’s radioactive. Stay away.
Tobias Carlisle: As far away from the blast center as possible.
Bill Brewster: But man, it’s hard to stay away. I mean, I was talking to… It is, right? I mean if you’re compared to an index and SAS is what’s ringing in my mind and I know that this is going to upset people, but whatever, it’s my podcast with you guys. So I can talk about what I want. So you know I’m talking to a buddy out in Silicon Valley and he runs a firm out there and he said to me, he goes, “Man, it’s crazy how much people are spending on engineers. And a lot of us know how crazy it is. But the conversations that I have with other CEOs are, we have to spend this because this might be our only chance to get really rich. And in order to create the appearance that we’re really big, we have to have a lot of engineers.”
Bill Brewster: And if everybody’s thinking that way, naturally that’s going to cause some inflation in the price. And, I don’t know, I look at some of these companies and all the free cashflow or a lot of it is share-based compensation. And I understand why all these businesses should be worth a lot. And I understand why the growth should be worth a lot. But culturally, what happens to people organization when you have to cut salaries, or get rational or something and I don’t know. I just feel like a dinosaur is sometimes because I look at it and I feel like I understand it and then I look at the numbers and I just can’t get there.
Jake Taylor: Did you see that news about SoftBank pulling a lot of their term sheets?
Bill Brewster: Oh no. That’s a shocker.
Jake Taylor: They’ve been stringing people along with promises like, “Oh yeah, yeah. The checks in the mail” kind of thing. Apparently… “Uh, actually, no, we’re not going to do that deal after.”
Tobias Carlisle: When I was still in undergrad, I knew one of the professors was a value guy who ran his own value fund. And he said he’d done this analysis on gold mining companies and he said, “Here’s something interesting about gold mining companies. When they go through periods of time where the gold price is low, which means they really struggle because they can’t make any money digging it out of the ground and selling it. But this is the unexpected thing. When the gold price is high, they really struggle to make money too, because engineers and all of the equipment becomes really expensive. So their margins are always squeezed.” That’s an interesting insight.
I always think about that. That’s true of a lot of different things. As soon as there’s a little gold rush in an area, not necessarily gold, it could be anything. Engineers in Silicon… Online, SAS businesses in Silicon Valley, the inputs all gets so expensive that it’s hard to make money. It’s hard to make money. That’s the nature of business.
Bill Brewster: Yeah. I mean, you look at something like Adobe, I mean, that makes sense. I understand why people like that. And Microsoft has proven how important a sticky user base is. I understand some of these bigger ones because I think that they can acquire some of the smaller ones. But the idea that everyone can land and expand without bumping into each other doesn’t make a whole lot of sense to me. And the idea that everybody can just spend a bunch on R and D hoping to expand before bumping into each other. I don’t know. I just get uneasy about that whole thing. And I feel like, if we were talking about 30 different retailers with decent concepts that were just dropping new stores in every single neighborhood hoping to acquire customers, people would be like, “That’s insane.”
Bill Brewster: But then you turn it into software and everybody just sort of forgives it.
Jake Taylor: I mean, doesn’t that kind of explain… I mean that that describes burger joints over the last five years. It was just like, “Let’s cram as many burger joints as we can into a square mile.”
Bill Brewster: Yeah. And look, there’s smart people on the other side of this thing, right? That understand it better than I do. But it’s just to your point Toby, it’s something that, unless I really can figure it out, I’m just going to watch it from the sidelines and hopefully I can deal with under-performance for a little while if that’s what it means.
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