VALUE: After Hours (S03 E29): Lumber; Einhorn’s Greenlight Letter; 17.5% Yearly Return Expectations

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In this episode of the VALUE: After Hours Podcast, Jake Taylor, Mike Mitchell, and Tobias Carlisle chat about:

  • The Real Cause Of The Lumber Spike
  • David Einhorn’s Q2 2021 Letter
  • U.S Investors Expect 17.5% Returns
  • Pig In The Python Economy
  • Realistic Returns
  • Netflix & Facebook Get Free Rides
  • The Future In Social Is Short Form Content
  • Best Environment For Housing Ever
  • When You’re Not Sure Buy A Basket Of Opportunities
  • Scott McNealy: What Were You Thinking
  • Investing Lessons In Berkshire Letters
  • Lumber Price Volatility
  • McDonald’s Daily Miracle
  • Construct A Mill Or Grow A Forest
  • The Weird Dynamic Inside The Home Centre

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 are going live. Preparing to stream the live stream or preparing to stream live on YouTube. All right, I think that’s it. I think we did it. Unbelievable. [laughs]

Michael: Good on you, buddy.

Tobias: All the buttons worked out. [laughs]

Jake: It’s a new record.

Tobias: It’s 10:30 AM on the West Coast for the first time in a long time.

Jake: [laughs]

Tobias: 1:30 PM on East Coast. We’ve got the lumber king himself. He’s in Colorado. How are you, Mike?

Michael: Coming at you live from the Elizabeth Hotel in Fort Collins, Colorado.


Michael: I do well. I do pretty well. Things are good. I missed you guys. When I went to Wyoming, sorry, to Montana. I was like, “Do I want to keep being out there and doing this?” I just decided that it’s–

Jake: [laughs]

Michael: I decided to talk to my wife a lot about and I had this great download and I was like, “You know what? I really like you guys.” If there’s a time, I told Bill, “If you need me to do this–” I probably only talk about the most fatigued topics on Twitter, things nobody really wants to hear about anymore. But anytime you guys want me get– [crosstalk]

Tobias: Well, it’s perfect for this show.

Jake: It’s going to fit right in. [laughs]

Michael: [laughs] –I am around. I feel refreshed. You’d think that the time away gave me a lot of things to discuss it, that would be factually incorrect. It did not give you a lot of things to discuss. But I do feel very refreshing, and happy to be back.

Tobias: JT, how are you?

Jake: I’m always happy to be here. It’s my highlight of the week, which is maybe a poor testament to the rest of the week, but maybe not.

Tobias: You’ve been hiking.

Jake: I did get a really nice hike in over the end of last week in the Pacific Northwest, the Cascade Mountains. Beautiful. Big fan now. First time up there.

Michael: Well, I saw those pictures. Those are great. Good for you.

Jake: Yeah, we actually took those too. They weren’t just stolen off of– [crosstalk]

Michael: [crosstalk] stock photos.

Jake: Yeah, stock photos off a Google.

Michael: [laughs]

Tobias: Just a reverse search.

Jake: Yeah.

Michael: They look beautiful.

Michael: How long was the hike?

Jake: That day, we did almost 15 miles.

Michael: Mm. Oh, my God. Okay, that’s real.

Jake: Yeah. It was a bit of elevation change to get up to see that view. But yeah, it was good. It was really nice.

Tobias: Very serious hike.

Jake: Well, sometimes, the best views are hard to get to.

Tobias: Oh, some wisdom there from JT.

Jake: Yeah. [laughs]

Michael: [laughs]

Tobias: Look out for his book of aphorisms coming out on Christmas. [crosstalk]

Jake: Yeah, don’t think too hard about that one.

Tobias: [laughs]

Michael: That’s funny.

Jake: Bed of Procrustes, Part Two. [laughs]

Tobias: We didn’t discuss this ordinarily. We get together and discuss topics beforehand, but we didn’t do that today. We’re going to find out what everybody’s topic are. You got some veggies for us today, JT?

Jake: Yeah, it’s not my normal veggies, but this is going to be called What Are We Thinking? We’re going to unpack a little bit of an expectation of a number that came out recently, and what would the world have to do to make that number come true, and we can then decide whether we think that’s reasonable or not.

Tobias: I like that. Mike, do you have anything?

Michael: I’ve been focused on– There’s a lot I’ve been focused on but regardless of the fatigue stuff, I’ve been focused on the other things, I’ve been focused on earnings. Earnings season is picking up, and I think it’s very interesting, because I’ve said this before, on Value: After Hours, no one has a post-pandemic US consumer playbook.

The most instructive things, you see the macro data come in nationally, but for me in my career, where I’ve spent all my time focusing is talking to management teams and hearing what they have to say, and what they’re saying on the ground. We’ve had the bank earnings now. They always come first. We got looks into the consumer there, which is where I obviously spend most of my time.

Then, we had builder earnings, we had D. R. Horton, and of course, this week, we’re going to get more looks into that. That’s the stuff I’m most focused on, and can talk about, and some macro stuff that just continues to confuse me like interest rates, I don’t get it, and then, your market reactions, things that don’t always understand. But for me, my topics are earnings. I will be curious what you guys are saying.

Tobias: Well, mine is Einhorn’s letter came out, and there’s an interesting quote in there, which I’m going to paraphrase where he’s talking about traditional industries being starved for capital, because so much capital has gone into the hotter industries, which is grist for our mill. We always love capital cycle theory discussions on this. I’m sure there are people on YouTube who just like capital sector theory. This is what I’ve been looking for.

Michael: [crosstalk] [laughter]

Jake: Yeah. Smash that like button for capital cycle theory.


Michael: Yeah, all right. I see the ones going the other way. They’re like, “No.” Nothing. Nothing.

Tobias: Should we kick it off with earnings, Mike? I think that’s interesting, and I think it’ll dovetail into my subject.

Jake: Mine, too.

Michael: Yeah, sure. Oh, okay. Perfect.

Tobias: Oh, good.

Pig In The Python Economy

Michael: The first thing I was paying attention and to no surprise, you see the banks, and they’ve got a finger on the pulse of capital markets, obviously, and then, a finger on the pulse of consumers, because they’ll have very large lending books, including credit card books. Not surprisingly, the numbers were phenomenal. Your laps are incredibly easy, but even, I think JP Morgan did a good job of talking about this.

Even if you look back to 2019, you’ve seen this. It’s almost the slowdown in COVID created this pig in the python for the consumer where it didn’t do anything for so long. Then, in the summer of 2020, we’ve now– and I’m seeing it. I’m sitting in Colorado. This is now my third vacation– and it’s not a vacation. I’m coming to visit a house. The third time I’ve been away. Usually in a summer, I go away once, maybe twice, and now, I’ve been away three times, and I’ve got a few more coming.

There’s this pig in the python that’d been created now. It’s like now everybody’s out, and everybody’s out. YOLOing is not the right word, but everybody’s going a little bit nuts. You see, chase sort of verify not only to spend, but then, they talk about the credit metrics and the health of the system, and consumer balance sheets, I think we all know, but it’s just good to hear it directly. They’re in pretty good shape.

Consumers have as much money as they’ve had, their balance sheets are as clean as they’ve been. When I think about the world, and what’s the setup, forgetting the market set up, but the setup for the US consumer, you have an amazing balance sheet. We have more jobs at higher rates than we can hire for. These are all things and the consumers out spending. They were spending on goods earlier in the year, they’ve been spending on services all summer. There’s a question about what they’re going to do in the fall. I have a view. We’ll see.

But the consumer is in great shape, and this is a consumer-driven economy. It strikes me as odd to think that with everything so accommodated, and the consumer in such good shape, and there’s so many jobs out there, and granted, that’s not for every industry. I’m thinking of the $20, $25 an hour jobs. I can’t speak to hedge fund jobs. But the jobs that I’m seeing– I’m seeing postings everywhere with good benefits, etc.

It just makes me think that, the setup is really good. Things are really, really good. There is this open question though of how is that going to play out in the fall? I would say more importantly, if you’re an investor, is how does it play out over the next five years? What do you see? Or, is this new, is this, to use a Fed word, transitory, is this a short-term, is this something that we’re just going to see a new normal? I don’t think that questions been answered yet.

Mike: The one other besides the banks, the data point that I really liked is, I’ve had this view that housing is just in the early stages of a really strong cycle. D. R. Horton’s numbers, the numbers themselves, their orders confirmed that, in fact, all the builders had pulled back going into the summer, which we knew, and they talked about that. But their projections for 2022, they’re talking about double digit volume growth.

The starts number that came in for June, it surprised everybody, which was 1.64 million housing starts. If you start thinking about, and D. R. Horton’s a little bit unique, because they do have a pretty good lot inventory. But if you start thinking about like, wow, if you could really get double digit volume growth, and we’re starting on one-sixth base, you really could have some good years in housing ahead.

I’m following that, and then of course, this week, we’re going to hear from wood products, guys, and it’s going to stretch– When we get into August into the consumer guys will hear from [unintelligible 00:08:14] and we’ll hear from some of the building products like Home Depot and Lowe’s will start to report, and so we’ll get that look.

But it’s real interesting. So far, everything you’re reading in the macro is yes, we did see that big transition from goods to services, and also, the expectation is that, when kids go back to school, which is a question mark, by the way, with delta, how that’s going to play out. But with what we know now, when kids go back to school, what are they going to spend on, and my guess is, it’s going to go back to goods from services, but we’ll see. We’ll see. So far, all the earnings I’ve seen, there’s been some misses out there, but in general, it has been pretty good. I haven’t seen a single thing from anybody, Fastenal, anybody reported anything where I was like, “Oh. that’s–” Everybody seems to be saying things are good. So, we’ll see. That’s my innings update.

Tobias: Let’s talk about lumber, because that’s something that you’re following really closely, and that’s one of the things– [crosstalk]

Michael: The most fatigued topic on Twitter right now is lumber, but I’m happy to go into it. I didn’t bring it up. I want to be very clear. I didn’t no– [crosstalk]

Tobias: You didn’t.

Michael: Yeah.

Tobias: That’s right. I’m interested for my own purpose. It had that exponential ramp, and then, it’s fallen away. I think that seems to add some ammunition to the folks who say, this is transitory, which is that’s exactly what you’d expect to see.

Michael: Yeah.

Tobias: You have this– As the system’s getting started again, the supply, demand issues are going to work their way through, and you’re going to have these weird moves in prices, and now we’re back roughly to where we were before this all kicked off. So, how do you handicap where we’re going from here, and it doesn’t have to be lumber specifically, but that chart exists in a lot of other [crosstalk]?

Michael: Yeah, everybody uses it. I’m not sure it’s the right thing to use, if you’re just looking at the broader picture, but for getting that to your point. Everybody looks at it, and points to it. Two thoughts. Number one is you will not be surprised to learn that I spend really an absurd amount of my week thinking about and talking about the lumber market. My wife– [crosstalk]

Tobias: The technicals aren’t right.

Michael: Yeah.

Tobias: You looking at the levels, cup and saucer. [chuckles]

Michael: You know what? Yeah, not the technicals. I’m not looking at the chart, but so, I did Brewster’s pod, and we were talking about Formula One, and I was like, “I just love the sport,” and my wife is like, “You went in 2016 never even really understanding what Formula One was.” To investing in 2017, and by 2018, she’s like, “I consider you to be somewhat of an expert on the topic.” I’m like, “That’s how my brain works.”

Jake: Somewhat.

Michael: I deep dive. Yeah. [laughs]

Jake: [laughs]

The Real Cause Of The Lumber Spike

Michael: Oh, don’t tell her. She thinks I’m an expert, I’m leaving it right at that. I do a deep dive in it, and that’s where I am in lumber. I’m happy to go through it. But the nuance, what you’re describing that happened which we all saw and got discussed by no fewer than me of the spike in lumber, it was something that has never happened in history. In the history of recorded lumber prices, you’ve never seen anything like that.

I happened to be involved in something that was doing lumber at the time, but when I saw that, I was like, “Wait a minute, this is different. This is not something that–” In my mind when I see that, I’m like, “I want to explain what what’s driving that?” In some cases, there are things that are non-usable commodities. I’m going to jump out and say something like bitcoin, which I know I’m going to get shit on, sorry for saying this, but– [crosstalk]

Tobias: Oh, gold. You can gold.

Jake: Yeah.

Michael: Yeah, gold.

Tobias: Non-consumable commodities.

Michael: Right. It doesn’t have a use. You look at it, and you can say jewelry, but that’s a small, it’s tiny, and you could say there’s industrial uses for gold, but it’s tiny. Really, people look at as a store of value. You can see these speculative price spikes, and you do see them all throughout history. It’s pretty common. It’s not common in lumber. The reason it hadn’t been common in lumber is because the old line of thinking for 30 years is that the mills can always produce whatever the demand is for lumber. The second the prices start to rise, the mills crank it out, and then, it just brings the price back down.

Tobias: You’ve also got the demand side too where people, they are not going to spend-

Jake: Cent or two.

Tobias: -too much on their house. Yeah. [crosstalk]

Michael: Yeah, correct. That is the line is that high prices cure high prices. As people see the price of lumber go up that they’re sensitized to that and they say, “Okay, I’m not going to be able to pay the extra $10,000 or $20,000 that’s going to cost my home. I’m just going to wait.” Sure enough, the price goes back down. My view or my bullish stance on lumber had been driven by watching that spike, and then, studying the differences between the current supply dynamic and the current demand dynamic. I’ve taken the view that the problem was not the supply issue. The problem was the demand issue, and the demand ramped very quickly.

In supply, and this probably won’t surprise you, but since 2005, since the housing crisis, that’s when supply peaked in mills. It’s also when housing peaked. So, it makes a lot of sense when new homes get built, you need more mills and you need more lumber. You saw that new homes are peaking, and mill capacity was peaking, and then what happens, the housing crisis and the crash, and then mills capacity just tanks, and then slowly recovers with housing.

But you see something really interesting. You can get this from West Fraser and again, I always say this, I just want to be very clear. If you let me talk, this will be an hour of me just droning on about this–

Tobias: That would be ideal.

Michael: [laughs] The West Fraser put out a really interesting chart in May, and they were showing how the capacity had been keeping up with housing, which had been a very slow recovery, which we all know. But what’s interesting is in 2016, capacities topped out and then started to decline. You saw this and you say, “Well, why?” and there’s very specific issues happening in Canada. There was pine beetle issue, there’s a fire issue, but really, it was the Government of Canada saying, “We’re just not going to let you cut more trees.”

That’s just it. I could go into how would this problem gets better, how the problem gets worse. But regardless, they’re just not going to let you cut as many trees as they used to let you cut. So, if you want to get trees like far out areas that cost more you can do that. But if you want these trees around here, for us, we want to grow our forests back, we want to be sustainable.

You saw the supply. The supply coming offline has all been happening in Canada. In the US, we’ve been growing supply in the southeast. What I saw is, I saw supply coming down and it crossed where supply had come down and demand from new home construction repair and remodel had crossed this threshold. What initially happened when lumber started ramping is everybody like this– Shoutout to [unintelligible 00:14:26], he’s awesome. Everybody was like, “The old peak was 700. This is going to pass.” Everybody’s like, “I’m just going to defer lumber.”

But what happened was, it spiked in the late summer, and it went above 700. It came right back down to 500, 600, and then, it just started this relentless March that just in May, totally peaked out on the May contract, I think at 1500. At one point, it might have been 1700. What happened was everybody was deferring and waiting, and deferring and waiting. However, all the suppliers and the builders had committed to building regardless of the price. They had already stretched themselves, said “We’re going to do it regardless of the price.”

What’s happening was, the mills were just cranking out lumber, but they couldn’t crank out enough to meet the builder demand. Finally, there was this capitulation that happened, and you saw it in the really early summer, where the builders and suppliers were just like, “I have to have it. I have to deliver lumber to you,” and they found themselves short on lumber, they’ve been waiting.

Really, it’s a long-winded way of saying the problem was there was too much demand and not enough supply to meet the demand. My personal view is that, that dynamic hasn’t changed. I don’t know if it’s going to get worse, but it hasn’t changed. What has changed is that, the US consumer is going on vacation. All in the spring, when Home Depot and Lowe’s were seeing this move, and they’d been working off their repairing remodel assumptions from last fall and early spring, which were huge.

The DIY guys were like me, I was out building bookshelves all the time, putting on additions, and that had taken a lot of lumber out of the system. They bought all the lumber they could. They filled up their shelves, and then, when summertime came, nobody went Home Depot. Everybody went on vacation. Nobody’s out. The pro-business is still in very good shape, but the DIY business basically went to nothing.

When lumber rolled over initially, the belief was that it was going to be the building suppliers, the builders were sources of the world that were going to step in, and they were going to set the floor. They did step in and they set a price. The problem was that Home Depot and Lowe’s haven’t come back. The question to ask yourself is, and now, we know– I said it on a podcast at Value: After Hours, I think earlier, the magic number for new housing starts is north of $1.5 million. Really, if you get north of $1.6, the supply can meet that level of demand. But right now, we’re seeing $1.65. If we sustain that, we can’t do it. Then, you have D. R. Horton– Well, that’s a misstatement. We can do it. We just can’t do it on cheap supply. We can do it on more expensive supply, but we can’t do it on cheap supply.

We’re seeing that number be at $1.6 and D. R. Horton’s out seeing that number and saying, “We’re going to grow double digits next year.” Well, if D. R. Horton’s growing double digits, I guarantee they’re the biggest homebuilder, everybody else is growing, too. There’s a double digits, I don’t know. But it looks like the builders are finding a way to make $1.6 plus the floor. The question is, the builders now, they are the demand, they are what’s setting the floor in lumber– Well, the marginal cost in British Columbia is setting the floor number, but they’re setting the demand side. What you need is the repair and remodeled step back up. That’s an open question of whether that will happen. I have a–

Jake: Two things like-

Michael: Yeah, sure.

Jake: -one, I need you to tell me when it would be a good time to finally replace my fence that’s falling over in the backyard-


Jake: -as far as lumber prices go, and then–

Tobias: You’ve got to build it out of brick, JT.

Jake: Oh, yeah.

Tobias: [unintelligible 00:17:44] with the three little pigs.

Jake: [laughs] Yeah, good point. Two, I was reminded of– it might have been Terry Smith, who said this, although I might be misattributing it, but he said something like, “Never buy a company that sells anything made out of metal,” because people can always defer the purchase.

Michael: The purchase, yeah.

Jake: If it’s made out of metal, it’s going to last at least until they want to buy it on their terms.

The Weird Dynamic Inside The Home Centre

Michael: Yep. Number one, the weird dynamic inside the Home Center right now, and I haven’t checked it this week, because I’ve been gone, but I checked a week ago. Inside the Home Center, the weird dynamic is, we see lumber prices rolling, but the home centers are still pricing to what they paid. From their perspective, they’re like, “This is what I paid. I take my margin.” Boom. Whatever they paid for their last order, they take their margin and that’s what they sell it for. As Jake, he said, “Mike, when do I go buy lumber?”

I’d say well, “If you could get it at the current spot, which is floating around 600, I would tell you good–” That for me, that would be my purchase level. The problem is, I think when you go to Home Depot right now, you’re still working through $1200 lumber, $1100 lumber. Those prices, they don’t think flowing through, and once that gets through the system, then you’ll have the reverse. You’ll have a period where they’re pricing based on their– They’re not really buying it right now. That’s actually the problem. But when they step back up whatever they pay, you’ll be paying that price. It’s a long-winded way of saying like, now, if you could get it somewhere around spotted tell you like that’s amazing. But if the problem is the homeowners just don’t have it for that price and they’re not. Their belief is at least– [crosstalk]

Jake: Away, rather than take a lot.

Michael: Yeah, because that– If you look at Joint Center for Housing Studies, a Harvard-based thinktank that tries to model out and project what they think the repair and remodel spend will be in the United States. It’s there’s not really complicated math. That’s why I can do it, because it’s really simple. They’re telling you repair remodel spend is going to go like this. That’s bottomed out in 2020. It’s going to go like this. What do you think the highest correlation is to repair and remodel spend? Its equity in your home. It’s your home value. What have home values done? That chart, everybody knows. Home values are doing this because there’s a lot of demand and not enough supply.

Jake: Cash out refinancing.

Michael: Yeah, and by the way, you can do that really cheaply. I’m not advocating for it, but if you wanted to, and get out there and buy some lumber from Home Depot, I’m not going to complain.

Jake: [laughs]

Michael: It correlates to home values and home equity, and so that the expectation is to spend a lot more plus the housing stock is pretty old. We haven’t done a lot of demo, and housing has been a dead place to be for 10 years. Housing is aging, and then, housing values are going up, and that tends to drive demand for apparent remodel. My guess is that picks back up. We’ll see.

On the metal comment, my underpin on this whole thing is housing. It’s US housing. The bet I’m making, and we’re going to find out if I’m right, the bet I’m making is that a 30-year-old, some– the average millennials, I believe, 30 or 31 right now, they’re now getting into your household formation children peak spend. My guess is, they are not going to defer that if the price of lumber is $800 versus $500. The one area where I could be dead wrong on this is, if you saw rates spiked to the point where it becomes massively unaffordable. Right now, rates are very accommodative. If you have a $20,000 bump in the cost of your home, you spread that out on a lower conforming 30, you’re going for now two and a half to six, if you spread that up– [crosstalk]

Jake: I do think that there’s a lot of probably millennials, they’ll check the spot lumber or the price of lumber before they decide whether to pull the goalie or not.

Michael: [laughs] That is not my family situation.

Jake: Okay.

Michael: But anybody else has that, I say good partner choice. If your partner says, “You know what? I realize that I’m 35, and I really need to start this before I turn 36 for health reasons. But I saw that lumber is up to $1000, and it just don’t feel comfortable making that commitment right now. So, we’ll just defer the family purchase.” I think it’s a different dynamic. That’s the bet that I’m making, is if it’s a car, and you’re already getting to work, yeah, do you really have to go buy the new car? If you’re having children, and you got married, and you’re forming a house, can you defer the house like, probably, I just don’t think it’s as easy as saying like, “I’m just not going to do it.” I think people are going to do it.

Best Environment For Housing Ever

Mike: What you see on the demand side, this puts a lot of wind in my sails with this. When you see on demand side, you talk to D. R. Horton. D. R. Horton says, “This is the best environment–” They’ve got a CEO who’s been doing this for decades. Best environment for housing I’ve ever seen, in his entire history of housing, he’s never had a situation where that when somebody showed up with cash to buy a house, he had to tell them he had nothing for sale. He said not only is that unusual and makes me sick to my stomach, when I tell them, I will call them in 30 to 45 days when I release a house, and if they want it, they can have it.

He said, when I call them, they still want the house. He said, now, normally, if you ever did that, they would have bought another house. He said, right now, they’re still taking the house. He said it’s unbelievable what the demand is. People talk about the lumber price, but I’m like, if you actually go look at the home buyer, they don’t care. They just want the home. As long as they can afford the home rates stay accommodative, then the lumber price, I don’t think is going to end up mattering that much. Also, you hear the anecdotes that like, “Man, lumber is getting cheaper. We’re starting to see people buy the discounted tip.” I’m like, “Okay, but lumber’s still like 75% above where it was for the last 10 years, and now that’s considered cheap,” and my guess– [crosstalk]

Jake: Yeah, anchoring bias.

Michael: Yeah, exactly. It is cheap versus the $1500 but you’re still down like 20% from the absolute peak prior to what we just saw. In my mind, basically where my head shakes out on this is that the demand side is going to be strong. it’s going to stay strong, and the supply won’t be able to catch up, and so the margin of cost of production is going to shift, and the margin of production has been within a few miles of my mill, getting a log. Now, the marginal cost of production is either going to come from very expensive logs in BC which are way away from the mill, and the shipping cost, again, with a mill, or it’s going to come from Finland, and either one of those means that the mills that are here, and have access to supply and can run are likely to make more money in the next 5 years than they made in the last 10. That’s the bet. So, sorry for the rant.

Lumber Price Volatility

Tobias: Is the price run a little bit artificial, because Canada has stopped a great deal of the logging? Is that what’s driving it?

Michael: Yeah, so, there’s two drivers. Canfor, what you’re referencing, Canfor actually announced, I think this was a week ago or maybe a week and a half ago, Canfor announced that they’re curtailing production in British Columbia. The belief is that that’s related to fires. Fires are causing all kinds of logistical problems. That to me resonates. What I’m talking about, what I’m looking for is, I’m looking for Home Depot and Lowe’s to come back and start buying. That’s what I’m waiting for when I think the price will really have found its bottom and start going up again, the builders are carrying their weight on this, it’s really the home centers. In my mind, what people are–

This is my speculation. The reason why people started buying the futures on Canfor closing is, you can craft a scenario in your mind. Futures is delivery in September and delivery in November. It’s not delivery in July, and it’s not delivery in August. You can craft a scenario in your mind where all of a sudden Labor Day happens, kids go back to school, and the guys who are DIY are like, that project that I put off to build a table outside or to put up Jake’s fence, the deck, all those projects, now, they are front and center. You go back to Home Depot, you buy what they have, then, Home Depot puts their order in.

The problem is, we’ve already sold to the builders, and we sold more than we thought we could, and by the way, Canfor shut their mills down, because of fires. So, you could see a scenario where we’re now short lumber again, because we already work questioning supply and we took supply offline. Now, you can ramp that back up. You just can’t do it quick. What I think is happening in futures is it’s not being driven by demand from the home centers, I think it’s being driven by speculation that the home centers will show back up. They don’t buy until they need it. They wait until they need it, and then, they show up at the mills, and they say we want it. They’re not– at least, I don’t think in mass playing the futures. I think people are just speculating that they will show back up. I personally don’t think that’s a crazy speculation, but I’m not making that speculation.

My strong bet is, it could happen after Labor Day, it could happen in the fall, it could happen next spring, just strong view is that repair and remodel over the next five years is going to be a lot higher than it was over the last five, and it’s the same on new homes.

Frankly, the volatility in lumber prices, in my opinion basically guarantees you’re not going to see supply coming in new mass. It’s like who wants to take the risk that that’s wrong. If you build a couple $100 million mill and it doesn’t work out, then you’ve got a real problem. So, we’ll see.

David Einhorn’s Q2 2021 Letter

Tobias: It’s interesting just to consider it in the context of Einhorn’s note which came out very recently, because he has his– Lumber maybe a special case, but his argument, and he is not talking necessarily about lumber here. But he was talking about capital-starved industries, and he’s put on a number of these positions. I just wanted to read the line. I’ve got the paraphrased line from before, but I thought this was a pretty good one. Everybody knows that Einhorn’s got a little bit of a bias to an Austrian economics view of the world, and maybe a capital cycle theory, which I did too, but I just wanted to– [crosstalk]

Jake: [crosstalk] we’re going wrong, I get it. [laughs]

Tobias: That’s right. The enormous emphasis on investing in often money-losing businesses in disruptive areas like technology has left traditional industries starved for growth capital. The result is they haven’t grown capacity, and now they cannot meet demand. The more these value stocks are starved of capital, the higher the prices are likely to go and the longer the inflation is likely to last. JT, what do you think about that? That’s a little bit more in your wheelhouse.

Jake: Well, I think it’s hard to deny.

Tobias: Self-evident?

Jake: Yeah. This is the beauty of capitalism is that when industries that are starved for capital are able to raise prices, they create profits that allow them to build more of whatever we need, and we find our way to having the right amount of supply typically when prices are allowed to find– I don’t want to say equilibrium, because I don’t think you’re ever in equilibrium. I think you’re just moving around and through equilibrium.

Likewise, things that get overinvested in, we get over capacity, and those that have a way of also eventually getting less capital into them, and brings that part of the system back in line with the demand. It’s a beautiful thing to imagine that all of the little wants and needs inside of my head, inside of your head, get expressed into the real world with actual code and atoms arranged in a certain way to create all these things that we want. So, all of our consumer preferences get expressed as assets around the world to give us what we want. So, it’s an amazing thing to imagine that’s actually how it works.

McDonald’s Daily Miracle

Michael: This is on topic, but off topic with your cycle theory or the theory that Einhorn put out. I went to a McDonald’s analyst eight years ago. I think it was 2007. The CEO of McDonald’s came out, and he described it as his little miracle– [crosstalk]

Jake: Ronald McDonald?

Michael: No, although, that would have been awesome. I would have appreciated that. He described it as a daily miracle that for all their hundreds of thousands of locations that they were able to deliver as many meals, just think logistics behind that getting all these meals to all the McDonald’s, they call it like the daily miracle. Hearing you talk about capitalism, capitalism just astounds me. It humbles. It’s the most efficient system for delivering the most amount of goods to the most amount of people as efficiently as possible. There’s so far nothing better.

Tobias: [unintelligible [00:29:53] did a pretty good job, didn’t it?

Jake: No comment.

Tobias: No, I don’t think– [laughs]

Michael: [laughs]

Tobias: Did you know that Einhorn had a discussion on lumber in his letter?

Michael: Oh, no, please tell me.

Tobias: Also, his view is similar to yours, but that’s not where– they’re not focusing their investments so much in lumber, but the areas that they’ve looked at I thought were interesting. They’re things that literally have been starving or things that have been starved of capital. They’re air freight, copper, titanium dioxide, cement, thermal coal, and natural gas, paperboard. Although they do have a discussion at lumber at the start, but he made the point that high prices were the cure for high prices there. Do you know any of those other commodities at all?

Michael: I’m not an expert on the commodity space at all. I’ve been totally immersed in what’s going on in lumber, but I’m not an expert on the other commodities. I would say, on cement, I’m a little bit surprised, because the aggregates business has been such a good business for a long period of time. I realized those are two separate things. But aggregates have just been, man, if you could own an asset, and own it forever, having a monopoly on sand and gravel in a growing region, think Austin, Texas, is one of the best possible businesses. You have a heck of an initial capital outlay. But once you put it in there, you really can’t be beat. It’s a little bit off topic, but cement surprised me in that discussion. But the rest, it makes sense.

I can tell you for the mills, mills have not been putting capital into mills. The returns are terrible. Every time they get capital out, the only capital going into mills going in the southeast. It’s the most efficient way to make lumber is with Southern Yellow Pine. These mills are being run for cash. That’s how it’s been run. Again, you see it, I think maybe that’s what he’s talking about. As you see it, when you see demand spike, the systems aren’t efficient enough. They have been underinvested, not universally, but in most cases to be able to adjust to pretty dramatic changes in demand. It’s an interesting theory. Oh, [unintelligible [00:32:03], Toby.

Tobias: Oh, sorry, am I back?

Michael: We lost you. [crosstalk]

Tobias: My internet connection is unstable. What’s that good– [crosstalk]

Michael: It’s not just the internet connection by the way.

Tobias: [laughs] It’s the host too.

Michael: [laughs]

Construct A Mill Or Grow A Forest

Tobias: What’s takes longer? Is it harder to construct a mill, or is it harder to grow a pine forest? Longer rather than harder?

Michael: With lumber, everything depends. It’s very different in the southeastern United States. It can take me 20 years I believe in there. But the problem is they grow tall, and narrow, and they’re really knotty, and the rings are really tight, which means they’re not really usable in a lot of dimensional– [crosstalk]

Tobias: [unintelligible 00:32:42], JT? [laughs]

Jake: Yeah.

Michael: Sorry. You think about capital, you’re trying to build new mills, but there’s also capital to improve processes at existing mills, and it’s the same for copper. In all of these industries and commodity industries, you can invest in building new capacity, but you could also invest in improving the efficiency of existing capacity. When I invested in Eastman Chemical, they would talk a lot about that as our production, we can take our existing production capacity, and we can grow it organically by investing capital in business.

Of course, you only do that when you think you’re going to have a good return on that capital. But that’s stuff that a lot of commodity business when commodities have been in the tank for 10 years, it’s a lot of stuff that they just wouldn’t invest in. If the theory makes sense, then it also means that, if they need that investment– It’s one of my favorite–

Somebody shamed me months ago, because I attributed a quote to Buffett, and he said, definitively, it was not Buffett, and he got very offended, and called me a Buffett fanboy, which I am. One of my favorite Buffett quotes, and it leads to one of my favorite investment theses is that, “You can’t have a baby in one month by getting nine women pregnant.” There’s some things that just take time. If you’re going to build out an overbuilt fiber network, it’s just going to take you a long time. There’s nothing you can do. You can’t snap your fingers. Google tried. You can’t snap your fingers and just have a dense fiber network. With this capital, you have been starving a business for capital for 10 years, you can’t just say, “Okay, now, here’s the billion dollars. I starved you, and now all of a sudden, everything works well.” It’s like, you see what happens when you chase money after something really, really quickly, it’s incredibly inefficient.

Jake: Who said that if it wasn’t Buffett?

Michael: Somebody told me, man.

Tobias: Buffett said that, surely? [crosstalk] Buffet said that.

Jake: Voltaire? [laughs]

Michael: No. Toby, Buffett definitely said it, but the guy took offense [crosstalk].

Tobias: Oh, was it originally–?

Michael: Yeah. I didn’t attribute it to somebody else, and Buffett’s known for his plagiarism. He steals his quotes from people and doesn’t– I’m sorry. I didn’t know that.

Jake: [crosstalk] joke about it. They said, if we had to stop and say who we actually were stealing that from, we’d never get through a meeting.

Michael: It’s funny. I quote Jake Taylor all the time and steal it for my own. That’s my jam.

Tobias: Michael Scott.

Jake: [unintelligible [00:34:53]

Michael: [laughs]

Jake: Yeah.

Michael: Wayne Gretzky, Michael Scott.


Tobias: JT, do you want to have a swing with yours?

Jake: I do. I’m going to change my background real quick for this segment.

Tobias: [laughs]

U.S Investors Expect 17.5% Returns

Jake: I’m calling this, “What are we thinking?” This came to my attention, there was a global survey of individual investors put on by this company called Natixis, I think it is. I don’t know. Not sure exactly how they say that. They surveyed 8,550 investors in 24 countries, and it turns out that US investors expect 17.5% returns from their equities for the long term, and converse that with professionals who are telling them that they should expect something more like 6.7%. We have a huge mismatch in professionals versus retail investors.

Now, I wanted to just walk through a little bit of math that I did back of the envelope of what would it take to make that 17.5% return per year materialized over 10-year period, which we’ll call the long-term? When I did the numbers, the price of the S&P 500 was $4,411. Let’s start there. Earnings per share were $131.5, which by the way are lower than December 2019’s peak earnings of $147.5. We’re already on the other side of maybe of earnings potentially growing, but forget about that. And profit margins at 12.6% right now, which is about double the long run average. But never mind all that as well.

The last 10 years, that EPS has been growing at a 2.3% CAGR. I’m going to take the last 10 years’ worth of growth, and assume that that’s going to be the same for the next 10 years, which gives you about a 25% total improvement in earnings over the next 10 years. That would put earnings per share at about 165 in the year 2031. Well, if we are going to have the price go up at a 17.5% clip, which is what the expectation is, then we would need the price then of the S&P to go from $4,411 to $22,126. It’s a 5x. You get 5x on 17 and a half for 10 years.

Michael: First of all, that seems totally reasonable, number one.

Tobias: [laughs]

Michael: Second of all, you’re a Debbie Downer for even bringing that up. [crosstalk] good question about that makes sense or not.

Jake: So, you’re telling me there’s a chance.

Michael: There’s a chance.

Jake: If assuming that, what does that then mean? That would mean the PE of the S&P 500 at 34 today would have to go to 134 in 2031. I will let you debate as to whether you think 134 is a reasonable amount to pay, but I– [crosstalk]

Tobias: [crosstalk] 10-year. Just tell me where is the 10 year is?

Michael: Negative 15.

Jake: Negative 25.

Michael: [laughs]

Jake: I tackle this another way, too. Let’s say that earnings you think are– Let’s forget about earnings. Let’s look at sales. Over the last 10 years, sales of the S&P 500 have grown at a 2.9% clip, so that would give you a total of 33% growth over the next 10 years. If we project that forward, sales then would turn out to be 1,855 in 2031, and that same price that we’re using, that means price to sales would have to go from the today’s current of 3.1, which is already very, very high if you look at a price to sales chart, but it has to go to 11.9.

Scott McNealy: What Were You Thinking

Jake: This reminds me a little bit of Scott McNealy’s, what were you thinking that he did about Sun Microsystems shareholders, when he told them, when it was trading at 10 times price to sales, and this is assuming we’re going to get to 11.9. But when it’s trading at 10 times, that’s basically saying that, I’m going to have to give you 100% of revenue is going out the door to you as a dividend, which means that, I have no cost of goods sold, which is not very reasonable. It means I’m not paying any taxes as a corporation, which is illegal.

It means I don’t pay any employees, which it’s hard to imagine how I’m going to deliver on that. It means there’s no R&D for the future to keep maintaining this business. All of which, it all has to go out the door for 10 straight years to you, if you’re going to get your money’s back on a 10-time price to sales. By the way, Sun went from $5 a share up to $64 roughly, and then back down to $5 again.

Here’s another way of looking at it. Let’s say that we got out to 2031, and we assume that the PE had gone back to a more normal 15x, which we can have debates about whether that’s a new normal, we’ve been higher than that. But anyway, we would have to have earnings grow. I’m just doing the math in a different way, kind of backwards, but earnings would have to grow at a 27% clip from today until 2031.

By the way, they’ve grown at a 2% clip, but they’d have to grow at a 27% clip to get to that same earnings number that would justify a 15 PE. In the last 32 years, earnings have grown five times at a 27.4 or greater amount, and those were typically off of a really low base, like 2008. The year before that it was down way more, and then, you get a big up year on a return to normal. Zero times in the last 10 years has it grown at a 27.4% clip. But we’re going to do that for 10 straight years back-to-back-to-back-to-back-to-back. What are we thinking?

Michael: I’m not part of the 17% camp. I don’t know what those people are. Can you imagine the source– people already talked about wealth disparity for those that have a lot of capital assets versus those that don’t, can you imagine what it would look like 10 years from now, if those that own stocks were up 17% compound- [crosstalk]

Tobias: Guillotines.

Michael: -people who didn’t? That just blows my mind. Jake, while we’re talking about this, you can go do the math. I know you’re able to do that quickly, but no, I’m just kidding. Don’t do the math.

Tobias: How much lumber is there in a guillotine? I think that’s the question. How expensive– [crosstalk]

Michael: It’ll always comes back to lumber.

Jake: Full circle.

Realistic Returns

Michael: It always did. No. What would you say, Jake, if your mother, brother, or someone called you who are unsophisticated, they said, “Look, I want to get involved in the market now, and I know you guys are not really market timers.” What would you say, what expectation would you give them in terms of return for five years, 10 years, longer term? What would you tell them to expect if they invested $10,000 right now?

Jake: Stay south of modest.

Michael: Would you think it would be positive? That’s my first question.

Tobias: I do. Not in the investment, but total return. I think it’s positive to the tune of about 1.4% at the moment.

Jake: That’s an exact number there, Toby. Yeah. I’ll say 2% for a 10 year, and that’s mostly going to be dividends. Otherwise, my variance on that is high, and it’s to the downside.

Michael: Yeah. [crosstalk] bullish. That’s what I’m hearing [crosstalk]

Tobias: I look at it regularly, because I always say this. I don’t know whether this assumption is reasonable or not, but this is the assumption that I make that over about a decade, you normalize. You go back to what the long-run average has been for the Shiller PE. I don’t like the single-year measures, because they’re very, very noisy. You can go and have a look at what the single year PE did in 2009, one of the best buying opportunities ever, and it said it was a-

Jake: Off the charts PE.

Tobias: -infinitely expensive.

Jake: Yeah.

Tobias: The single year is a terrible measure, because it looks expensive when it should be cheap, and the other way around. The Shiller PE is a better measure, because it takes the cycle of the underlying earnings out. Everybody who’s had a look at that recently has just been– I am astonished at how expensive the Shiller PE is at the moment. I think it was 38.5 last time I looked. It’s heading towards 39. Peak that we’ve seen the US is 44. The 1929 peak was a little bit south of where we are now. We’re in very rarefied air. We’re in the last 9 to 12 months, I think, of the 2000 ramp where it ran rapidly up to about 44, and then, it collapsed pretty quickly thereafter.

If you assume that you get mean reversion over a decade, then that might not be reasonable, it might be two decades, it might be one year. I don’t know how long it’s going to take, but over a period of time, then, you get on the index, you get a negative number, it’s negative to the tune of about .8% and the positive numbers, all dividends, and so, you get 1.4% so I think dividend– Maybe it’s under 1 right now. Maybe it’s 0.8% positive and that includes 1.4% in dividends, which has a negative index of about 0.5%. That’s where I am.

Michael: That makes sense.

Jake: Cheery.

Michael: Yeah, very.

Jake: That’s a little bit below 17.5, Toby.

Michael: It’s a little bit. Just a little outside. I think about this actually a lot. I’ve seen some polls on Twitter run about it. I think about what the right expectations should be. Of course, the answer is that should be low, because then, everybody’s happy, if you deliver something better than a very low return that you set them up with going in. So, expectations should always be low. But I wonder, what should it be? If you told me the over under was 5, I would really struggle to take the over on that one. I really, I want to because I’m very optimistic, but I struggle to take you over just based on the valuation setup.

But then, I also, step back and I wonder like, “How could that be wrong? What would it take?” I realized Jake got into that a little bit of 27% earnings growth, but not to hit the 17%. Because if you told me right now, it actually is going to end up being 10. It’s going to be in a big 10. 10 for me, I’m like, “That’s amazing.” I don’t want to hold cash. If it’s 10, and you tell me inflation is not going to also be 10, and frankly, even if it is, I don’t know that I have another choice, because I don’t want to lose 10% of my earnings power over there. If you told me it was going to be 10, I probably would say like, “That’s terrific.

I need to be involved.” I just wonder, what would have to happen with? We have to see GDP growth finally get north of 4 or 5. Maybe an uptick in inflation, where you actually can really see some businesses that haven’t been able to earn what historically they’ve been able to earn, actually pick it up. Is that where it’s going to come from? I don’t have an answer. It’s this wild dynamic where I’m incredibly bullish. But then, you look at the world, and you see where people’s expectations are versus where you think reality is and you’re like, “That’s really bearish.” [laughs] That’s really not a good– That has happened in history at very bad times to be involved in the market.

Tobias: It’s a good setup, but the market has already discounted a good setup.

Michael: Yeah. I think what we’re deciding is potentially the market is starting to overdiscount a very good setup. I guess, we’re just saying, there isn’t a solution for this other than for the market either sit in the setup to continue to be good or the market to pull back. I don’t know.

Tobias: The assumptions in that little market level, valuation thing that I was talking about that comes from that’s John Hussman’s method. I just use a different– I use the Standard and Poor’s 500. I forget what the precursor was. It runs a long way back. It goes back to about 1,850 that data and you can look at the underlying growth. I think the market has averaged about nine and a half percent over that four period. That’s a reasonable valuation-agnostic assumption for the market is probably 9.5%. But then– [crosstalk]

Jake: That feels high to me.

Michael: Feels high.

Tobias: Well, to be fair, that’s probably influenced by the ending point. That may be overestimating where it has got to and so you need to adjust that down. That’s true, also for the Shiller PE long-run mean about 16. That’s probably higher now than it has been in the past, because we’ve spent so long trading above it. It might go back to 15, or something, if you look back far enough.

Jake: That’s going to hurt.

Michael: Yeah.

Tobias: That’s going to stink.

Michael: That’s going to stink. I can tell you this. I would be willing to put a lot of money– That 17.1%, Jake, is not the right number for the next 10 years. I would put a lot of money against that. I don’t know what the right number is, but I put a lot of money against that expectation. Even if you were to give me that expectation at the trough of 2009, and tell me what’s about to happen, I probably would have told you that’s a very aggressive expectation like 18-ish percent is an awful lot.

Tobias: But this is one of the problems of the Shiller PE at the trough of 2009, it only got back roughly to about its long run average, which it would have told you about 9.5% then, and so, it’s clearly exceeded that. But that’s because you’re not following the fundamentals. You follow the price. That’s why, if you look back over– I can use Hussman’s method to look at the forward the expected return, and what the market actually delivered over the subsequent 10 years, it’s a remarkably good fit to assume that you get this mean reversion over about a decade. But there are these periods of time that stand out very materially where the market price delivers far more than the expectation than the model expected. It’s always notorious peaks and troughs when–

Jake: When [crosstalk] just connected.

Tobias: Yeah.

Michael: With that in mind, how do you respond to that? Again, not asking you how you’re doing your individual portfolios, but if grandma comes to you and says, “Here’s $10,000. I want to invest.” What do you do? You hold them in cash, and say, the returns are going to be terrible. Let’s wait for a better entry. Do you try to stagger it and say, “I’m going to buy you every month for two years, and I’m just going to put the 10,000 to work over time?

Tobias: You almost always underperform when you stagger like that but that’s because most of the time the market goes up. I guess it depends a little bit. It’s personal. Depending on your regret minimization. For me personally, I think that you can identify stocks in the market that will deliver returns that are higher than those, because you can undertake evaluation. That sounds crazy, right?

Michael: Sounds wrong. Sounds wrong. Just hearing it, it doesn’t sound correct.

Jake: [laughs]

Michael: Go ahead. Sorry.

Tobias: I just think you can look at like, let’s look at the cash flows from some of these businesses that are reasonably consistent over a period of time in the past, and assume that they stay reasonably consistent into the future. You can buy that stream of cash flows at a price that gives you a reasonable return based on the amount of risk that you’re taking. And then, I don’t really know what happens over that period of time to the price, but I’ve got a reasonably good guess what happens to the underlying business, and I think if that plays out, then you’re going to be okay. I don’t think you get 17.5%, but I think you can do reasonably well.

Michael: You just blew my mind. What I heard you say was treat it like a business rather than a piece of paper. Is that where you’re going with this? It’s like is that a different– [crosstalk]

Tobias: It’s going to be in my aphorism book coming out [laughs] Christmas.

Jake: Better be careful, or Buffett’s going to steal that from you.

Michael: [laughs] [crosstalk] had some breakthrough here. [crosstalk]

Investing Lessons In Berkshire Letters

Tobias: I’ve had thoughts of my own since I’ve read the first Berkshire Hathaway letter about it.

Michael: They’re so good. I know that like, I see that some stuff Charlie says, and age is what it is, and Charlie is what he is, but there’s just so many good things in there. That’s why when the guy said, you’re a Buffett fanboy, I’m like, “That is factually correct.” I’m not going out, and doing the things that he was doing, and I’m not sure I’m capable of doing it. But God, when he talks, this is like, “Man, this is great stuff.”

Tobias: It ages very well, this stuff too. You can go back to the stuff that they were talking about in the late 1990s, and that stuff holds up pretty well I think.

Michael: Are you guys aware the Overcast app that were– I forget the fund that in [unintelligible [00:51:22] that put all the meetings on as podcasts going back to 1994? Have you guys listened to this? You probably have.

Tobias: Jake’s meditates with it.

Jake: That’s true. I have this little loop on my house. That’s a little hiking trail, and I go and I take Warren and Charlie with me pretty much daily, and then, I tell my wife, “I’m going on a hike with Warren –


Michael: He just doesn’t know it.

Jake: -and [crosstalk] have fun.

Michael: There’s some good tidbits and all that. Then, there’s some other things that come out over time like, that there was that letter. I’m sure it’s been on Twitter a few times that he wrote to an executive, I believe.

Tobias: Microsoft one?

Michael: Yeah. In the investment process, I have evolved over time and shifted over time, and it hit me a few years ago, it’s probably 5 to 10 years ago now. But it hit me that the focus should be more on having an insight, something where you like it’s not really– It could be an insight into a KPI, it could be an insight into an individual, it could be an insight into a– [crosstalk]

Tobias: A differentiated insight.

Michael: Correct. If you read that, his insight on Microsoft at the time, now looking back, his idea that you are now taking a toll on AT&T wires that they’re putting out all the capital, and you’re getting all the benefit, that single insight would have gotten you involved in Google, Facebook. It would have gotten you in some losers too. I’m not saying that they all of them– [crosstalk]

Tobias: Didn’t get him into the mud.

Michael: No, he didn’t follow that insight, but had I been able to read that letter and you’re like, “My God. You’re right. You’re getting a free ride on everybody else’s.” Netflix, perfect example. Netflix gets a free ride on Charter’s rails. Charter actually had an issue with that. That was when you go back to Title II under Obama. [crosstalk]

Tobias: It’s that the net neutrality?

Netflix & Facebook Get Free Rides

Michael: Yeah, that was the big issue. Netflix was a big proponent, obviously of net neutrality. Why? Because they’re the single biggest user of these rails, and Charter, and Comcast, and HSD providers are out there saying, “Look, I spent the money. I’m charging the consumer. What if we subsidize the consumer by me charging Netflix for these rails?” Of course, that’s not going to happen, but think about the business model. You could take it a step further.

Think about Facebook’s business model. You get to use somebody else’s content and somebody else’s rail. You don’t even have to come up with anything. You just have to produce a medium that somehow increases engagement, and all of a sudden, it’s like free on both sides. That was Malone’s insight on Facebook. He’s like he gets free content. I got to pay for my content. This guy’s getting content for free that everybody loves.

Jake: [crosstalk] Loves or gets angry about?

Michael: Well, yeah. Good with the bad, Jake. The good with the bad. That’s my theory of social media.

Jake: Yeah.

Tobias: Did Malone buy big chunk of Facebook?

Michael: No. Of course not. Malone had an opportunity in all of these things, obviously, and in all of these things, you’re only seeing the ones that he actually hit on Sirius XM, Charter, etc., but he was early at that party on social media, and he just never acted on it. Back long time ago, when I first got invested in Liberty, you’d hear the stories anecdotally like John would be walking through the halls, I’m like, “Well, what does he say?” Like, he’s not there. I’m curious what he says. He says, “He oscillates between Netflix being literally the best business idea he’s ever come across, or Netflix being a crazy short,” and he couldn’t figure out which one does it.

Jake: [laughs]

Michael: It just depends on the days. Reed just created the best business I’ve ever seen or Reed totally going out of business. This stock is a short. Luckily– [crosstalk]

Tobias: What’s the short argument?

Michael: I think at the time the short argument was that, Reed was going to require so much capital, and there was so much risk in the transition to basically becoming your own studio. This is going back when they had license from Starz, and John’s initial view was that Starz made Netflix the platform that it is, because it allowed them their early days very cheaply getting new subscribers by using Starz library, for, I think, it was like $35 million a year. By the way, I love you, John but that’s definitely John’s fault, he never should have done that. That was a huge mistake. You never should have given that library to Netflix so cheaply.

The idea was that they were able to get some scale to the point that they could actually go out and get some capital to then create their own studio. But the risk was, if you lost Starz, and you weren’t able to create a studio that made sense, then you you’d lose the subscribers as well, and somebody else could jump in and take him. Then, of course, they came up with their very first successful self-made hit, which was the–

Jake: House of Cards.

Michael: House of Cards, yeah, of course. Then, Orange Is the New Black and, it was just like this very– You could say, it’s Reed being a genius in picking the right things, but it also is a big part of it’s just serendipity and luck. I don’t know that you could have known that House of Cards was going to be as good as it was before it came out.

Jake: I think that you could just answered it with one word. Kwibi.

Michael: Yeah.

Tobias: [laughs]

Michael: There you go.

Jake: That was the risk.

Michael: [laughs] Sorry.

Tobias: Well, with Facebook too–

Michael: [crosstalk]

When You’re Not Sure Buy A Basket Of Opportunities

Tobias: Because Facebook, of course, wasn’t the first social network. It was MySpace before that, and that was SixDegrees, and there were a whole lot of those, merely having a network effect didn’t deliver to you all this money, if there are other people able to build their own networks and consumers prefer those.

Michael: That was always a reason I never got involved, and that was a mistake. I think now in hindsight, we realized the answer was, MySpace went public, but $10 in the space [crosstalk] understand it. Yeah, it’s very Peter Lynchian, and Peter would say, I don’t know who’s going to win between A and B, but I know, somebody who does win is going to make a whole lot of money. In this case, I think that was the– I think history now tells us that was the right answer. It was really easy for me to say exactly what you’re saying now, which is– It was GeoCities, and then Myspace, and then it’s going to be Facebook. By the way, it was Facebook, and now, it’s being something else. But Mark figured out, why don’t I just buy the other thing?

Jake: Well, it sounds [crosstalk] they say.

Michael: Well, let’s just buy Insta.

Jake: You had to know that the regulatory antitrust was going to be like a chihuahua, and not a Doberman.

Michael: Yeah.

Tobias: Do you think they made mistake with that? It’s so small at the time. It was a $1 billion, which that seemed like a preposterous amount of money to pay for it at that time. A billion dollars for something was basically an app with not very many users, but they could see that it might get there, and so you get there early enough, but then they give it a big boost by giving it access to Facebook social graph as well.

Michael: Correct. Yeah. Their engagement algorithms, and everything that they put on it, I’m sure they made it more valuable. But I’m also sure, if you’re Facebook and you’re making so much money, I think you’re more at risk for not buying that stuff, even if it doesn’t work, because on the off chance it does work and takes your business away from you, and you’re left with nothing. I think the answer is, you just buy it, and buy them all, and then you hope that you can protect the mothership, and then grow these little ancillary assets.

Tobias: How much of a risk is TikTok?

Michael: I don’t use the TikTok.

Tobias: Yeah, neither do I, but that might be a generational thing.

The Future In Social Is Short Form Content

Michael: It very well maybe. I’d say it this way. My observation is that the future is in social media in short form content. Short form videos, [crosstalk]. Yeah, [unintelligible [00:58:18]

Tobias: I got this idea for [crosstalk]

Michael: Thank you. I’ll take a look. Send me your notes, I’ll take a look. In my imagination at 20-year-old to a 30-year-old now, the people that are going to be doing all the spending, and driving, everything in the future is, those people are getting their content in small snippets, and that’s what TikTok built for. Is there something unique about TikTok that? And now, we’re starting to get way, away from my circle of competence. But I get the idea that people say like, well, even now, you’re rather than going out and doing all these things individually, you’re smarter, and you just to go out and buy Facebook stock, because it’s cheap on current– I think it’s cheap. I think it’s like– [crosstalk]

Tobias: It’s cheapish. I think that’s right.

Jake: Yeah, 30,000 [crosstalk] or something.

Michael: It’s cheap on current numbers, and you get these little options floating around. You got Oculus. There’s so many little things that they’re involved. Any one of them might be it, and by the way, whatever trend is happening, if it’s TikTok or whatever, Mark is probably in a better position to identify that and act on it than you are, so just outsource that whole decision making to Mark. I think you actually make the same argument if you’re going to go by Google.

Tobias: Yeah.

Michael: You say like, look, they’ve got short form video content on YouTube. They’ve got that, like, lock down, and we’re on YouTube right now. Obviously, we’re users of it.

Tobias: We agree.

Michael: Yeah, we agree. They’ve got Maps, and they’ve got Local, and they’ve still got search locked down, and those guys are going to be able to spot. There’s going to be some leakage there, and some inefficiencies and some frictions, but those frictions exist today, and you’re paying for them today, and you’re still getting it somewhat of a very reasonable price, especially in the market. I sort of get that dynamic. I don’t know in any of them, but I get that people would just say, “Just buy the big ones, and then, don’t even think about it.” That was what I did with John and Cable. It’s just like, I didn’t want to think about. You know what you’re doing like, here’s my money, go figure it out.

Tobias: That’s smart, and that’s time, folks. We’re off next week, because I’m going to be on vacation taking the kids camping and fishing.

Michael: Do you get a vacation, Toby?

Tobias: Just this one time. One time. [chuckles]

Michael: All right. Just this once, because it’s vacation time for everybody.

Tobias: So, that was fun. We’ll be back in two weeks’ time. Not entirely sure what the lineup is. It could be Mike. It could be Bill. It’ll likely be Jake and I. [laughs]

Jake: [laughs]

Tobias: Could be four of us.

Michael: I will come back anytime you guys want. I love doing this. This ss a lot of fun.

Tobias: We love having you, sir.

Jake: Yeah, Thanks, Mike.

Tobias: Thanks for sharing your ideas, Mike.

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