VALUE: After Hours (S03 E01): GMO’s Last Dance, Challenger “O” Ring And Internet-Scale Businesses

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In this episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle chat about:

  • GMO’s Last Dance
  • The Challenger “O” Ring Disaster
  • Internet Scale Businesses
  • How To Build Out Your Circle Of Competence
  • How To Quantify The Quality Of Management
  • Carlota Perez’s Technological Revolutions
  • James Surowiecki – The Wisdom of Crowds
  • Online Real Estate Investing
  • Chamath Palihapitiya’s Mining Calls
  • Bitcoin The Ultimate Speculation Tool
  • Online Used Car Retailer $CVNA
  • How To Identify Value Traps
  • Choose 3 People You Would Like To Have Lunch With
  • Marginal Opportunities That Are A Little Expensive
  • The Bezzle
  • Surely You’re Joking, Mr. Feynman!
  • Masa, Chamath, Or Einhorn To Manage Your Money

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: We’re live. It’s the first show for 2021. 10:30 West Coast, 1:30 East Coast, 6:30 Australian Eastern Standard Time, 6:30 PM UTC, I think that could be right, that could be wrong. I missed you guys so much. How you doing?

Jake: Woot, woot. Good to be back.

Bill: I missed you, too.

Jake: Yeah, that felt like a long two-week layoff, didn’t it? Felt like two months.

Tobias: We did 51 shows last year and we only missed the one between Christmas and New Year’s. I think that might be the most we ever do.

Jake: Yeah. [crosstalk]

Bill: We’re dedicated.

Jake: That was a Cal Ripken performance there.

Tobias: Toronto in. What’s up? New Jersey. How’s everybody doing? Cincy. Samson, India, Edmondson. All right, everybody’s in the house. What are we talking about today, gents? What uplifting topics for the brand-new year are we going to be talking about? Where are you, JT? What have you got?

Jake: I’ve got a little segment prepared on the Challenger disaster and base rates that I’m hoping I’ll tie back into some recent conversations. We’ll see, might be a slow start to the year.

Tobias: Sounds bullish to me.

Jake: Yeah. [laughs]

Tobias: What about you, big Bill?

Bill: I don’t know. I’ll probably piggyback on Jake’s. I was thinking of waxing poetic on this thread yesterday that Wall Street Dropout tagged us in.

Tobias: Yeah, that was a good thread. I’ll be talking about Jeremy Grantham has got a new– you’d be surprised to hear that he’s bearish. He’s playing the flag, he said it’s weeks or months. He says it’s one of the great bubbles of our time. We’ll be talking about that, I guess, right after these messages. There are no messages.

Jake: [laughs]

Bill: Does he not know about rates, bro?

Tobias: Rates, bro. Yeah, I don’t know. Someone should ask him.

Jake: Or index melt-up or Fed put, all the other theses that everyone hangs their hat on?

Bill: Rates, bro.

Tobias: You want to do Jeremy’s thing first?

Jake: Yeah, let’s do that.

Bill: Yeah.

GMO’s Last Dance

Tobias: It’s called our Waiting for the Last Dance referencing the MJ documentary, which was excellent. He says that all of the quantitative signs are there. The overvaluation, like we’ve just had overvaluation for a long period now, so overvaluation doesn’t count for much. He says the qualitative signs are there, all of the speculation, market’s rocketing up, you get that ramp up the last stage of the ball. Then you get a lot of retail participation. A lot of new issuance including the SPACs, all of the new IPOs do very well. He says it’s one of the great bubbles of our time. So, 1929, 2000, 2007, and 2021, I guess. I enjoyed the piece. I don’t know that it’s that different from anything else that he’s been saying.

I love reading Hussmann too. Every time I read Hussmann, I’m like, “Holy shit.” Then I go back and look at some of the other ones, and I realize it’s the same message. I don’t think it’s wrong. All I would say is that the market is extremely expensive, there’s no question about that. Rates are pinned really low, so there’s nothing else. There is no other alternative. We’re at expensive on the cyclically adjusted P/Es, expensive on market cap to GNP, Tobin’s Q, all of those sort of measures are really expensive. The big difference, I think, the only thing to bear in mind really is that Japan got a lot more expensive before it finally collapsed and ruin a generation or two of investors. So, you can go from 30 times CAPE to 100 times CAPE, China did the same thing. You can get to 100 times CAPE. I think if you’re hanging your hat on that, then good luck to you. I think the market is expensive. [crosstalk]

Bill and I, we all have different opinions. Bill’s a fan of the third or fourth inning. What inning are we in today, Bill?

Jake: Yeah, where are we at?

Bill: I don’t know. We’re still playing ball.

Jake: [laughs] Are the starters still in or are we into the bullpen yet?

Bill: I think the starters are still in.

Jake: Hmm. Ouch. What’s the pitch count?

Tobias: The only other thing that I would say– I don’t know.

Bill: Like 40.

Jake: [laughs] Get out of here.

Bill: [chuckles] Yeah, they’ve been pitching a good game.

Jake: Yeah. No-hitter.

Tobias: Do you think it’s helpful to focus on this kind of stuff? Do you think it’s useful?

Bill: Not really. I’ll tell you what I [crosstalk] think it’s useful at. I was looking at my allocation and the way that stocks have run, I am way overallocated right now to stocks. Relative to what I’d like to be. It is not easy to reduce risk right now for me emotionally, and risk management probably shouldn’t feel very easy, but that’s probably when you should be doing it. I don’t know.

Tobias: The thought I always have is when you look at 2000, if you were thinking about the level of the market, you’re out, and that was a bad decision if you’re a value guy because you had two of the best years that you could have possibly had. I think these are always interesting. I like reading them. I’m a fan of base rates. I think it’s worth remembering what is going on around you. But I also think that it’s not helpful when you’re constructing a portfolio. If the market is nosebleed expensive, but you find Microsoft trading on a 10% free cash flow yield, I’ll just buy that all day long. I’ll fill a portfolio full of that. I don’t know that it’s that useful, but I like reading them because it does sort of reinforce my bias that the market is expensive. [crosstalk] Yeah, reinforced my price.

Jake: [chuckles] Yeah, I think you’re right. You’re pointing out the important thing is that you can have a very expensive market, but a very rich opportunity set still of hunting ground for whatever your approach is. So, maybe not worrying so much about the macro. Although they tend to go together, like, really cheap markets, when rates are high, when valuations are low, when sentiment is low, when profit margins are low, that’s where you get a 10-, 15-year bull market setup. I don’t see that right now. It seems like we’re the opposite of all of those. So, I don’t quite understand how people get to the roaring 20s kind of thesis.

Tobias: I can get you– what part of the roaring 20s we had? That might be a better what year– [crosstalk]

Jake: Well, the part where we’re going to have a decade of just– Yeah, is it 19–?

Tobias: Not 21. It’s 2028 or 2029.

Jake: Right now? Well, that’s what– But no, but people are acting it’s like ‘23 or something, and we’re going to have mostly the rest of the decade as like, all aboard, here comes another generational bull market. I’m a little pessimistic about that. But if there is a value opportunity there, boy, you don’t want to miss it sucking your thumb because you’re macro calling.

Marginal Opportunities That Are A Little Expensive

Tobias: Well, one of the things that I think is useful is, if you’re thinking about– if you have a marginal opportunity where it meets all the criteria that you like but it’s just a little bit expensive– maybe a little bit expensive might be okay, but this is the thing that I think traps all investors, can trap value investors too, you just keep on just shifting what you’re prepared to accept, just so you can get that marginal opportunity into your portfolio. And then you find that– you’ve got a good holding in the portfolio right before you go over the edge, and then you just think yourself, “If I just stayed disciplined, this wouldn’t have happened.” That’s what I thought in 2007, 2008, 2009. There was stuff that I was trying to sweep into the portfolio in 2006 and 2007 that if I had just been a little bit more disciplined at the time, I wouldn’t have had it in there and I would have had a higher cash holding because I just wouldn’t have been able to find the opportunities.

Bill: Yeah.

Jake: Yeah. Lower your standards just a little bit by bit.

Tobias: Discount rate. Just let that discount rate down a little bit, 10%, 9%, 8%. 7%? Probably okay.

Jake: Growth rate. Oh, that’s probably 10% now.

Tobias: Oh, that might be a good segue for WallStreetDropout. You want to do that thread?

Jake: Yeah, go for it, Bill.

Bill: Oh, me? I’m not ready.

Jake: [laughs] You’re not in the mood. Well, you get in the mood.

Bill: I’m not ready. JT, go.

Tobias: Bill’s got alleged suspected COVID. So, he’s playing hurt today. We appreciate it.

Bill: I don’t know that it’s COVID. But, yeah, I don’t feel great. Jake, [crosstalk] why don’t you go and then– [crosstalk]

Jake: [crosstalk] -demonetized for that.

Bill: Why don’t you go and then I’ll pull this thread up.

Jake: All right, that’s good. It’ll be a good transition anyway.

Bill: I was just looking at Comcast as you were speaking, and that’s a 7% free cash flow yield looking back. In what world does that not make sense? That’s not where the craziness is, in my opinion. I think that’s what you’re saying. There’s a lot of stuff that I think you can look at right now and say, “I can own this and be okay.” But there’s a lot of stuff that I don’t think people are going to do very well in, but I might be wrong. All that shit I’ve been wrong on forever, so I don’t know why anyone would care what I have to say.

Jake: That applies to all three of us. So, that’s a good place to wrap it up.

[laughter]

Tobias: See you next week.

Jake: Yah. See you next week.

Bill: [laughs] And done.

Choose 3 People You Would Like To Have Lunch With

Jake: All right, this little segment we’re going to start out with playing a little game, and I’m springing this on you, guys. I probably should have given you some fair warning so you could think about it. If you had to choose any three people, real people, not fictional characters, to get together and just have a lunch with, who would your three be?

Tobias: I’m going to take Buff Dogg.

Jake: Okay.

Bill: Yeah, the D-O-G-G.

Tobias: I’ll tell you who I’m going to take. I’m going to take Buff Dogg. I’m going to take Sun Tzu, and I’ve got one more, I’m not going to mention because he’s going in the book right now, but it’s a one thing I want to hold back. But I’ll think of a third. What about you, Billy?

Bill: Well, it’s got to be the Buff Dogg, and Mung’s got to be there, too.

Tobias: You probably need to drink. You need someone who can– You kind of two blokes drinking cokes. It’s not going to be much fun.

Jake: You need someone who’s going to stir the drink a little bit there.

Bill: I don’t know. I think you get Munger alone, I think that he would stir some drinks. I mean not drink himself, but I think he’d get it pretty heated. Man, I don’t know who the other one would– probably Paul Hilal.

Jake: Hmm. Interesting. That’s an off-the-beaten path selection. I like it.

Bill: Yeah, well, I like Paul.

Tobias: Who are yours, JT? Who are you going?

Jake: I have Munger and then Andrew Carnegie, and then my third one is Richard Feynman.

Bill: Oh, yeah, that’s a good selection. That’s much more thoughtful than us. [laughs]

Jake: Well, I thought about it. I had two weeks to figure this out. It actually does bring up another point. I don’t know if you guys do this, but I think it’s like a really healthy and interesting practice, is to imagine that you have a little board of directors at your disposal at all times, and it’s made up of those guys. You could just put yourself and imagine, what would they say about this decision that I’m about to make? Evaluating my behavior or my actions, my thoughts, my decisions against this board of directors of people who you’ve studied enough to where you have a pretty good idea what they might say about that. I think that’s actually an interesting hack to keep yourself centered.

Tobias: Yeah, in constructing a discretionary portfolio, I’ve got a little picture of Buffett with what would Warren do? Because I think that if you got to take the idea and pitch it to him, he’s going to tell you that’s a dogshit idea. You know why that’s already not going to work. Stop worrying about it. Even if you miss out, it doesn’t matter.

Jake: Yeah.

Tobias: Probably he’d be a little bit kinder than that.

Bill: Ah, it depends.

Surely You’re Joking, Mr. Feynman!

Jake: Yeah. As I transition to that, Richard Feynman who– I think there’s a new book out actually, I don’t know if it’s new, but I’m going to read it here soon. It takes all of his personal letters and arranges them and I’m really looking forward to reading that. If you haven’t already read his autobiography, Surely You’re Joking, Mr. Feynman! It’s a terrific read, check it out. He’s just such an iconoclastic character. Talk about just living your life by your own inner scorecard and focusing on what matters to you and who gives a shit about what anyone else thinks. He’s so good at that.

Tobias: The thing that I took away from, he’s clearly a genius, that’s not the point. It’s just that how curious he is. He just keeps on going until a problem is pulled apart. He just won’t stop. If there’s something he doesn’t understand, he just keeps on drilling on it until he resolved it one way or the other. The way he describes it, it doesn’t seem that he’s that brilliant. It just seems that he’s really, really curious. But at some point, I guess you’ve got to acknowledge that it is brilliance and not just curiosity, but it seemed to me that curiosity was the defining factor.

Jake: Yeah, I couldn’t agree more with that observation.

Bill: Six whys, right? You just keep asking why. It’s funny how superficial most answers are.

Jake: [crosstalk] –six wives, that might have been– [crosstalk]

Bill: No, not wives. No.

Jake: [laughs]

Bill: You keep asking your wife why, you might get more than one.

[laughter]

Tobias: Or, less than one.

Bill: Yeah, that’s right.

The Challenger “O” Ring Disaster

Jake: We’ll keep going with this, is that I was reading through his– he has a report on the Challenger disaster. He was part of a commission that was trying to untangle what went wrong there. Famously, at one of the hearings, he pulls out a little rubber O ring that was part of the problem and puts it into some ice water and then shows everyone how brittle it became. That was one of the key things why the booster blew up was because the temperature was outside of the normal range and this rocket exploded.

What’s interesting in his appendix to this report is that he’s talking about assessing base rates. He’s asking the management of NASA, what does he think that the odds of failure or success are of any individual given mission? They’re saying 1 in 100,000 would be a failure, like a total loss. Then, the engineers are saying 1 in a 100. He’s trying to figure out like, “Well, how would you get to 1 in 100,000?” Because that would imply that you could launch a shuttle every single day for 300 years and not have a disaster expected. Their actual historical base rate at that point was they had done around 2900 flights and 121 of them had failed. So, that’s like a 1 in 25 percentage. To go from 1 in 25 base rate to 1 in 100 for the engineers, to 1 in 100,000 for the management, he was pretty pessimistic on management and how they were basically fooling themselves or at least being blind to what the true base rates of failure were.

Tobias: Was that specific to the O ring?

Jake: No. This is just NASA– [crosstalk]

Tobias: Or, was that for the whole shuttle?

Jake: Yeah, NASA launches in general.

Tobias: One of the things I remember from my business economics class in my undergraduate degree was that Toyota figured out that when they built the cars, they had some parts that were very– this is a while ago now, I don’t know how they do it now. This is not a comment on Toyota. When they built the cars, they had some parts that were very, very robust, and some parts that were very fragile. And they figured out that you could take some of the robustness away from the parts that lasted forever, and then concentrate more on the fragile parts of the whole car became, it was all roughly going to fall apart at the same time. Well, you save some money on that part because the problem with them is, you only need one part to fail for the whole thing to fail. It’s all in sequence. It’s not in parallel. There’s no safe fail, there’s only one part fails, everything fails.

Jake: Yeah, that makes sense. To tie this back in with this podcast and what we like to talk about, as we’re assessing– and to tie it actually back to a WallStreetDropout’s thread that tagged us. The question is really, is it different this time when it comes to digitization and companies that have had a tremendous amount of acceleration of the future pulled forward through because of COVID dynamics? Is it different this time? Because sometimes it is different. To say, it’s never different, I think, is wrong but to say it’s always different is also wrong. How do we figure out what’s the actual base rate somewhere in between these two extremes that people tend to live in?

Tobias: Yeah, so the question is, what are we seeking to do? It’s not so much that we have this known flight path for the revenue earnings and so on and we’re trying to handicap that back to where we are today. We’ve had this step change, and now we have to try and figure out how do you then interpret what that means for the step change into the future? Do we assume that we’re going to have that gain every year or that the gain is stable, and going to keep on growing from that level or we’re at some point going to go back to the rate that we had before, which might mean that we have some stall period? This is not talking about prices, this is just talking about the underlying business economics, just so we–

Jake: Correct. Yeah. The other thing, too, is the sort of Brian Arthur’s observation from the late 90s about returns to scale for businesses, like network effects. The digitization, winner-take-all economics that may exist in a lot of these companies, is this a completely new game that we’re playing now because of that dynamic? Or, can we look and see other technological revolutions to get some kind of inference into a Bayesian update of our probabilities? So, that’s what I’m trying to capture here.

Tobias: I thought you’re going to tell me the answer, I was really excited for a moment there.

Bill: Yeah, that’s it?

Jake: No, no, no, no, hold on.

Tobias: There’s more coming, more clues coming.

Bill: Geez.

Carlota Perez’s Technological Revolutions

Jake: Keep your panties on. This then led me to going back and revisiting my notes on Carlota Perez’s Technological Revolutions, and what do those tend to look like. She has it divided up into, there’s an installation phase. That starts out with what she calls eruption, and then it moves up this curve towards frenzy, and then there’s a stall period, and then it flattens out into an S. The next phase is called deployment, and you get synergy, and then finally maturity. Then, you get– the next revolution starts underneath that.

She has five technological revolutions, and you have the 1780s-ish, these are according to her. You have factories, canals, and machines, is this first Industrial Revolution, technological revolution wave. Then 1840s, we get steam and coal and railways, and we get the same thing. By the way, we see this slow adoption that then turns into a frenzy, a bubble, the bubble pops, everyone actually starts using, it becomes more widespread diffusion of the technology, and then it just becomes old hat again. Then, so after that, 1870s was steel, heavy engineering, bridges, things like that. Then we have 1910s, 20s, was oil and cars and radios, televisions, mass production. And then, 1970s, she marks as the information revolution where we get computers, we get technology in the information space.

If we assume it was 1970s or 80s– each one of these, the deployment period, or installation period is, she says, typically 20 to 30 years. I’m not sure exactly how to map on to where we are today with when did the technological– this particular revolution start? If it’s the 70s or 80s, then we’re already like 40-50 years into this, which would put you towards the back half installation phase of the S-curve that she would say. Or, are we on that frenzy part where we’re about to get the layover into the S and get more into the deployment phase? In which case, all this stuff starts working better, but you don’t get the same kind of financialization of it as you do in the early phases when everyone is hot on it and you can’t put money into it fast enough. That’s sort of were the hallmarks of these things.

Just some food for thought on maybe helps us tell us a little bit what inning we’re in. If you’re trying to project out how the returns to scale these businesses, do we have 20 or 30 years more of this phase for an Information Revolution? Or are we towards the back end of it and there’s something else that’s like waiting behind it and it’s not going to be as good? I don’t know. I’m not sure what the answer is to that. But I think it’s an interesting way to frame the problem and think through it.

Tobias: There’s clearly a big difference between– the web is a big difference to just having a personal computer. I grew up in an era where you just had personal computers on your desk and didn’t attach to the internet. I just can’t imagine now what you’d do with a personal computer that didn’t attach to the internet.

Jake: [laughs] Play solitaire.

Tobias: Yeah. It’s a useless machine. It’s got like a word processor on it. It’s like a typewriter or something like that. I guess it doesn’t really- I think that this one probably begins when there’s everybody connecting to the internet– or connecting over the world.

Jake: 2000 would you say? It would be a start for it?

Online Used Car Retailer $CVNA

Tobias: Late 1990s, yeah. The processing power is just going up, still going up. It goes up 1000 times over five years. It’ll go up 1000 times over the next five years. I saw that last year. So, it’s probable we’re one year into the 1000, but I think it persists. Then as the processing power goes up, the computers can do much more interesting things that we’re all networked, the companies, businesses are getting better at using the networks for various different things. Carvana, I’m surprised that– Carvana just seems to me to be such an obvious idea. It’s surprising it’s taken to this point to get it done. I guess the problem is that there’s a lot of back-end infrastructure and something like Carvana you need someone to come and pick up the car, take it back, detail it, turn it around, deliver the car to somebody else, inspect it and do all those sort of things. That sounds more expensive than making the customer drive it down to the lot.

Bill: Yes, especially when you have a time value on your money.

Tobias: They charge you a delivery fee. I plugged my car into it to see what kind of a deal I could get. It’s pretty good deal, but it was like a $500 delivery fee, something like that.

Bill: Yeah. I mean, there’s a lot of backend logistics to that, right?

Tobias: Yeah.

Bill: I do think that the base rates of growth are going to be much bigger for longer on these companies that are growing like a weed. I think that historically, if you look at the total set of companies, there was a greater probability of coming up with a substitute product. How different is a Camry than a Taurus or whatever, at its core? I don’t think it really matters.

Tobias: They’re all very similar, right?

Bill: Yeah. Toyota is leading, but then they get caught. I do think that there’s sufficient evidence to infer that software, no matter how much people bitch about it, tends to stick a lot more than people may think it does. For instance, Excel is still around and ubiquitous, and everybody bitches about Salesforce as a product, but their distribution and tie-in has worked. It’s not a superior product came in and beat them.

On the other hand, if you extrapolate it into, I don’t know, like Pinterest, or Etsy or any of these sort of marketplace-type attention aggregation machines, I just don’t get what makes that any different than a retailer. You have a set of goods, you’re trying to accumulate attention, you compete on whether or not people can find your goods or goods that they like in your store. Your store happens to be on the internet. But think about like our podcast, we’re platform agnostic. I mean– Hey, Ack, if you want to pay us, holler, because Google tries to demonetize us a lot. We’ll sell out for 40 times $6 revenue, so bring the bucks here.

Tobias: The fact that I said that you might have– you’ve got alleged COVID probably means this one gets demonetized.

Bill: Yeah, we’re not getting shit, and they’re probably going to load it with 50 ads on top of that to drive everybody–

Tobias: That’s right.

Bill: I do think that some of these things will stick, but some of these other things, like, why is one platform too much different from another? I know that somebody would say, “Well, they’ve invested and they’ve got the attention, and they’ve got the consumer habit and all that.” Yeah, so does QVC. The difference is QVC generates a ton of cash. Any knock that people have on QVC, I think could apply to some of these other things. Except, yeah, they’re on the internet, so they feel safer, but I don’t know, can another marketplace pop up and start to buy attention if people have patient enough capital? That doesn’t seem like [crosstalk] the hardest– [crosstalk]

Tobias: Or they get some hard, killer piece of content. That’s always been my argument that the pipes always start out being valuable, they always attract a lot of attention. But then after a while, it migrates back to the content, because people– if they want that particular show, for example, in Netflix, Disney Plus, HBO, and so on, and so on kind of world, they’re going to watch that platform for that show. The content providers know that. The problem is for content, it’s a real hit or miss business. If you hit, it’s huge, you do really well, but it’s not easy. It’s not a replicable process. Game of Thrones maybe they could have kept on going on for a few more years, but it was getting a little bit long in the tooth.

Jake: Long in the dragon tooth.

Tobias: This Value: After Hours– [laughs] Yeah.

Jake: [laughs] They had [crosstalk] good run.

Bill: I guess I don’t know why I think of those things is a distinction but that was one of the pushbacks that I got after our podcast, Toby, was people were like, how you view Netflix is how a lot of people view software companies, and this damn-the-torpedoes attitude is what they’re trying to accomplish so that they get the network effects and the login or the lock-in. What’s his name? Not Boring, I think is the Substack that I subscribe to. He wrote this great, like just thrashing of Bill.com today. He was like, “This product sucks. Can we just kill this thing before it becomes so ingrained in all of our lives that I can’t get away from it?”

Tobias: What is it? I don’t know what it is.

Bill: It’s a $12 billion company because why the hell not?

Tobias: What’s it do?

Bill: Like AR and your working capital and stuff like that. I’m sure it’ll be pitched as a FinTech, because it’s got insight and data into who pays and when, and we can factor receivables as if that’s some novel concept that a bank can’t do better with lower cost of funds, but I digress.

Tobias: It does make sense. I’ve got lots of expenses that come in that are one-time expenses that are material over the course in the business, a material over the course of the year. When I’m working out what my breakeven is, I assume that all of that is averaged over the year. But it’s not in reality, like in a cash flow basis, some months, you’ve got to write a really big check. Sometimes you don’t have to write much of a check at all. It feels like a pretty profitable month. But on average, it’s not. It’s all breakeven.

[laughter]

Tobias: But it would be good. If you could factor it, that’d be good.

Bill: Yeah. Well, businesses that are credit-worthy can factor it. That’s what banks do. You get an accounts receivable line, and you can get 85% of it, and you can pay LIBOR plus 125 and you can get your money today. There’s a reason a lot of small businesses don’t, so we’ll see whether or not the data can overcome that hurdle.

Tobias: You’re just building another cost into your business, right? Now, you’ve got to carry that all year long.

Bill: Yeah, the thing I don’t understand about like these FinTech stories is everybody’s, “Oh, they’ve got the data.” I read something today that Uber is going to start funding drivers. Why does everything have to be a bank? I thought these were high ROIC businesses, now you want to get into lending? Okay.

Jake: [crosstalk] -buying houses.

Bill: Yeah, like whatever. I guess that makes sense. Last I checked, the lending and collecting of money was a crappy business that investors no longer care about, but somehow you attach it to a tech product and it’s genius.

Tobias: Dotcom. Oh, my God.

Bill: So stupid.

Online Real Estate Investing

Tobias: Why is buying and selling houses such a pain in this country? Why is there a 6% rip every time you want to do that? That seems crazy to me.

Bill: It is crazy. The realtors, man. I tried to use Redfin to buy a house.

Tobias: They– [crosstalk]

Bill: Yeah, but they won’t see you. The realtors will duck you because they know that a Redfin agent is coming, because they’re trying to protect their profit pool. That matters, if you want– how we went through selling our house was a pocket listing in the city that I lived in, and the Redfin agent never got a look. That matters.

Chamath Palihapitiya’s Mining Calls

Tobias: That’s just protectionism, that can’t really last that long, can it? I get the feeling that the dam is breaking now. You got Zillow in there buying and selling, and the other the Chamath IPOB, what’s it called now?

Bill: I don’t know. That dude was talking about getting into mining last night.

Tobias: I saw that last night. [laughs]

Bill: [laughs] All these fucking SaaS guys be like, “Oh my God. Yeah, what mines are we going to–” Okay, don’t do it.

Tobias: It’s all very first principles.

Bill: Enjoy value investing, guys. Have fun.

Tobias: They doesn’t seem to have been a lot of innovation in the mining space.

Bill: That’s right. Didn’t realize that the mining guys didn’t understand mining. Leave it to the software guy to figure it out. Okay.

Tobias: Yeah, that’ll be funny.

Bill: If only they had hired the right consultants.

Tobias: I got blown up on Twitter because I got an offer for the house that was clearly meant for somebody else. I didn’t realize. You didn’t get these things unsolicited. It came to me unsolicited. The city that I live in, there’s another city with an identical name in Arizona. The houses in the California city are a little bit more expensive than the houses in the Arizona city of the same name. I didn’t realize you had to request it yourself. So, mine just showed up, and I thought this makes sense to me that they’re about to go public. They’re doing a big push to let everybody know that they’re here. So, they’re just doing these mailouts to everybody with like, “Here’s our best guess of what your house is worth.

Do you want to come–” It’s just a teaser to get you to go into their site, and then they’re going to hit you with all these other things. But I was interested because I knew that the IPO was coming up. I participated a bit, but then they reached out behind the scenes. I didn’t ever hear what the end of it was but I had to share with them all of the details about myself, which is a typical Silicon Valley transaction where I shared a whole lot of information with them and got nothing back in return. So, thanks very much for that, but whatever that thing is, they’re trying to make a market. I don’t know they’re doing any– you want to warehouse, a whole house at the top of the market? You want to stick that in your inventory?

Bill: Look, in March, it would have looked really bad, but now everybody got bailed out. Maybe it’s not such a bad strategy.

Tobias: When I saw the offer, I went straight on this site to go and look at things to buy. I was like if they’re going to be out by this much, I’ll buy something, no.

Bill: You get screwed in that model in a liquidity crisis but I don’t know, are we done with liquidity crises? Maybe.

Tobias: That’s the kind of thing you say right before you get a liquidity crisis.

Jake: Yeah.

Bill: Maybe, yeah, I don’t disagree. It’s interesting to look at Carvana. That company was close to the brink. Now, it’s a darling, and it makes sense. The facts changed.

Tobias: I think they’re probably being a little bit more generous than they would otherwise be on both sides of that transaction. Their margin is squeezed a little bit. Joe Frankenfield will have a view on this, probably. I think he probably did on the podcast. They do seem to be encouraging people to go to the site to use it. I thought that the offer for the car was pretty generous.

Internet Scale Businesses

Bill: Going back to the base rate discussion, if the new method of business is basically underprice things and just go crazy to get all these network effects going and then– I guess the thing that I get thinking about is, if all these valuations are justified, what does that mean for competition in capitalism? It seems to me, that you’re going to end up with a lot of winner take all. If that’s the case, what happens to labor? I don’t know.

Tobias: It looks to me there’s a lot of competition out there, though. You can start one of these things up and get a massive valuation, raise money on it. That’s competition.

Bill: Well, you can’t [crosstalk] because once they hit scale, then you’ve got to go pitch. We’re going to be underscaled and we’re going to have to build out secondary infrastructure, and they’re going to cut their price–

Tobias: Has anything hit scale yet?

Bill: Well, no.

Tobias: It’s all in the future.

Bill: Yeah, but that’s the whole point. That’s the ethos that everybody’s okay investing under. That does change the game and the strategy that you run.

Tobias: Does that make you want to pay super high multiples for it? This is the conundrum that I have. All of these things are unprofitable because we’re pricing them on where they’re going to get to once they lock in in the future. Everything is–

Bill: Let’s be somewhat generous, they’re overspending on SG&A because they’re expanding.

Tobias: Plus acquisitions.

Bill: Yeah, I agree. I’m just saying, let’s just– we’ll be charitable– [crosstalk]

Tobias: They’re overspending, you don’t have to specify where it’s going.

Bill: Okay.

Jake: Plus, [crosstalk] -compensation.

Bill: Yeah. Okay. I didn’t mean to cut you off, Toby. I’m sorry.

Tobias: No, no, you’re fine. I think I probably cut you off.

Bill: No, you didn’t. I cut you off.

Tobias: I insist. I insist.

Bill: That’s why I like you, guys.

Jake: Well, let’s think about a little bit like some other revolution–

Bill: No, wait. Toby had a thought. You said you don’t want to– [crosstalk]

Tobias: No, no. Go. JT, go.

Bill: Oh, son of a bitch.

[laughter]

Jake: You’ve ruined it again, Bill. Just thinking about other revolutions, let’s just take railroads for instance. Talk about changing the world in a way that how– your competition before that was putting it on a wagon and a horse pulling it across the country. And now, you can move it at a scale that was just like the energy required per pound of movement and distance was just a complete phase change. That’s become ho-hum eventually.

Bill: That was a terrible industry for a long, long time [crosstalk] had some regulation in there.

[crosstalk]

Tobias: But to be fair, it’s still the most efficient way of doing it. We haven’t got any better than that.

Jake: Let’s say airplanes as a thing of moving freight now. Okay, not as energy efficient, but all of a sudden, the world just gets incredibly smaller. That is a phase change of amazing proportions to changing the world of humanity and how do we exist. I don’t feel the same like awe, at like– [crosstalk]

Bill: Oh, you being a Luddite.

Jake: Hold on. Now I can sell my [crosstalk] on it or something.

Bill: Oh, you’re such a hater.

Jake: I could buy a partial interest in an old Camaro. This is fucking changing the world.

Bill: You such a hater, bro. What about– [crosstalk] the Michael Jordan card, man. It’s scarce. There never will be another card printed on-

Tobias: They’ll never print another one.

Bill: -cardboard that people value. You need fractional interest in that card.

Jake: Okay. All these other things were so amazing and became humdrum. Why is it so hard to imagine that these amazing things also don’t become humdrum at some scale?

Bill: It’s not. Where I think there’s some legitimacy in the argument. First thing you touched on is airplanes. A sufficient condition is not that there is a duopoly, because if that was a sufficient condition, Boeing and Airbus would print cash all day, and they don’t. That does not guarantee economic profits that are outsized. So then, I get to Dorsey’s, well, it’s really like a relative scale advantage that you need to look at. If the first player is way bigger than the second and third, that’s where the economics can accrue. That’s where I do understand some of this like really go nuts and build scale today because if you can shower people in the stock comp, and you can get all the best engineers, then maybe you can actually create this network effect where you are truly the biggest and no one can penetrate. I guess that can work. I just don’t have the skills to know when and where and how much to pay.

Jake: Back to our base rates. I think it’s totally possible that there’s lots of those in there but it’s not all of these, and they’re priced as if they’re all going to get it and win. That I think is going against the base rate that you could probably expect.

Bill: You think it’s going to be like DC versus Avengers when the TAMs collide?

[chuckles]

Tobias: Gee, I hope there’s some more [crosstalk] superhero movies this year. I haven’t seen enough of those.

Jake: Yeah, right.

Bill: You’ll get them. Disney is going to crank them out. Don’t you worry.

James Surowiecki – The Wisdom of Crowds

Tobias: Just to go back to the O ring. Have you heard the James Surowiecki book, The Wisdom of Crowds? I think it’s the first story in the book. When the disaster occurred, all of the aerospace stocks sold off immediately. And then, all of them recovered pretty quickly, except for, I think, it was Thibalt, T-H-I-B-A-L-T, I’m not entirely sure on the name, and now the manufacturer of the O ring. Somehow, the market figured it out, like almost immediately. I’ve probably got some of those details wrong, but that’s an interesting point. I don’t know what you can draw from it, but it’s just interesting to know.

Jake: [laughs] That’s not going to happen in a world of only indexers.

Tobias: That’s true, but bring on that world. I can’t wait for that. I thought you said Dorsia before. Mike Bartlett’s got a comment up on the– I got a reservation at Dorsia, I got the best table, standing reservation.

Bill: Oh, no. It’s Dorsey, like Pat.

Jake: Should we do some questions?

Tobias: Yeah, hit us with your questions.

Bitcoin The Ultimate Speculation Tool

Bill: Everybody wants us to talk about bitcoin. Here’s my take on Bitcoin today. You’re betting in my opinion on sound money, you probably have some optionality, but I think you have less historical precedent. That’s where I’m at right now. If the idea is around in 10 to 20 years, and it’s something that people are willing to try to store value in, then you make a ton of money on it, probably. I think it’s interesting to listen to Real Vision. I was listening to them talk about it. I really liked how– they’re very honest, or at least my perception of very honest, about how they’re straight-up trading it and why they’re trading it. Those have been very interesting conversations, like Raoul Pal did one with– Oh, who the hell– What’s her name? I should know her name. I don’t know, Lyn Ann Alden or something like that? Lyn Alden? That’s an interesting conversation. I get how they think of it. I’m not there yet, for me.

Tobias: I feel we discuss this every week and every week people come in and say talk about, like, what more can we say–? [crosstalk]

Bill: The price is going up.

Tobias: Jake’s take on is the one that I agree with. I should probably let you talk about your take on it.

Jake: I don’t even know what my take is. Yeah.

Bill: What you did the– all the companies that you could buy, right?

Tobias: Oh, no, I mean, I’m sympathetic to the idea. I like the idea. But I don’t have a view on gold. I can’t value gold. I can’t value Eurodollars. I have no idea in currencies. I have no edge in bitcoin. I’m just not going to play a game where I don’t think I have an edge. Why would I? It’s just pure speculation at that point. If you’re a speculator, good luck to you. I’m not one. I’m trying to be an invincible industrialist. I’m not trying to be a speculator. Hold it, I don’t care. It’s not an interesting subject because you’re just guessing which way it’s going to go.

Jake: I think it’s interesting because it is maybe the ultimate speculation tool because–

Tobias: Pure speculation.

Jake: -there is nothing in which to compare it as a– there’s no dividend to compare it against, there’s no flow out of it to compare it. There’s never going to be earnings in which to anchor to reality. I find it to be fascinating because it’s like– Ponzi had to pay the original old investors with the new investors’ money, you don’t even have to do that. He would have creamed his shorts if he had the chance to speculate on something like bitcoin and con people with that. It’s such a better instrument than previously has been created. I think my favorite– I’m probably getting this wrong, but it’s something like, imagine if idling your car to solve Sudoku puzzles, which allowed you to buy heroin.

[laughter]

Jake: That’s my favorite definition of it.

Bill: I spoke to Tyrone V. Ross. That’s coming out, not too long. I do like his take. I have a huge blind spot in my life for the underbanked and unbanked. I think he has some takes on what it could do for real-time payments, and how transferring via bitcoin can actually get people paid in time to pay their rent and very important things that could be solved through it. I agree that there are really smart minds that are working on how the technology can speed up payments and reduce total fees in the system. If that’s what comes out of it, then I think this will all be a good experience. But I don’t know what the price will be.

Tobias: Nobody who wants to talk about it, wants to talk about that though. They want to talk about where it’s going. It’s at $37,000, it’s going to $100,000. It’s at 100,000, it’s going to million. It’s at a million, it’s going to 10 million. That’s what they want to talk about it. They don’t want to talk about the actual use of it. If you talk about the use of it, it’s as useful as anything else out there, really. It’s no more or less useful than some FinTech figuring out how to use catch.

Bill: Well, that’s why I tried to have somebody that I thought had something useful to say about it on the pod.

Tobias: Am I wrong?

Bill: No. Well, look, I don’t know what everybody is saying. I honestly stopped listening to Preston Pysh, because that’s all he talked about for a little while. I actually like you, Preston, I’m not trying to take a shot. I just got tired of it. Tyrone had a different view on it that opened my mind for the reasons that you’re talking about, Toby, because a lot of times people are talking about like stock to flow and the halving cycle and this and that. He was like, “No, this is what I think it can do for society.” I was like, “Alright, I’m down to listen to that.” It was a good talk.

Masa, Chamath, Or Einhorn To Manage Your Money

Tobias: I got a fun question here to move away. If you had to choose one investor to manage all your money, Masa, Chamath, Einhorn. How does Chamath get in there with Masa and Einhorn, honestly? No disrespect, Chamath, I’m a big fan.

Jake: Actually, Einhorn is the odd one out on those three.

Tobias: Well, here’s how I think they’re different. Masa has been around since before the dotcom 1.0 bubble burst. He was the genius investor back then. So has Einhorn. Masa had his big run-up and then bust in 2000. Einhorn’s run started in the late 1990s, but he had it really mid-2000s, up to 2010, and has fallen off. Chamath is brand new. I like the way Chamath pitches, I like Chamath’s ideas. I’m not trying to be disrespectful to Chamath. He’s a little bit unproven at this point. It’s Einhorn for me from here, easy.

Jake: I like underdogs, so I’ve got to go Einhorn.

Bill: I don’t trust anybody that sits up in an auditorium and says, “Get as much money as you can.” So, Chamath’s out. Then, I don’t know enough about Masa. I guess I’d probably– Einhorn is the guy that I think I could stick with if stuff went wrong. I think that that’s probably the most important way to answer that.

Jake: [crosstalk] -in 2011, who have left. [chuckles]

Bill: I wouldn’t be happy about it.

Tobias: All three value guys, pick the value guys. [crosstalk]

Bill: It also depends how.

How To Build Out Your Circle Of Competence

Tobias: Here’s a good one. How do you build out your circle of competence?

Bill: I’ll let you know when I find mine.

Tobias: I do have some thoughts on that, and you and I’ve talked about it before. I think you do have one area probably where you know more than anybody else. Whatever industry you’re already in, you probably know that really, really well. Then you can probably move out horizontally and vertically and temporally into adjacent industries and get increasingly good at understanding things. There are some things that are not understandable at all and you just avoid those ones and don’t worry about it and live your life really happily. Keep on looking at them. Keep on trying to understand them. If you don’t ever get there, don’t worry about it. That’s my view.

Bill: Yeah. When you look at what’s in my portfolio, they almost all came from a differentiated view on leverage, a differentiated view on customer psychology or some sort of scale thesis. That’s almost the entire portfolio.

Tobias: Is that QVC?

Bill: That was psychology and a differentiated view on the deck structure.

Tobias: The leverage as well. Yeah.

Bill: Yeah. The psychology is what made me okay with the debt.

Jake: I think you need to take both a top-down and bottom-up approach to this. One is learning the individual businesses, the unit economics, the micro-economics of the business. At the same time, I think the top-down part is studying different mental models that are helpful, that Munger would point you to, looking for analogs in large data sets like physics, biology, human history, because those things, I think, help speed up your ability to discern the bottom-up part. You probably don’t have to do as much maybe to arrive at a reasonable conclusion, if you have some top-down tools as well.

Tobias: Yeah, I wanted to do a big research project, if anybody’s interested in this, hit me up. The idea was just to figure out, of all the money spent in a business context or spent inside– I was going to say, in the US, but globally, really, how does it break down by industry? Then who does it break down into in the industry? Who makes the most to generate the most revenue? Who makes the most profit? Who has the highest return on invested capital? Who’s growing the fastest? Which industries have the tailwind and which ones have a headwind? Which tailwinds are permanent and built in and which headwinds cyclical and may turn around at some stage?

That’s a top-down macro as I would ever get because I think it’s useful to know. I have no idea about the scale of some of these industries. We talk all the time about market cap. So, the market cap of energy, everybody knows, is miniscule now, and used to be quite big. I don’t know if the underlying businesses have done the same. I think they’re probably at the top, the market cap flooded them, and now at the bottom, the market cap understates how important they are to the economy. I’d just be interested to know. I don’t know the answer off the top of my head.

Bill: On what basis?

Jake: I’ve been shocked at the operational– the lack of– so revenues have fallen quite a bit, but expenses have fallen pretty fast too for a lot of the bigger energy companies. I’ve been shocked that there wasn’t more operational leverage to the downside to kill them. You would think like, “Well, this is heavy industry.” There’s probably a lot of operational leverage, a lot of fixed costs. It’s been more variable costs than I would have thought in the last five years.

Tobias: Lots of compensation.

Jake: I don’t know where– I’m not sure [crosstalk] got scrubbed off.

Tobias: This is the funny thing, when I graduated from law school, a lot of my friends went into energy because that was where energy was– That’s where you got paid stupid money to go and do deals. I doubt that’s where they’re going now.

Bill: Yeah, I mean, Exxon’s gross profit in 2009 was $43 billion. Well, let’s go to 2019, because this year is sort of an add back, whatever, $25 billion. Their gross profits declined substantially over time.

Tobias: 43 to 29?

Jake: Yeah, but when you think it’d be like negative 29, given the sentiment–

Tobias: Well, the market value’s moved a lot more than that.

Jake: Right. That’s what I’m saying.

Bill: Yeah.

How To Quantify The Quality Of Management

Tobias: I got another good question here. How do you quantify the quality of management best? What are the main things you look for?

Jake: I look at the cash flow statement. And that tells me the story of how these people operate. How do they think? What are they looking at? After doing it for a while– and I try to empathize, that’s my other big thing I like to do is put myself in their shoes. I try to imagine what the opportunity set looked like, how do they spend money inside this business? Would I do some that same thing, what they did make sense to me. Knowing what they could know at that time period.

Tobias: Overtime.

Jake: Over, yeah.

Tobias: So, you’re looking at period by period. Yeah.

Jake: Series of cash flow statements.

Tobias: Yeah. I like that.

Jake: That tells me everything. I mean, a lot of it.

Tobias: Just look at the investing cash flow line. See that that’s negative. Look at the free cash flow line. Look at the compensation. Look at the proxy to see how they’re compensated. Make sure all of those things line up with what they’re saying. You find that basically nothing passes that test.

[laughter]

Jake: I wish you were more wrong about that statement.

Tobias: There’s a few 100 companies and everybody knows who they are.

Bill: Yeah, I think you’ve got to look at what they say they’re going to do versus what they did. For what it’s worth, in 2009 Exxon, now this is ‘09, so multiples are depressed, traded seven and a half times gross profit and today 11.6 times gross profit. The multiple on gross profit has actually expanded.

Tobias: Interesting.

Bill: There you have it.

Tobias: It’s just that the rest of the market has gotten more expensive, is that why it’s shrunk down so much?

Bill: I don’t know, man. I don’t know oil. Look, to the Chamath’s stuff, I was saying earlier, I like the guy, I like his story, I root for the immigrant story that wins, I’m into that, but there’s something about saying get as much money as you possibly can and then pitching mining ideas that I think you’d get in trouble. I think at some point hubris can make you stumble. It’s maybe getting close to that point. Maybe it’s not. Maybe that dude just continues to crush and he’s the next Buffett, I don’t know. But talk about base rates, that thing’s tough.

How To Identify Value Traps

Tobias: Do you guys want to take one on– What do you consider a value trap? We’ve done this a few times, but what do you look at to see if it’s a value trap?

Jake: If the price is going to go down in the future, that’s the value trap.

[laughter]

Jake: That’s how people define it. Did it work out or not?

Tobias: You buy it at a big discount, one forward, one year, it’s still at a big discount, but the value is done lower than it was before. Or, the revenue just keeps on marching up and the profit line keeps on going down. That’s often a good signal that there’s something coming that’s nasty. Look at the free cash flow line. Free cash flow keeps on getting more and more negative, even if the revenue line’s going up. They’re just paying for that, they’re just buying revenue. Bill, you want to have a chop at that one?

Bill: Ah, yeah, I don’t know. I mean cyclicals with low P/Es, that’s a good way to get hammered. I think you guys are right. You start seeing consistently hitting numbers by a penny is probably a good thing to avoid. Watch how proxy statements start to change. I don’t know that there’s clear-cut answers to a lot of these questions. I think that’s part of the issue. It’s company specific.

Tobias: Didn’t Jack Welch– was he open about the fact that they’d go to the acquisition? I forget though. There was some accounting adjustment that you could make to the acquisitions, and then he’d go to his accounting team and he’d say, “We’re $27 million short this quarter, figure it out in the acquisitions.”

Bill: Yeah.

Jake: Well, I read that the managers would tell him like, “Hey, I’ve got $20 million accounting that I can release now if we need it.” That was his version of how this is all a good team.

Tobias: [laughs]

The Bezzle

Jake: Like they’re all in on the– Well, it worked for a long time. The bezzle worked for a long time.

Tobias: It does, it always does. It works every single time until it stops working. Then, everybody forgets that there was such a thing and we go back to business as normal. I mean, it takes about 5 or 10 years for that to happen, to be fair.

Jake: That’s something we’ve talked about offline is that, now with the scale of the tools and the interconnectedness of the world, it used to be if you were a snake oil salesman, you could move fast enough to stay ahead of the information and not get called out on it and lynched or whatever. Now, you can get so much bigger but you probably only get one bite at the apple. It has to be a huge, huge bezzle, huge con. I would anticipate in a highly interconnected world that we see bigger bezzles but you don’t get to do more of them. Maybe that’s may or may not be playing out in some companies today, who knows? But we’ll see. You don’t know until the tide goes out.

Bill: Dude, I guess we’ve had this debate before, but people would say that about Musk. But the other side of it is, it’s not. [crosstalk] He didn’t. His shareholders don’t care. You know what I mean? They buy the vision. I’ve said it’s the golden age of selling dreams, it is. Is that a snake oil salesman? Is the line who’s successful and who’s not? These are not clear-cut questions beforehand, I don’t think. Now, some are. Also, rather than reciting stuff that people hear on podcast, can people start going to source materials again, rather than just the freakin’ narrative stuff that– somebody says something, all of a sudden, it’s as if it’s fact. Find some data, people, find data.

You know what? If people made money somewhere else, it doesn’t mean they’re smart somewhere else. It means they’re smart and how they made money.

Tobias: One time.

Bill: That’s right. Let’s not impute all this political knowledge and all this other knowledge onto somebody that made money doing one thing one time. Idolize the right things.

Jake: Maybe [crosstalk] transactions at the right time, right?

Bill: Yeah. [crosstalk]

Tobias: We’re completely out of time. But Jack Ma, where’s Jack Ma?

Bill: I heard there was a sighting of him. Also, it’s not something to joke about. I do feel like that’s some messed-up stuff.

Tobias: Somebody said he was on Bloomberg. I saw something like that, his little green light was on Bloomberg, but he’s probably got the browser open. I don’t know.

Bill: Yeah, well, I don’t know, man. I hope he’s okay. I know nothing about it. I’m not trying to be on China’s radar.

Jake: No, we don’t want to deal with– we’re not Paul Singer. We’re not dealing with sovereigns.

Tobias: YouTube’s going to demonetize us for that one probably.

Jake: Yeah. [crosstalk]

Bill: Yeah, you’re going to have to pay them now for carriage.

Jake: Damn it.

Tobias: This was fun. Can’t wait for 2021, big, big things are happening. It’s going to be fun, big projects. We’ll see you next week.

Jake: By the way, quick shout out to RW who sent me a box of peanut brittle for Christmas and I smashed the whole thing in two days. I appreciate it. It was so good. All right.

Tobias: There’s nothing healthy about [unintelligible [01:01:58] but they taste great.

Bill: Well, Happy New Year to everybody. I hope you enjoy the ads. We get none of the money.

[laughter]

Tobias: See you, guys, next week. Ciao.

Jake: Cheers.

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