In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:
- Butterflies, Trust, And Ethical Collapse
- $NKLA Goes Downhill
- Berkshire Versus S&P 500
- Why $QRTEA Is A Great Asymmetric Bet
- Opendoor Going Public By Way Of Chamath Palihapitiya SPAC
- Buffett’s Rare Bet On Snowflake
- Gross Profitability Tells You A Lot About The Quality Of The Business
- Cashflow From Operations Eaten Up By Stock Based Compensation
- Tesla’s Valuation Is Bananas
- Californian Wildfires And Power Companies
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Full Transcript
Tobias: And we’re live. It’s, as always– Not as always. Actually, we got it live on time. It’s 10:30 AM on the West Coast.
Bill: Bang!
Tobias: 1:30 PM on the East Coast. If you’re listening to this on the audio podcast and you’d like to listen to it live, if you go to The Acquirers Podcast YouTube channel, you can sign up and ask for a notification. It will send you an email and give you a link to click. When we go live, you can click that link, and then you can come and watch it live. About a couple hundred people typically catch it live, for what it’s worth.
Jake: Toby will text you when it’s–
Tobias: [laughs] I’ll let you know. What’s happening, fellas?
Bill: Just loving life, man, Florida life.
Jake: I’m jealous of your fresh air, Bill.
Bill: You should be jealous. My kid’s in school is what you should be jealous of.
Tobias: Yeah, true.
Jake: Oh, I’m so jealous of that.
Tobias: I’m getting used to gray skies with a red sun. I guess this is what the future looks like.
Bill: Dude, it sounds kind of scary out there, huh? It sounds almost more ominous than values future.
Tobias: I saw somebody the other day said if you told people in 2019, if you show them a picture of the sky and show them everybody wearing masks, and then told them they’re not wearing the masks for the sky, that’s for the pandemic– It’s Blade Runner real world. Blade Runner 2020.
Bill: It’s a bizarre world we’re living in.
Tobias: Victoria BC, British Columbia gets all the smoke from the West Coast US without the fires. People in from everywhere. It’s great.
Jake: Could you maybe tell us the top 50?
Tobias: [laughs] New York, Portugal, Sweden, Dubai.
Jake: [crosstalk] –Toby likes to read off.
Tobias: India, Philly, Stockholm.
Bill: Shoutout to all my VPN users.
Tobias: Tampa, Chapel Hill, Dubai.
Bill: You’d think Ian Cassel has something better to do with his day than make us think we have more than 10 listeners, but he does not. And I appreciate it, Ian, thank you. A loyal listener.
Tobias: We should probably get Ian on at some stage to comment about Nikola, which is going to be my topic today because it’s a micro-cap swanning around with a $13 billion market capitalization which was 30, but we can talk about that in a little bit. That’s going to be my topic. What are you talking about, gents?
Bill: Jake, you want to go?
Jake: Yeah, my veggies are going to be, I’ve titled it Butterflies, Trust, and Ethical Collapse.
Tobias: Mmmm, appropriate for this market.
Jake: Perhaps.
Bill: And I think I’ll probably talk about my Qurate experience one last time.
Jake: Therapy session or what’s the–?
Bill: It could be, crying Qurate tears. I need somebody to sell me some tissues to wipe my eyes. I should check it out.
Tobias: Probably get them delivered to your house from Amazon, another stock we should have owned.
Bill: Hey, no. It’s Qurate that–
Tobias: [crosstalk] You get a decorated box from Qurate. You get some seashells on a wooden box that you put over the top of your tissues.
Jake: Will Sean send you some tissues?
Bill: I don’t want to promise too much.
Tobias: Whose intro is it?
Bill: I think we just did it, didn’t we?
Tobias: Well, welcome to Value After Hours. I’m Tobias Carlisle. As always, I’m joined by Bill Brewster and Jake Taylor. You’ve heard the topics. Who wants to go first?
Bill: Jake.
Tobias: You criticize by category and then I’ll name the culprit after you’re done. Everybody already knows what it’s going to be. Let’s go, JT. Most popular segment, veggies up the front.
Butterflies, Trust, And Ethical Collapse
Jake: That’s fair. All right. There are currently roughly 10,000 species that we know of who will parasitize ants. What that means is they’ll infiltrate the ants’ layer and get the ants to do all the work for them and these species will just live off of the ants’ hard work. Anything from flies to beetles to even other ants will enslave ants.
Now, the one I’m going to be talking about in particular is called the mountain Alcon blue butterfly. When it’s a caterpillar, it will secrete these chemicals that are found on ant larvae so that the ants think that it’s one of the larvae. And it’ll sit there, and it even will mimic the actions, like the movements of the larvae. The ant workers will actually rescue the caterpillars from danger. They will feed them and in fact, they will even slaughter their own young to feed the Alcon caterpillar in times of food shortages. And the reason why, is that the Alcon has figured out actually how to sing like the queen of the ants. So, apparently, ant queens make these– they rub parts of their body together and make these vibration sounds. And this caterpillar has figured out how to do the exact same thing by scraping different parts of its body together and it sings the same tune.
Tobias: That’s horrifying.
Jake: Nature is amazing, right?
Tobias: Horrifying, I think, is the word you’re looking for there.
Jake: No way, man. It’s awesome. So, the caterpillar, it’s learned how to hack the social structure of the ants and bend it to its well. Now, estimations are that roughly 1% of the general population of humans are potentially like psychopaths. And they can be actually very charming if you hear stories about like Ted Bundy, and it’s possible that they’ve learned how to sing the queen’s tune to make people do the things that they want to do around them. And even they tend to use cause-and-effect statements more than average. They had to because– they give reasons like, “Oh, this had to happen because something,” which if you’re familiar with the psychological research on cutting in line for the copier, just giving any reason at all will make people sort of turn off their critical thinking.
Anyway, it is in the nature of these caterpillars to take advantage of the ant situation. For the same reason, you don’t blame nature for that. I actually don’t blame the psychopaths who take advantage of humans. It’s their nature as well. However, we’ve designed systems to help us control for that. Even at the federal level, just federal only, we have the SEC, the DOJ, the FBI, the Federal Trade Commission, the Bureau of Consumer Financial Protection, Department of Labor, Better Business Bureau, the Fed. That’s just federal level, who are supposed to be looking out for us to protect us from these– the human–
Tobias: Oh, he’s gone into the matrix. Everybody’s gone to the matrix.
Bill: Just you, dawg.
Tobias: Just me. You were listing off all of the federal agencies, the one that you missed was the post office. They’ve got the armed guys who–
[laughter]Jake: Yeah. The post office as well. This was just me off the top of my head, all of the different federal agencies who are supposed to be protecting us from psychopaths. That doesn’t count the state regulators, the local municipalities. Why is this important? Well, trust is a huge, huge thing for capitalism and democracy. It lowers the cost of doing business, of transacting with each other when there is a lot of trust. And it allows for nonzero-sum interactions. If trust is completely lost in the system, then we end up in much more of what it looks like in like a prisoner’s dilemma type of game theory where you cheat the other person, it’s all transactional. The costs are much higher to research who you should trust or not.
We need to make sure that trust stays and is kept. And we need, I guess, these other– the people who are supposed to be looking out for us to do a better job of that because it feels like, at least in my opinion, that things have gotten a little bit post-truth, post-fact. It doesn’t seem like anything matters anymore. Nobody’s really looking out for as much as you would hope they would.
Tobias: The original dotcom boom was a similar kind of thing. The promise of these things was so much greater than what was delivered in the short term at least. Maybe, we have in fact delivered on that early promise. But I mean, is that possible, we just go through these periods where it’s all very new and exciting, and we don’t really know how to handicap it?
Jake: It’s possible. Yeah. I mean, there is– if you read Carlota Perez’s book on technological revolutions, and there’s an initial effervescent phase where everyone gets excited about the technology, and then that dies down, and then there’s like an actual installation phase where things actually start working the way that they were promised.
Tobias: Sorry, mate. You might have been asking a rhetorical question. I answered it! [chuckles]
Jake: [laughs] All right, I’m going to pigeon or dovetail in with this. A really nice book, the author’s name is Marianne Jennings and it’s called Seven Signs of Ethical Collapse. And it’s nice because it gives you the causes of the ethical collapse and then it weaves in these stories from WorldCom, Enron, Adelphia, Tyco, HealthSouth, Sunbeam, Arthur Andersen, etc. Then, it also actually gives antidotes for– if you were running the culture of a company, how could you help, ensure that you don’t get ethical collapse? So, I’m going to run through these seven. This might help for your segment, Toby.
Tobias: I’m going to take some notes.
Jake: Yeah. Number one, the pressure to maintain those numbers, like you always have to make the numbers that you promised, whether they’re true or not potentially. Number two, a culture of fear and silence, stifling whistleblowers, firing people who dissent. Number three young’uns and a bigger-than-life CEO. Does that describe any companies that you might think of? [chuckles] Number four, a week board? I find this one interesting because, look at Theranos. Everyone pointed to that, like, “God, look at all the people who are on this board.” And they had, I don’t know, three or four people who are Secretary of State at some point, pretty prominent positions. But I don’t think they had anyone who actually had a PhD in blood chemistry or–
Tobias: No domain expertise.
Jake: –no scientific Yeah, exactly. If you’re Henry Kissinger, I don’t know how much you know about micro-platelets and measuring blood readings. Anyway, so the board doesn’t necessarily– just the names alone, don’t let that fool you into false sense of security. Number five, conflicts of interest. This would be self-dealing, family members working for the company, buying your cousin’s failing startup. I don’t know what company that might be. Number six, innovation like no other. Where do we have that? All over the place right now? Okay. And number seven, goodness in some areas atones for evil in others. So, maybe saving the environment or–
Tobias: That’s quite a checklist.
Jake: Interplanetary species. There’s lots of different options there. So, anyway, those would be seven signs of ethical collapse to watch out for.
Tobias: Yeah, I’ve got to say it, Tesla, I know this immediately gets me downvotes and people just hang up. But if that’s not a list of the stuff that Tesla’s doing, I don’t know what is. The only thing that makes Tesla look good is Nikola.
Jake: [chuckles] So, yeah, let’s just go right into Toby segment.
Tobias: I like the idea. I think psychopaths are now known as sociopaths. So, I think the DSM, they’ve updated the word, they don’t like to call them psychopaths anymore because they felt bad.
Jake: My apologies to all the psychopaths out there.
[laughter]***
$NKLA Goes Downhill
Tobias: It’s so funny that in the moment, all of these things sort of seem to make sense. But given a few years’ distance from them, I think that a lot of the things that are going on now will look really silly. And Nikola, I think is the most egregious example of it and I’ve haven’t really followed that closely until recently. I know that it’s been around, and it’s been comical in the background. I feel a little bit bad because they are trying to do something good. It is a good idea. Whether they can execute on that good idea is another question entirely. I don’t know how charismatic the main guy is but clearly, they’ve modeled it on Tesla. They’re trying to create– they’ve taken Tesla’s first name, they’ve created a– and it’s not battery-based but it’s a hydrogen-powered truck. They’re trying to save the environment. It takes many of these–
Jake: I thought it was gravity powered.
Tobias: It turns out. [chuckles] [crosstalk] I don’t want to steal from your segment, but I think it’s useful to use your tools to deal with my problem. Shall we do that?
Jake: Yeah.
Tobias: Just so I’m not entirely stealing.
Jake: I don’t have anything else smart to say.
Tobias: Well, you can maybe comment on what we’re talking about here. So, Nikola, if everybody hasn’t been following, there are quite a big company, that it’s a $20 billion or $13 billion enterprise today, got about $700 million in cash.
Jake: What was the revenue?
Tobias: A 100 grand, which they got from installing solar panels on the roof of the chairman and the CEO, I think. That’s roughly what’s happened, something like that. I might be getting the people wrong, but it’s roughly what has happened, 60 grand and 40 grand over a couple of years. They’re trying to build these trucks that are going to run on hydrogen, laudable goal.
If it was a micro-cap, and I was doing these things– you hear so many stories about an entrepreneur gets a VC into his office, and he hires a whole lot of people who are like extras who stand around looking really busy and passing bits of paper and typing. And everybody says, “Well, that’s a hustle, man.” That’s what it takes to get across the line. You get the investment, then you figure it out. Theranos was trying to do the same thing, except dealing with people’s lives and at no stage, they actually come up with a working prototype.
These guys, how is it any different from what anybody else is doing? They just say we’ve got a working truck, they didn’t. The way they pretended that they did was they had it roll down a hill. And then, they’ve raised some money. Now, they really do have a couple of working prototypes, from what I can tell. I’ve looked at a little video where the guy gets in it and drives around, maybe there’s blokes pushing it the back and they just put the– [laughs]
Bill: Get back here, we’ve got to make a marketing video.
Jake: Yeah.
Tobias: It looks like they’ve got something working now. This is the thing– Hindenburg is the short report. They’ve come out with 52 questions. Nikola’s dealt with about 10 of them. The 52 questions, I’m not going to go through all of them, even their responses, just the ones that– So, the truck rolled down the hill, not under its own power. They said they’re buying this battery technology, turned out to be totally vaporware. Nikola’s in the same boat, so they can’t really get too upset about that. And they kind of hid it from everybody else. They say they’ve got this $3.5 billion truck order, but it comes from a company with $1.3 million in cash. So, it’s going to be difficult to pay for it. And then–
Bill: Got to tap those debt markets.
Tobias: Well, what would they feed it with? How do you pay for the interest?
Bill: Dude, that equipment finance money.
Jake: You joke, but that’s actually an important point of how much of this stuff had been called bullshit on if you couldn’t get easy monies so readily.
Tobias: Well, that’s it. But then, they’ve used all of this to raise– the last Q, they had $700 million in cash. So, now that’s real, you can get a prototype with $700 million in cash. So, then they’ve done a deal with GM, where they’ve given them 10% of the company, which is a $20 billion enterprise at the time, $2 billion. [crosstalk]
Bill: It is a surprising deal to see.
Tobias: From GM’s perspective, it’s not a bad idea. They get the $2 billion in cash to sign the deal. Sorry, $2 billion in stock to sign the deal. Then, they get paid to design and manufacture the truck or the Badger or whatever it is that they’re going to do for them. They’re paid as they do it. From GM’s perspective, they’ve got a partnership with this hot company, and they’re going to get paid to do the deal. I wouldn’t fault them for doing that. They’re not tying up any more closely– [crosstalk]
Jake: It’s like AOL-Time Warner.
Tobias: What Nikola goes and tells everybody about the deal is a different matter to how GM views the deal. All of these things are grey. From my perspective, if it was a micro-cap, and it was making all of this move, this is like these guys have got some hustle. Maybe they’re going to get there. Maybe they’re going to get there. Maybe this is something that you want to take a flyer on. And then, you go and look at the market cap. And it’s as if they’ve already done it, it’s as if they’ve been doing it for a decade.
Jake: Yes.
Bill: Well, you just discount what you think that they’re going to do on the future at zero and, boom.
Jake: Infinity.
Tobias: That’s it. That’s the only way to justify it.
Bill: I don’t know. I don’t understand any of this stuff, man.
Tobias: Well, what’s to understand?
Bill: I guess there’s probably some theory out there that makes it worth it. To be perfectly honest, I’m not 100% sure what is different about that than some of the other things that I read. Now, that said, many of these other companies have a working product. I don’t discount that.
Tobias: Prototype.
Bill: Yeah. I guess it seems to me that– this is maybe because I don’t understand what I’m talking about and I will freely admit that but–
Tobias: This is a podcast. That’s true!
Bill: No, I understand that, but it just sort of feels like generally speaking, the narrative game is like–
Tobias: It’s all that matters.
Bill: It certainly seems it’s pretty important right now.
Tobias: You don’t have to deliver.
Jake: Let me make a flimsy counterargument.
Tobias: Yeah.
Jake: Let’s imagine that there is a natural rate of technological progress, that just humans tinkering in garages will come up with. What if all of this cheap money and lack of criticism, lack of caring about it actually working is almost like overclocking that technological progress that we would normally have. It’s like throwing more balls into the lottery and we pull one out that happens to actually change the whole game. Maybe, they have some hydrogen breakthrough that completely revolutionizes how humans move atoms around the Earth. Well, maybe it was worth printing all this bullshit money and being able to borrow and dividing everything by zero rates. I don’t know, maybe that’s good for us. Who knows, and maybe just join them instead of crying about it.
Tobias: I sort of thought–
Bill: Especially when it’s the first inning.
Jake: [laughs]
Tobias: I sort of thought I was making the counterargument. Ian Cassel would have a much better way of diligence in something like Nikola than I would. But from my non-listed VC style, I look at it and I think like it does have some of the ingredients that you would need to make this thing succeed. They’ve got the cash. They’ve got a big partner. They’ve got a couple of working prototypes, now they seem to– they’re doing stuff. I’m not going to take a swing at this thing at $13 billion. I wouldn’t take a swing at $1.3 billion.
Bill: [crosstalk] –had my boy, Uben, out there, long hair and all. Man, come on, Jeff, tighten it up.
Tobias: He’s a very charismatic, good-looking boy. And he also did Valiant, so got to be careful there.
Bill: I still like him. But this is tough. This is strike two and the potential frauds.
Tobias: But maybe then again, their deal is different too. They get in super, super early, in the SPAC before it goes through it. Their pay off looks different to everybody else’s. They’re like, “Yeah–” Many of the things that I listed, at a much, much lower valuation, you’d be like, “Yeah, I’ll take it. I’ll have a swing at then.” My whole objection to this is the–
Jake: Yep. You get early on the pyramid scheme, it can work.
Tobias: That’s it. My whole objection is the valuation. I’m just like, “This is nuts. It’s crazy.” Even if everything works, it’s too expensive.
Jake: [crosstalk] –valuation doesn’t matter.
Tobias: Yeah, valuation doesn’t matter anymore until it does.
Bill: I find some of this stuff– If I didn’t look at valuation, I’d probably enjoy it a lot more. So sometimes, I just don’t look. Sometimes, the valuation of things offends me to the point that I close my mind, and that’s not a very good habit.
***
Tesla’s Valuation Is Bananas
Tobias: Well, let me turn this around. Let’s talk about Tesla for a moment because I’m always critical of Tesla. But I should say that I have enormous respect for Musk. I think he’s one of the best entrepreneurs that we’ve seen for generations. I think Tesla is a real business with gigantic amounts of revenue, doing something original, producing cars that people absolutely lust after and doing a lot of other interesting things. I’ve got a lot of respect for that enterprise, for that man. The issue that I have is that the valuation is bananas.
Bill: Yeah.
Jake: Well, it was bananas 10X ago.
Tobias: That’s true. It might be worth 100 bucks.
Bill: I’m open to the idea that the valuation was somewhat reasonable before–
Tobias: Before it ran up 10 times?
Bill: Yeah.
Tobias: Is that because it’s run up 10 times?
Jake: Yeah, exactly.
Bill: No, look–
Jake: Everything is reasonable. [crosstalk]
Bill: No, that’s not true. I think that probably a bias that I have had in the past is, there is an argument that the company is running subscale. It’s got investing growth. You can’t really value it on what it is today. I get that, it’s uncomfortable. And I think that it’s a game that probably not too many people can play well. But there are thoughtful people that thought Tesla was undervalued. I mean, Vitaliy was one of them and he was right. So, there has been a point where I have been blind to the valuation and I’ve been wrong. I think that that’s objectively okay to say, I still think it’s a little bit absurd right now.
Tobias: I think Vitaliy thinks it’s a little bit absurd right now.
Jake: Run the counter to that though. In March, had things completely blown up and it had– first that was too expensive then because they were subscale. They were going to have to deploy too much capital to catch up with everyone else. There’s too much competition coming in the EV space for them to make any money. All those same things would have been said and true and would have been good justifications for why it was down 90% from there and it went the other direction. I don’t know, it’s so easy in hindsight.
Tobias: I agree with you– They’ve got to finance it. They still got to finance it. I mean, now it’s getting a little bit easier. China built the factories, they got $5 billion in cash. It has sort of self-reflect– it does have a very chunky valuation. The problem is that its price is way, way over that chunky valuation, in my opinion, in my humble opinion, and I’ve been completely wrong for a long time. Take that for what it’s worth.
Bill: Yeah, I think that’s fair.
Tobias: All right, BB, let’s do yours. You’ve come to the confessional, brother. Tell us what has happened.
Bill: No, first of all, I see some comments that I think I’m a rapper. Rappers don’t wear a Titleist hats. I just have terrible hair.
Tobias: They should.
Bill: Well, they maybe should, but I’m just saying, I need a haircut bad and I can’t get in till Thursday, so I can’t show it off right now.
Tobias: Don’t that hold you back, man. Look, I get the [unintelligible [00:26:41] curls going.
Bill: Yeah, but you have to have that good look, just naturally. I need to work at this. Anyway. No, I was just going to say– like I put out my Qurate right up. It’s the first idea that I–
Jake: That was good by the way, check that out, people.
***
Why $QRTEA Is A Great Asymmetric Bet
Bill: Well, thank you. It’s the first idea that I’ve had that’s, I think, pretty objectively contrarian. I mean, I know that there’s like some Qurate bulls that like it. But I think if you look at the way that it’s trading today, the market continues to view it as an over-levered entity. I tried to address why I’m comfortable holding it in the event that this situation today did not result in the stock getting a bid. I tried to articulate why I am okay holding it for a while. I guess it’s just been an interesting experience to have some attention and also be so public about some– it has not been the most emotionally easy thing to live through. It’s just been an interesting– I see why some of these guys are like, “I’m just not going to talk about my positions anymore.” “I’m not going to do this shit.” Like, “I don’t need to be pinged in my DM box about why you should own it.” You don’t like it, don’t own it. I could care less.
I don’t mean that in a way like, “Don’t ask me questions.” That’s not the point. But just a lot of the commentary I don’t think is particularly helpful to my psyche. And then, the feeling of having to defend something or whatever, it’s interesting to live out something right now that gives me some insight into why these guys are like, “Ah, I’m just not going to do this anymore.” It has never been a problem before because no one ever gave a shit what I–
Tobias: [chuckles] I don’t know who is–
Jake: –are you pounding it in, as Munger would say?
Bill: Yeah, I don’t know, man. I could articulate why this thing is a zero. I really can. I guess that what– the issue that I don’t think that people– the disconnect in the conversation that I’m having with people is a lot of people are saying, “Well, what does this look like in 10 years?” And my whole comment is like, I think you’re having a conversation– If we are 10 years from now, and this entity is still going, my money is out. I’m fine. By then, I basically have an option.
So, the real question to me is, why can this business continue to perform at a level similar or where it is for the next four to five years, and I tried to address– basically, it’s a bet on customer habit. Now, if a bunch of 50- to 60-year-old women change their habits over the next three to four years, I’ve got big problems, especially with that much debt. And I think that is a valid criticism, and I think that the debt is real, and I don’t think that it should be dismissed. That said, and I could be wrong here, but I think that most of Buffett’s really contrarian bets came from a psychological edge and like a consumer behavior bet. I wrote up Facebook whenever it was being puked a couple years ago, that was all just a psychological thesis. This is the same thing in a very different wrapper.
Tobias: What’s the psychological element?
Bill: Well, it’s just how these women that love this business, love this business, they visit the website 35 times a month or 33 times a month. They visit the TV channel 18 times a month. They are ordering anywhere between 68 and 72 items a year at an average spend of 50 bucks an item, that is really habitual. And yeah, I think that you’ve got a problem if the bundle erodes. It has historically been their customer acquisition funnel, and that has helped. I think you would be hard-pressed to convince me that the 50 plus age group is cutting the cord at a rapid clip, I think you’re probably seeing that among younger users and the data supports that.
Jake: Still, they’re living with their parents?
Bill: Yeah, maybe. I’ll tell you what, man. I was on Netflix last night. Boy, is there a lot of shit on that. I couldn’t find anything to watch.
Tobias: It’s unwatchable. I almost thought about closing it out last night for that reason.
Bill: It was amazing how long I was just clicking, and I was like, “There is nothing that I have any desire to click on.”
Tobias: But the kids watch it, that’s why you can never get rid of it.
Bill: That’s right.
Tobias: That’s the boat that I am in.
Bill: They do have strong kids’ stuff.
Tobias: Kids don’t care. Kids will just watch garbage for hours, that’s what I’ve discovered.
Bill: Yeah, well, and to be fair, Netflix does have some good kids’ franchises but I’m full blown with you. They need to put out something that makes me want to watch it. So, anyway, I don’t know how I got diverted.
Tobias: Let’s talk about Qurate for a moment because I really do like it. It’s cheap. It’s in the Acquirers Multiple screen. You can go into further analysis on it that shows that it’s undervalued. It’s really, really cheap. The question is, what does that business look like over the next decade? I think one way that I think about it is that it’s just this content monetization machine that has– It goes up over a variety of channels. One of them is television. One of them is the internet. I think it’s an incredibly good business.
The issues are, it’s carrying some debt. It’s paid out some cash today along with some press, but then you’ve got the absolute GOAT capital allocators in there. The Liberty Complex Malone, and those guys. I think this is one of the more asymmetric bets in the market right now. I don’t have a position, so I can talk about it this pretty freely, but I came very close to getting a position on the issue is, this payment makes it difficult for me because the way my thing is structured, but I really like Qurate as one of the better ideas out there right now.
Bill: The whole thing can blow up. When you’re dealing with that much debt, if consumer behavior changes meaningfully, you’ve got a donut. So, that’s a real problem.
Tobias: Do you think that they would let that happen?
Bill: I think that they’ll try everything they can not to. And I think that the habitual patterns of a group of women that skews a little bit older is why I’m comfortable holding the stock. They refinanced the 2022 debt, they kicked it out to 2028. The appetite is there for the 2023 debt, but they can’t retire it because the make-whole plus the premium that it trades at, according to somebody that help me work on it, it would cost them $109 per $100 to retire it. So, on $750 million, you’re talking about a lot of money. It’s over $60 million of cash flow that they really don’t need to use today to retire the debt just to make people a little bit more comfortable.
From my perspective, if they can get the 2023 debt refied, you’re looking at a lot of free cash flow to common equity, who can then choose to either pay down debt and reduce the risk to the entity. Or, if the stock just trades at stupid cheap prices, they could buy in shares if they think that it’s worth playing the game of staying highly levered.
The reason I think that they went with the preferred is they basically shrunk the equity base down to two and a half billion and they aren’t restricted. The debt, you have restricted payments. If your consolidated net leverage gets in excess of three and a half times, then you start to not be able to distribute the cash. This preferred allows sort of you to get a little bit more juice in the equity [crosstalk] without having those covenants. And that’s what I think these guys are thinking.
Everyone is saying to me like, “Well, Malone doesn’t believe in the entity, and he doesn’t take cash out of stuff.” I sort of agree that generally he doesn’t. But if somebody said to me like, “Well, you could shrink your equity by 45%, reduce the duration of the buyback from eight years to three and a half years, and by the way, you could also get some cash out, and you could also have a yielding 8% instrument to your estate, if you were to pass away,”
I think that that might be something that I would prefer more than just blowing buybacks into the wind in a stock price that’s just like cratering. I might try something interesting. So, that’s how I see it. I could be the real sucker here. I had sized it larger going into the event because I thought it might catch a bid. I’m definitely not going to change that until this settles out. But the only other question is, how big of a position do you want something like this to be a part of the portfolio when it’s got that much debt? My gut says somewhere between 5% and 10%, but I don’t know exactly where that’s going to land for me.
Jake: If you had to keep only one of the securities, which one would you keep, the preferred or common?
Bill: The common. I just think the risk reward in the common–
Jake: Gambler.
Bill: No, it’s not even that. Look, I don’t understand. We’ve talked about this over and over ad nauseam. I don’t understand some of this debt. To me, the preferred is one step away from the debt. And I understand why if you had a mandate, why you would want the preferred. But holding 10-year paper on this entity to get 8%? In what world is the common not okay, and the preferred is okay? I don’t think you have two ways out in the preferred. I don’t even think– [crosstalk]
Jake: Shrinking cash flow from operations will– it’s going to go to the preferred first, right?
Bill: Yeah, you’re right. You are right. It is definitively superior in the capital structure. But I think your risk reward is much better in the common.
Jake: You want that last tranche.
Bill: Yeah, well, especially if they could shrink the share count by– I think realistically, 15% a year, that can get pretty interesting.
Tobias: What’s the free cash flow?
Bill: I don’t really know off the top of my head. I underwrote– [crosstalk]
Jake: Maybe about a billion.
Bill: I underwrote a little bit more than that. I think sustainably $500 to $700 million to the common equity after the preferred dividend.
Jake: Oh, after preferred. Yeah.
Tobias: Yeah, so the EV after the preferred, $6.6 billion in debt.
Bill: Yeah, you’re looking at– I don’t know what it is today, but call it a $10 billion enterprise for lack of a better term on $2 billion of EBITDA and a whole bunch of the EBITDA goes to interest expense. Your market cap, you’re looking at $2.5 billion on what I think is $500 million to $700 million, and I think it’s sustainable for the reasons that I underwrote. Now, I could be really wrong. If I am, it could suck. That’s why the sizing sort of matters here.
Tobias: The market has just stopped thinking about this, but you’re getting the right odds to put the bet on.
Bill: I think. I hope it matters, right? Maybe, it doesn’t matter anymore or maybe I’m wrong.
Tobias: What this market likes in the short term is at once really high growth, and that’s it. And it doesn’t matter where the valuation is. They just look–
Jake: [crosstalk]
Tobias: Yeah, I think the story has to match the growth, and nothing else matters. That’s what–
Jake: Well, not necessarily.
Bill: I tell you what I wouldn’t own. I’m looking at the debt distribution right now. Forget about the 2068 that retail bought. That’s crazy shit. But the 2046 right now, I wouldn’t own that. I guess it’s convertible. But they got 20–
Jake: 2046? Jesus, we might be living on Mars by then.
Bill: Yeah, dude, you got like 2038 or wait, what is this? 2043, I don’t know, yielding like 6 or so. I don’t understand that at all.
Jake: Is that in dollars or bitcoin?
Bill: Well, that’s the thing.
Jake: You might not have dollars anymore by 2046.
Bill: And then, the other thing that I would argue, and I know that this is a dangerous way to think because if everything is cross-defaulted and you’re called, you’ve got to pay it all upfront. But in a screen that 2043, the 2046, and the 2068 debt shows up as like dollars today. That’s not really a dollar today, is it?
Tobias: You’re saying that the bullet shows up as dollar today. The big payment shows up as a dollar today, whereas you say it’s inflated away by the time you get to 2068.
Bill: Correct. Yeah, that’s right. I agree that it does count against the enterprise value, and if you needed to pay off all the debt, you would need to pay everything off today. There’s merit to the argument that it should count as a dollar, but I also think there’s merit to the argument of, then again, it’s not due till 2068. Some of it, not all.
Tobias: Throw any questions, guys.
Jake: Question time, let’s do it.
Tobias: Got about 15 minutes, a little bit more than 15. 19 minutes.
Bill: Anyway, if everybody’s looking at the stock price today, the reason looks it like it’s so off is they had a big distribution.
Tobias: Yeah, so I think what’s happened is–
Bill: [crosstalk] –has not traded well.
Tobias: –it’s down because this is the type of market for and stuff that’s down just get sold, regardless of what’s happened.
Bill: Look, people think it’s over-levered. I get it.
Tobias: That’s what you– interest rates are zero and we’re printing all the time?
Jake: Well, if it was over-levered yesterday, then as the common, it’s definitely over-levered today.
Bill: Yeah, that’s right. And I do think one of the things that sort of interesting to live through is it’s the old, like the market doesn’t give a shit that you own it. If they thought it was over-levered yesterday, I guess the question that I’d have for myself is like, why did I actually think it would trade strong today on the event? Because [crosstalk] really nothing different.
Tobias: I thought there’s a risk that might happen.
Bill: I thought it was possible.
Tobias: I thought it could trade really, so I thought people would be like, “Oh, hang on, this is real. They’re actually going to go and do all this stuff. This could trade up.”
Bill: Still could. I mean you’re talking about five hours of trading.
Jake: When does S&P inclusion happen? That’s going to be– [crosstalk]
Tobias: [laughs]
Bill: Enough of this.
Jake: Okay. Because that’s the only thing that really matters.
Bill: That’s a good point.
***
Californian Wildfires And Power Companies
Tobias: I got a question for you, JT. What’s going on with the power in California?
Jake: Well, [clears throat] I’m not as connected to it as I once was obviously working in the industry. But, in general, it’s a fragile situation. We put on these– we call them renewable portfolio standards. We had to have a certain amount of our power delivered by green energy, which unfortunately can often be intermittent. So, if it’s smoky out and maybe the solar panels aren’t working as well as they normally would, which both impacts the utility-scale solar, which is the ones out in the fields that you drive by, these giant solar panels. But also, your local residential ones also are impacted. So, they then will be drawing harder on the grid at that point. There’s a lot of solar what they call behind the meter, you don’t really know how much power they’re producing there. And when they go away, and they want power from the grid, all of a sudden, it’s like, “Wow, that’s a lot more than we were expecting.”
Tobias: That’s the [crosstalk] solar?
Jake: Yeah, and commercial. But the other problem is that California is very dependent upon– in times of high demand, on power from outside of the state. They import a lot from the Northwest, which has a lot of hydropower and also renewables. When there are fires, they happen to be in typically more rural, like mountainous type of areas, and those power lines come through areas that happened to often burn down, and so those lines can go out of service.
Now, all right, shoot, what do we do? We can’t get power from outside, we don’t have enough internal generation necessarily– and you have to remember too, to get on some of these big turbines, it can take five days to get it up to the right because they have to go through certain temperature ranges at the right speed to not crack the machinery. So, it’s not just like, “Oh, well hey, just go turn the light switch on,” and flip that power plant on. Some of these have very long lead times. And so, if it’s unexpected, you can get caught with your pants down relatively easily.
The other thing that’s happening is that PG&E has been called out and sued for starting a lot of fires. Some of that– I don’t want to get into the politics of it, but there could be a bit of punitive action on their part–
Tobias: Oh really?
Jake: –saying like, “Well, all right. I mean, you guys are going to sue us for causing these fires. But meanwhile, you didn’t do a very good job of managing the forest. It was all dried tender ready to go and we don’t have enough probably natural burns so that it builds up into these giant conflagrations. So, you blame us for the spark, but it was you who let the fuel get so out of control. We don’t want to get sued anymore. If it’s even close, if winds are high, we’re going to shut your power off because we can’t afford to take that risk.”
Well, all right, I mean that’s the world that we’ve let it evolve into. So, that’s what’s happening, my understanding of what the power grid is looking like in California lately.
Tobias: That’s a terrifying insight. I think I would have rather not known.
[laughter]Bill: Basically, you’re screwed.
***
Opendoor Going Public By Way Of Chamath Palihapitiya SPAC
Tobias: So, here’s the next question. Did you guys, Chamath, he’s got another SPAC. It’s going to buy Open Door. You guys got any thoughts on that?
Bill: I don’t have any that are worth sharing.
Jake: I don’t even know what open door is or does.
Tobias: I watched his presentation, didn’t really know much about it beforehand. Watched his presentation this morning on CNBC. One thing, Chamath is a superb presenter of his ideas. He just went through the bullet points for why the acquisition makes sense. It’s like $4.8 billion in revs this year. By 2023, it’s 9.8. They’re paying one times revs this year, so 4.8, they’re paying 0.5 revs in 2023, assuming they can get there. Basically, buying a house is a nightmare. So, they’ve found a way to use technology. You tell them that you want your house bought, they give you a pitch in three days, they give you a bid in three days in cash, you can hit the bid, and they’ve got all these other things they can sell on it.
Jake: Who’s buying the house? They are or the–?
Tobias: They are. That’s the big problem. That’s where I was going to get to too.
Bill: This is sort of what Zillow tried to do, isn’t it?
Tobias: That’s the– [crosstalk]
Bill: I’m going to look into it, but I–
Tobias: I only know what Chamath said but the immediate thing that I thought was, “Gee, we’re going to have a lot of house inventory there. Hope you’re right on those pricings.” I’m guessing the way you do it is you just come in with a lowball bid or cash. But then, they’ve got this back end of stuff they can– mortgage origination, do all these other things, that’s how they can get financing cheaply. Chamath presents really, really well. Super, super smart presentation. And then, they listed out all the other things that he’d pitched and it was like bitcoin in 2012, might have been Tesla in 2016 or something like that, Facebook in 2018. The guy’s hit rate is at a high, I don’t think he’s missed. It’s worth thinking about. I don’t know, I wouldn’t necessarily buy, I’ll buy it when it trades down 50%.
Bill: Yeah, I think if he’s right, I’ll do just fine in IAC. I know those guys, and I’ve watched them for a while. I think if his general thesis that everything’s moving online is correct, then Angie should do pretty well and that’s just how I’m a little bit more comfortable.
***
Buffett’s Rare Bet On Snowflake
Bill: I see a couple of these things about Buffett buying Snowflake.
Here’s the thing that I would just say about these IPOs. First of all, it looks like a great company. I have no idea. I’m supposed to get on the phone with somebody on Friday, that’s going to explain the tech to me and why it’s needed. I understand there’s a lot of data stuff that goes on in the cloud, and they help do that. That’s about as specific as I can get. If it grows, I think Berkshire is probably going to do great. The probability that I will be able to obtain that entity at the same price that Berkshire did is zero. So, that matters. And I think that Berkshire is probably right. They probably have a ton of businesses that use that platform, and that’s why they’re doing it. It sucks that they can’t buy more. But that’s a function of their size.
Tobias: What are they sticking, $500 million in?
Bill: I think it’s maybe even like 250.
Tobias: Might have been sized up.
Bill: There used to be a lot of money.
Jake: That rounds to zero at Berkshire headquarters.
Tobias: Yeah.
Bill: Yeah. That’s the big knock.
Jake: But it’s good for stories and it’s good for a lot of articles and handwringing.
Bill: It could 10X, then it’s real money.
Jake: Is it, though? [crosstalk]
Tobias: Still not really– [laughs]
Bill: Yeah. That’s the problem.
Jake: Not really. That’s the difference between IRR and actual returns.
Bill: Yeah, that’s fair.
Tobias: There’s a question here that I jumped over.
Bill: Oh, shit, NonGAAP Mike listens, what’s up Mike?
Tobias: Yeah, welcome, Mike. He’s got a nice comment up here on the screen. I’ll read it out for the fellas at home. “Chamath has a nice feel for trends. Dorsey is similar. Doesn’t mean their moves turn out perfect, but I like the way they look at things.” Yeah, I agree with all of that.
Bill: Yeah. For me, IAC is just something that I can be a little bit more comfortable with because– to be totally honest, I trust those guys a little bit more than I trust Chamath. That dude sat on stage and was like get as much money as you possibly can so that you can do– that’s not the kind of– why do I want to give that guy that kind of money? Even if IAC thinks it, articulating it is different. It just feels too slick to me. Which is cool. If he changes the world, that’s great. You just don’t have to do with me as a partner.
***
Berkshire Versus S&P 500
Tobias: Berkshire versus S&P 500.
Bill: I don’t know.
Tobias: Anybody want to take a go with that?
Jake: Looking backwards or forwards?
Tobias: From here, which one would you rather own?
Bill: I think Berkshire’s got a real shot because I think Ted and Todd are going to evolve the business in a positive manner. And I think that you give me a company that has that ethos and that focus on capital allocation, and over time, it’ll work out well. I don’t know that I love the current collection of businesses versus the businesses in the S&P, but then you’ve got valuation. If this Apple valuation is real, the rest of Berkshire is dirt cheap, in my opinion. I guess over a long-enough time horizon, maybe S&P gets it, but I think that they’ll be able to evolve in a way where they would be able to catch whatever the S&P would be able to catch on them, if that makes any sense.
Tobias: JT?
Bill: I agree. In my mind, it’s a bit of a function of cash flow now versus story of cash flow later. If the story still matters more than the actual cash flow, if the two birds in the bush continue to be worth more than the one in the hand, then Berkshire lags the S&P. However, if for whatever reason, that world goes back to that, whether that means interest rates are higher or whatever, who knows, then, Berkshire has a lot of birds in the hand today already, and they look pretty cheap and attractive right here.
The S&P, I would say– there’s that chart about how the biggest five companies have carried all the returns basically over the last five years. If you don’t get that kind of amazing repeat performance out of them, which goes against a lot of base rates, not impossible–
Tobias: Is that unusual for the S&P 500 to be that driven by a handful of companies? Isn’t that the way it always is?
Jake: I don’t know how that changes historically and how this is relative. You hear about time periods, which make you think that this is an odd time, late 1960s, where it was the NIFTY 50, we’re carrying it. I don’t know.
Tobias: What about the fact that Warren has said S&P 500?
Bill: Well, I don’t know that he said that.
Jake: He said it, but he didn’t do it.
Bill: And I think he just means if you don’t want to pay attention– you’re going to have to watch Berkshire, you’ve got to watch how these guys invest. What I’ll tell you is, like the Kroger investment, I know that it’s not that sexy, that was a pretty good investment. That Restoration Hardware investment when they made it, that required a lot of creativity. They’re getting early on Snowflake. I get that maybe some of that stuff doesn’t make some of the people that are used to the Buffett-type investments that excited but it does indicate that the way that the company may evolve could really surprise some people. That utility business is so damn good and Geico is so good and the insurance business is so competitively advantaged that–
Jake: –railroad too, I think is like– [crosstalk]
Bill: Yeah, that’s right.
Jake: That’s north of $100 billion, right?
Bill: Yeah. I get why people think that it’s too big. I’ve said it too at times. I’m looking at my portfolio right now, it’s the biggest position I have. So, I obviously believe–
Jake: So, you don’t really have to say anything else. [chuckles]
Bill: [chuckles]
Tobias: I think when you look at Berkshire versus the S&P 500, it’s got a higher return on invested capital than the S&P 500 and it trades more cheaply. So, for me, it’s easy that it’s going to be Berkshire. Who knows really what happens with– There’s lots of silly things can happen with the share price. But in terms of the fundamentals, I think it’s Berkshire.
Bill: Well, what somebody would say to you, though, is like five years out the return on the invested capital of the S&P is going to exceed Berkshire because the software that grows. That would be the devil’s advocate argument. I don’t know. [crosstalk]
Tobias: Let’s see.
Jake: Only because you’re overstating return on invested capital because you’re not counting all the intangible capital.
Tobias: Yeah, let’s see. And then, I think that I prefer Ted and Todd to the S&P 500 committee and as evidence for that, I’ll give you the fact that the S&P 500 didn’t include Tesla.
Jake: [laughs] Idiots.
***
Bill: Well, I’ll tell you, you know what’s interesting– I’m going to take it back to Qurate real quick, but there’s a tension between growth and profit today. I think, Liberty and Sirius XM got outflanked by Spotify a little bit. I don’t know that they could have ever owned– Spotify is global. Sirius XM is the US, but they do have a little bit of– there’s some arrogance in there, like we harvest cash flow today and everybody else is doing something stupid in the future.
On something like Qurate, I actually think that reduces your downside because the cash flow that comes in today can be used to get returned to you. I could see how it also increases the probability of a bad outcome down the road because you can get outflanked. I don’t get the sense that Berkshire has the same problem. But I wonder if some of those businesses could have been a little bit better if they were allowed to invest a little bit more frivolously. But the other side of that is, this is business and you’re in it to make money and they make money. It’s just sort of an interesting tension– [crosstalk]
Jake: Well, Buffett’s been called out for that, for underinvesting in Dairy Queen, and kind of letting it decay and other businesses within there, but yeah.
***
Gross Profitability Tells You A Lot About The Quality Of The Business
Tobias: Fellas, we got a Super Chat. It’s from Anttivillekorhonen. Sorry, if I have mangled that. €5, so it’s real money. “Have you backtested/tried to use gross profitability to screen out, not combine, the worst companies instead of FS_score?” So, I think we discussed this in quantitative value which came out in 2012. We looked at Novy Marx’s gross profitability. It does fine. It’s as good as any other quality metric at identifying high-quality companies. The question is sustainability. I prefer gross profitability to the other metrics, but it does fine.
To the specific question, do we use it to screen out, not combine the worst companies? Yeah. So, you can use– if you create five quintiles of companies ranked on gross profitability scale to total assets, the worst ones tend to not do very well. And so, you want to kind of avoid the worst. But aside from that, there’s no real advantage to buying the best.
Bill: Makes sense. Gross profit to total assets, I just immediately go to commodity companies.
Tobias: It’s funny, that’s what it picks up.
Bill: They’re like dairy producers, like corn traders, shit like that.
Tobias: Why do you intuitively think that’s right?
Bill: Oh, it’s just like super thin margins, and it’s all a throughput business and it’s just garbage. Those are great businesses to lend money to horrible businesses down the equity in.
Tobias: Oil producers, it’ll pull up a whole lot of oil producers right now. Sorry, JT.
Bill: Yeah, for sure.
Jake: This is how my thinking has evolved on there. When I think about the gross profit, that to me talks about the quality of the business. And then below that, in the income statement, tells me about the quality of the management. So, you get kind of the hand that you’re dealt a little bit as a manager and the upper part of the income statement. And that’s Buffett’s quote about changing your leaky rowboat, if it’s too leaky. And then, below that, it’s talent.
Bill: The problem that I have with these hypergrowth companies is, to your exact point, what I find very difficult to parse, and it’s probably because I’m just too stupid to do it, is the gross profit everybody can see it’s a great company, but there’s so much SG&A in that, that I don’t know how these guys are going to manage when the company is slower growth. And part of me says, “Well, screw it, just ride the Momo train until it breaks and then almost sell the stock when it gets below a 200-day moving average that way you’re out.” That’s not actually a dumb strategy in my mind. But to your point, I don’t know that I have a good sense of whether or not they can manage through a tough period because a lot of this growth has been so good, which may be silly of me, but I think you have a really good point there on gross profit or operating margin getting inside.
***
Cashflow From Operations Eaten Up By Stock Based Compensation
Jake: Yeah. They say growth hides all sins. And so, you can hide the sins of a sloppy run business and below that income– down in the lower part of the income statement if you just keep growing that top line, no one seems to care as much that you’re being wasteful. God, did you guys hear, I think it’s [unintelligible [01:01:00] talking about for the S&P 500 technology companies, the 18% of cash flow from operations is eaten up by stock base– [crosstalk]
Tobias: Yeah.
Bill: Yeah.
Jake: 18% of the cash flow! Holy cow, that’s a big number.
Tobias: It hasn’t mattered yet.
Jake: Hasn’t mattered yet?
Tobias: It matters to valuation, it should matter to valuation. It hasn’t mattered to the stock price yet. Hasn’t mattered to stock price performance.
Bill: Well, conversely, we’re in a period where you can start saying, “Well, the share-based compensation when the shares are going up, it actually helps them get more [crosstalk] and that actually like helps them compete. So, the more shares they can issue and the higher the stock price, the better– this works, I get it.
Jake: Meanwhile, the return on capital, if you’re including that share-based compensation–
Tobias: Yeah, looks a bit uglier.
Jake: –just keeps coming down and down.
Bill: To be fair, they’re overstaffed. You’re staffing for growth, but the other side of that is like, “Well, shit. I mean, if you could let every business go out and just spray money everywhere, maybe they could grow a little bit more.”
Tobias: You definitely can.
Bill: Those are the questions that are tough for me.
Jake: Especially if it’s 80 cent dollars you’re giving away.
Bill: Yeah.
Tobias: Guess what, fellas? That’s time. Went by really quickly today. Thanks, everybody.
Jake: Because the technology worked.
[laughter]Bill: Yeah, that’s right. Thanks for tuning in, everyone. Have a good one.
Tobias: We’ll see you next week. Bye.
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